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spk01: Greetings. Welcome to Superior Drilling Products Incorporated's second quarter fiscal year 2022 financial results. At this time, all participants are in a 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 will now turn the conference over to Craig Mihalik, Investor Relations for Superior Drilling. Thank you. You may begin.
spk11: Yeah, thank you. And welcome, everyone, to our second quarter 2022 earnings call. We certainly appreciate you joining us today. And joining me, Troy Meyer, our Chairman and Chief Executive Officer, and Chris Cashin, 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 accompany our conversation today. If you do not, both can be found on our website at sdpi.com. Turning to slide two, I'll point out that 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 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 be found on our website or at sec.gov. I want to point out also 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 relief, as well as in the slide deck. With that, please turn to slide three, and I'll turn it over to Troy to begin. Troy?
spk03: Thanks, Craig, and thanks, everybody, for joining us for our second quarter 2022 call. When we look at the second quarter, I'd like to highlight four items that we spent a good majority of our time and resources doing, and one of the things that I think first thing to highlight is the hiring and training of new talent. As you all know, as the business grows, we've got to bring on more personnel, and our management team has been doing a good job picking up talent and getting them trained. A lot of the services that we provide here take a special talent, especially working with heat. I want to tell our team good job for what they've been doing there, and we're building a good, strong team here. So the next thing I'd like to make sure that we mention today is the securing of additional opportunity with our legacy customer. That's another biggie that we'll be talking about. Securing the Amina channel partner is another bullet point I'd like us to discuss or talk about today. And then also in the second quarter, we get a lot of repair and maintenance of equipment that, as you well know, over the last few years, we haven't had the opportunity to get to that. And we've spent some resources taking care of the plant and equipment here. So I want you to all be aware of that as well. So as we look at What we've got going on in 2Q, or what we had going on in 2Q, a very, very strong demand for our services. When we look at our legacy side of the business, you know, on the refurbishment of tools, that is very strong, and it's growing every day. That demand continues to strengthen. both on the flagship tool, the drilling ring, as we see DTI keep a strong presence in the North American markets as they bring on new customers and they're doing a good job there. We also have the legacy bit refurbishment, as you know, with Baker Hughes, and they've been... keeping us very busy as they get stronger and stronger in their position in that market. You know, we see improved market conditions. As we see rig count go up, you know, of course there's more demand for our services. And I think that even though, you know, when we look at rig count, it's nowhere near where it was a few years back. However, the rigs that are there are drilling a lot of footage. So keep that in mind that the demand for tools at the current rig levels is tremendous. So be very aware that the footage being drilled per rig is very impressive. The strengthening of our balance sheet, Chris will talk about that. We continue to keep focused on that as we pay down debt and build cash, and he'll talk about that. Then we look at the working to improve capacity and demand. We've brought on additional shifts to supply both new tools that we're manufacturing in our machine shop, as well as when we look at the people that we need for that, it's a very talented operator that we're looking for that not only do they program and run the CNCs, but they're very, very talented in the design side as well. And we've been picking up some good talent there and we continue to look. You know, we have issues like everybody else does in the labor market today, you know, finding talent and getting them on board. But our team is doing a good job and they They're doing that every single day, trying to find better ways to attract some good talent. We spent a lot of time in the international side of the business. You all know that we signed on a channel partner in the MENA region, the Ben Zayed Petroleum Group, and we work with them. you know, on a weekly basis as our teams are getting to know one another and how we're going to work together to saturate the markets with the drill and ream technology and other technologies that they may need. It's been a very refreshing opportunity to deal with such a world-class organization. We're very We're very pleased with the individuals we deal with, and we think it's going to be good, sure, steady steps as we go forward. Keep in mind, we talked about the turnkey process. We purchased a new machining center. It was a million-dollar machining center that we've put into place. We now have it in place. We're making the jigs and fixtures that are going to allow us to do this turnkey process that we've talked about. Right now, today, we machine new product, but we don't finish the product. We ship it off to Houston where it's brazed and hard-faced. this new turnkey process that this machine will be addressing is going to keep those products that we machine and then keep them here so that we can also finish this product and then ship it out. We think it's going to be a great opportunity for this company and I can say that machine's in place and we're running the programs right now and we will start turning our first products off of there this month, actually. So we're excited for that. But that being said, I'm going to go ahead and turn it over to Chris to talk about the financials.
spk04: Chris? Thank you, Troy, and welcome, everyone. Let's continue our review by turning to slide four, where we will review our strengthened top line. Q2 revenue rose 34% to $4.5 million. over the prior year period and grew 10% sequentially. While we are certainly benefiting from the continued improvement in the oil and gas industry, we also equate our success to our manufacturing processes and business development effort that have resulted in obtaining additional business with existing customers. North America revenue was about 89% of our total revenue, which has been increasing thanks to improving industry conditions, the growing demand, for other related tool and contract services, and more rigs utilizing our flagship tool, the drilling ring, which continues to demonstrate its value to operators by improving drilling efficiencies which serve to reduce oil and gas drilling and production costs. The U.S. rig count continues to increase, leading to a number of customers recognizing the value of our technologies and expertise. The average U.S. rig count of 715 in Q2 2022 was up 82 rigs sequentially, or 13%, and up 264 rigs since last year's second quarter, a 59% increase. We expect this steady trend in North America to continue, and as of last Friday, the U.S. rig count was 764. Over the last year, the international market growth has increased has been at a slower rate compared to our domestic growth due to ongoing pandemic-related restrictions, which have impacted travel and labor recruitment in that part of the world. We are really excited about our new marketing and distribution agreement with Bin Zayed, as Troy mentioned. We believe this will accelerate our international growth. As we previously announced, this agreement provides that Bin Zayed Petroleum will initially purchase the company's existing Middle East drill and ring tool fleet, and they will purchase new drill and ring tools as they penetrate the Middle East and North African markets. The company will repair and maintain Ben Zayed's purchased tool fleet and will share in the revenue that Ben Zayed receives from the rental of the tools to the end users. In total, through the purchase of tools and the revenue share model, The company expects to realize roughly $13 million in revenue over the 12-month period beginning July 2022 through its relationship with Ben Zayed. The initial tranche of purchased inventory of approximately $4 million will be recognized in revenue in the third quarter of this year. Market penetration expectations are still being agreed and will be adjusted on an annual basis. Now please turn to slide five to review our tool and contract services revenue, which are both appreciably higher. Total tool revenue, which is the sum of other related tool revenue and tool sales and rental revenue, increased 27% to $2.9 million from the prior year period and was largely driven by higher drill and ream royalty and repair revenue, given the increase in the end users of the tool. Contract services were up 47% to 1.6 million as we have leveraged our improved capacity to support our customers increasing demand. They continue to recognize the value of our high quality PDC bits and other tool manufacturing capabilities as well as our PDC bit refurbishment services. On slide six, you will see that our costs and expenses have increased We are working hard to keep up with the demand for our products in the face of global inflationary headwinds, which specifically have impacted us in payroll expenses, raw materials used in our manufacturing operations, supplies, and repair and maintenance costs. We have also expanded our workforce to accommodate our current growth, with talent being added to quality, safety, and general manufacturing support areas. We continue to demonstrate strong leverage on the SG&A line, which declined 160 basis points as a percent of revenue from the prior year. Depreciation and amortization expense decreased approximately $180,000 or 31% year-over-year, primarily as a result of fully amortizing a portion of our intangible assets and fully depreciating some of our manufacturing center equipment. We remain focused on our cost-controlled efforts but are making the necessary investments to help capture the tremendous demand for our products and services. Inflationary pressures are expected to endure for at least the near term, but our teams are working to optimize processes and build relationships to expand our global presence. And while we have had some success in adding talent, labor constraints are still an issue as we move forward and prepare for additional demand. To help combat the inflationary headwinds around materials and labor, we implemented customer price increases effective July 2022 and expect to make further pricing adjustments this fall and into next year. Now let's go to slide seven. And we see that our bottom line and adjusted EBITDA were pressured by these increased costs, as we just noted on the previous slide. Net loss for the quarter was near break-even, slightly negative. Adjusted EBITDA of $831,000 was 18% of sales. Now moving to slide 8, we see that our balance sheet remains strong with reduced debt and stable cash levels. For the first half of this year, our cash balances exceeded our debt. Cash generated from operations for the year-to-date period was $1.4 million, compared with $335,000 in the year-ago period, largely reflecting the improvement in net income. We have utilized some of our cash to support an increasing capital plan, which to date, $1.2 million spent in the first six months of 2022. This reflects the down payment of roughly $300,000 to secure a new CNC machine in Q1 of this year, an increase in maintenance and capacity improvement projects, and an increase in our Middle East drill and ring tool fleet. CapEx for the comparable period of 2021 was $55,000. We expect our increased level of capital spending to continue into the rest of this year and total approximately $2 to $2.5 million over the last two quarters. Troy will review our capital priorities in just a few moments as he goes over our outlook. Total debt of $2.4 million was 2% lower from the end of calendar year 2021. We have sufficient cash and expect to pay off our hard rock note, our final payment on our hard rock note, I might add, of $750,000. And we'll make that payment in October, and that will retire this portion of our debt. In addition, with the cash from stage one drilling and inventory sale to Ben Zayed, we would consider retiring other high interest rate debt. Now let's continue on slide nine and take a look at our guidance going forward for the rest of this year. We're guiding 2022 revenue of between $22 and $25 million. As a point of reference, I might add in 2021, we did $13 million in revenue for the year. We believe SG&A expenses will be between $7 million and $7.3 million. We believe adjusted EBITDA will be between $6 and $8 million. And our capital expenditures for the year will be between $3 and $4 million. As we would like to note, in Q3, as we mentioned, we'll be selling roughly $4 million of our existing inventory in the Middle East of inside petroleum. And we expect that to happen this quarter, Q3. And with that sale of tools, our revenue in Q3 would be between $8 and $9 million. And adjusted EBITDA in Q3 would be between 3.5 and 4. So now with that, I'm going to turn the presentation back over to Troy as he goes through our outlook and opportunities. Thanks, Chris.
spk03: So as we look at our opportunities that we see throughout the remainder of this year, like I said earlier, there's a tremendous need for our legacy skill set, what we've been doing, and we've We're building out that part of our business. When you look at the facility here, we're increasing our braze capacity. We're building new braze stations. We're moving some equipment from one building into another as we find more efficiencies and teaming up with the braced stations from the drill and ream and then into the drill bit side of things. So we're going to see some capex spending there. We're looking at bringing on another large five axis machining center to support the activities that we have there. You're all aware that we've got several large, we call them five axes, but they're seven and actually nine axes machining centers We're going to be duplicating the two large ones due to the backlog and whip that we have on those machines. And it will also give us a good backup machine in case something was to happen on these two main machines. So there will be some CapEx spending there as well. And, you know, with that, when we bring these machines in, we also have got to do some work to our foundations to support these large machines that allow us to keep the accuracy that we keep. We do modifications. We cut out the existing floor and then lay in a really good support structure for these machines. We're also going to be, we've got to get a refurbishment service center done and running in MENA in Dubai. So our team is very focused on that we're identifying the equipment that we've got to to get purchased and get over there and get installed as well as getting a Workforce over there trained to refurbish the tools inspect and refurbish Along the same lines as what we do here, and and you know of course that'll start off being for the drilling ream tools but there's a lot of drill bits that get run over there as well, so I'm sure that'll come in right behind the drilling reams, the need to also service those type of tools. We'll also, you know, we expect the drilling ream demand to increase, which is wonderful. We're making sure we have the equipment and the personnel in place to service that demand, keeping Keep in mind the turnkey process that we've talked about. Expect that to be up and running. And by the time we get to Q4, it should be a meaningful addition to the services we provide here. And the contract services, like we've said, we've got a massive demand for that service. So lots of opportunities. We've got to continue to expand our manufacturing capabilities but with that again I think the biggest biggest part of all this expansion is going to be the hiring and training of qualified personnel and we'll continue to to get creative on how we attract a high-end workforce and retain this workforce so with that being said I'd like to turn it over to Q&A.
spk01: Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question is from John Serges. with Oppenheimer and Company. Please proceed.
spk05: Thank you very much. Nice quarter, gentlemen. I'm curious about if you can provide an update on Strider. Where is it in the other tools that you have? Are some of them ready to go into distributorship? And then the second question, which fits in with that. Uh, fourth quarter typically in the U S is slower for you. I would imagine maybe his business would, uh, offset a bit of that. Uh, but with the pace of drilling, uh, fourth quarter may not be that week. So I'm just curious as to what you're seeing at this point in time versus the fourth quarter.
spk03: Okay. So regarding your, your first question on the Strider, uh, you know, I don't, I don't, uh, I don't talk much about that tool just because we put that on the back burner in 2020. We started off Q1 of 2020, and we were really excited about the Strider, sold our first four tools, and then you know what happened. But since that time, we've had a very high-end customer that took those tools that we sold in Q1 of 2020 and actually ran them in Q1 of this year, and they performed very, very well. We've since brought that product in. Everybody that we had that was involved in that product line, when we did our reduction in force, we lost those individuals. And so it was a pleasant surprise for us. And we've now got a manager in that department who is who has taken that on and we refurbished those tools that came in that performed well and we put them back out and they've performed well again. So we know that there's a need for that product line and we are addressing it. We haven't put anything in our budget for that, although we are doing it on a small basis. We've now gone to, we're moving that product line. Instead of having an elastomer power section is what we started that design with many years ago. The relining and the elastomer in that product line has gotten very expensive. And so we're moving that to a metal on metal. It's very exciting for us. The metal on metal, we believe, will last least ten times longer than the elastomer that were used and we're just now modifying those power sections we've got four of those that we're going to be getting out here over the next month so we're excited to to get those out and get them in the field and see some wonderful performance on those and we'll probably be talking a lot more about that in our in our in our Q3 in November, but really it's going to be Q4 where we start to see these tools getting out and getting multiple runs on them. And then we start to look at addressing a really good buildup in that side of the business and starting in Q1, Q2 of next year. Regarding Q4 and the typical slowdown that you see there, we're not expecting that at all. You know, in the past, what would really affect the Q4 is the fact that the drilling efficiencies were becoming so great from year to year that, you know, these companies, the E&Ps, would say, we're going to drill 100 wells this year. And they were looking at wells that may take them 25 days from spud to TD. And then they'd plan that out throughout the year, and then they'd find out that they'd have that drilled up because of the efficiencies. You know, it's drilled up by September, October, and those gains kept happening year after year after year. And what we're seeing now is the wells are being drilled very, very efficiently, but we're not seeing those days come off of wells that we've been seeing in years past. So even though they're getting better at it and more efficient, I think we're reaching the point where we can only put pipe in the hole so quick. And so the efficiencies of drilling wells are being recognized in other places than just days off of wells. So I don't think we'll see budgets drilled up come October. I think we'll continue to see some good activity throughout Q4 and with the need to, when you look at the rig count, you see it's trying to get pushed towards that 800 mark. But I think one of the issues that you have with that is You know, what we see here past 750 now, it seems like, you know, we go up a few rigs and then we come down a few rigs. And I know when you're talking to the service, the servcos, when these EMPs want to put up more rigs, those hands are coming from the service companies. And so it's a tradeoff now of if you want the tools, quit taking the hands, right? But you've got to have the hands to stand up the rigs. So it's really interesting dynamics where we're at right now with the rigs and the CERVCOs. So I think we're going to see a strong Q4 in the drilling activity, and we plan on participating in that with some of the other things that we've been talking about with the new product line adoptions that we're bringing on and the new services that we're adding. I hope that answered your question.
spk05: You did. That was a great lot of color. I really appreciate that. Just one little follow-up, and that is the duct inventory that was usable seems to have worked it down. So all new production pretty much is coming from fresh greenfield drilling or something close to that, which would imply just to keep up with current production, you'd have to have either longer laterals or more wells. And I'm just trying to get a sense of what you see along those lines.
spk03: You know, it seems to me like a two-mile lateral is commonplace now. You know, when we first started, you know, getting out there, you know, we were doing 1,000-foot laterals and then 2,000-foot laterals. And now we do laterals that follow property boundaries in a square U. But it seems to me that the talk that we hear is a lot about these two-mile laterals. And I'm not quite sure how much further they can go to be productive. I know when you get to the toe of a well, which is the end of the lateral, I don't know if you get as much energy from your frack as you do at the heel. And so we may not have the efficiencies and not get the return if the well gets too long. You know, I'm not an expert in that field, but just from talking with people, that's what I hear.
spk01: Our next question is from Ben Pico with EF Hutton. Please proceed.
spk02: Thanks, guys. Nice quarter. Just on Ben Saeed, if we can... peel that back a little bit more. I mean, it looks like margins will explode to the upside Q3 as that transition occurs. But just can you talk a little bit more about the longer-term implications to just the capital intensity and the margin profile of the business as the Middle East looks a lot more like North America? And then a follow-on, you mentioned that there could be a nice opportunity to have a drill bit refurbishment business in the Middle East as you open up the center in Dubai? Maybe just define the fairway or how big of an opportunity could that be for the company over the next couple of years? Thanks. Okay.
spk03: All right. So when you look at the opportunity that we believe we have with Ben Zayed Group, it's, you know, they're new into the upstream, right? They sell oil. And they're now entering into the upstream market. And so as they go into this market, they're looking for a lot of support from us. And we're looking for a lot of support from them. They have the contacts in these oil and gas companies. that we didn't have. We didn't have those contacts up in these companies that we could just go and call on, like maybe we could do here in the U.S. And so that's always been a struggle for us, being foreigners over there and trying to break into a market. And they're very much into that market, as you're well aware. So when they look at... the services that they expect from us, you know, not only are they looking at, you know, the drilling tool to be one of those first tools that are getting them into the service side or the upstream side of the market, they also have needs for products in their side of the things, you know, in the production and the downstream side of things that they would like us to look at as well. You know, there's I'm not quite sure what all those products are, but they're very, very interested in our machining talents that we have here. And I know they have mentioned that multiple times as we look past just the drilling room and the drilling tools that we may be able to provide them. They have a directional drilling team, a very small directional drilling team that they're going to expand on. And so, as you well know, when a directional drilling team goes out, they need bits, they need motors, they need rotary steerable systems, and they need all that stuff serviced. And so, as we set up our service center in Dubai, we'll be looking at all of those things. We know what we're going there for is to service the drilling ream. but we also know there's a lot of additional opportunities. Our first trip over into that region, and this will touch on your second question, our first trip over there, I want to say it was probably... 2018? Yeah, it might have been 2018, 2000. No, I think it was around 16. And it was over there. When we went over there, it was to look at the drill bit refurbishment market for Adnock, you know, Abu Dhabi. And at the time, you know, we looked at that. We couldn't really justify going over there and setting up a facility just for the volume that we'd be getting, you know, just from the UAE. But now... you know, as we look at the volume that we could be getting from the MENA region, it looks a lot more appealing. So as we set up this facility that we're looking to have open by year end is our goal. And I'm hoping we can have it up and going by the first week in December. But, you know, we still have a lot of issues we're dealing with with the supply chain and and logistics, you know, putting equipment in sea cans and trying to get it over there. And there's no – nobody can give you a timeframe on when that sea can will arrive at its destination. It's just kind of – you just kind of got to go along and hope that it gets there in some meaningful manner. So we're trying to fabricate the stuff we can over there. and try not to get stuff on the CCAN. But when we open up that service center, we're designing things in a way that we know there's going to be additional products. So when we look at amperage, when we look at cleaning stations, when we look at inspection stations, this whole facility is being laid out based upon other tools and equipment coming in there. Did that answer your question, Ben?
spk02: Yeah, that's helpful. Just to try to dig in on the margins a little bit more, just conceptually, should the margins as you expand the opportunity with these folks in the Middle East, should it be better than the margins in North America? or similar, or maybe it's not as good. Just any color on kind of profit profile as incremental growth comes from part of the business.
spk03: You know, I think when you look at the margins, you can consider, look at them to be about the same. When we look at, you know, the rental of products over there is a little higher. We get a little more per foot, but it costs us a little more to do business over there. So I think it's going to be a wash. We expect good margins on the products that we do over there. But I think they're going to be a lot, they're going to be really close to what we get here.
spk08: Thanks, Troy. And again, congrats. Thank you.
spk01: Our next question is from John Bear with Ascend Wealth Advisors. Please proceed.
spk09: Thank you. Good morning, Troy and Chris. Good morning. Good morning, John. How are you? Given the strong demand on your services as well as the tools and so forth, I'm wondering how that plays into your pricing environment and whether you're able to, you know, raise prices, you know, to accommodate that.
spk03: We are. You know, as Chris mentioned, We had a price increase of 10% in July on the drill and ream service part of our business, and we expect a price increase on the bit refurbishment side of our business in September is what we're shooting for. And so, yes, everybody understands that they're going through the same process Same situations we are, you know, with the price of steel, the price of saw, the price of cutter, everything that we use has gone up. And they're sharing that, what we're charging, it's going on to the end user. So the price of drilling a well is definitely going up. And I think you're probably very aware that, you know, the ENPs have talked about how, you know, the price of drilling a well they expect to continue to rise. Right.
spk09: Are you seeing any leveling off in general component prices or metals or so forth?
spk03: Metals, we are. They peaked around November, December timeframe. And, you know, so we're starting to see a little bit of easing on Metals pricing, I don't know how that's going to play into this third and fourth quarter. It's not a bunch. But when you look at the raw metals per ton, it's coming down. I want to say it peaked at 2,000, a metric ton, sometime back in October, November time frame. And I think we're back down to about 800. So it's come down quite a bit from the foundry, but we're not seeing that big of a price decrease from the supplier.
spk09: Okay. And in the last couple of years, you had mentioned that you were having trouble getting folks into the Middle East. How's the situation there? Has that eased up to, been alleviated somewhat to where you are able to get your folks over there more easily?
spk03: Well, in Dubai, uh, we can get, we can get people in and out of there. Uh, you know, there's, they've, uh, they've got less restrictions than say Kuwait. And Kuwait was where we were really strong pre COVID is where we were making our, our best headway was in Kuwait. And, um, And then that locked down pretty hard. And it's just not for our services. Keep in mind that a lot of these wells are being drilled with the support of expats, right? And so when they went into lockdown mode, some of the expats were over there, had to stay in there a lot longer than what they were planning. And so there's some... uh concerns uh with with people going over there and and maybe getting involved in another lockdown where you maybe have to stay longer than what you wanted so i think that's why we're not seeing a big increase in rig count over there um it's just the fact that um it's just not real desirable right now with with you know the the new world of pandemics and uh But we are seeing, you know, like what you've seen in the news here lately, you know, where they're easing up on, you know, on what happens with COVID. And, you know, we're starting to see a lot of easing here. And I hope that it seems like the UAE follows really close to what happens here in the U.S. And then when you get into countries like Kuwait, they may follow a little bit later. but I with the exception of Getting materials in and out of there and see cans in and out of there I don't think we'll have an issue getting personnel in and out of Dubai I think it's that that we're going to be okay with that You know for training purposes and remember, you know, we have a whole drill and ring fleet over there as it gets used and We've got to get it repaired. We're not going to ship it back here to the states like we've done in the past because you can't rely on that at all. So there's tools that need to be repaired, and they're building up. And so we've got to get it done. And I think we'll get a facility put in place over there and get people moving in and out of there as we hire and train people over there to do this service work.
spk09: Great. One last question, and that's just in the past. What opportunities do you see, perhaps, in South America? There seems to be, you know, there's a robust industry over there, Brazil, and, of course, Guyana now. Do you see any opportunities there, looking at that, maybe a channel partner or whatever that can help you break into that market?
spk03: We have. We've talked to... several companies that would like to rep the drill and ream down there. One of the issues we have with that is we don't have a service center down there. And the drill and ream, one of the reasons it's a successful product is we really keep tight reins on the procedures and processes that are followed when this tool is After after it's run, you know, it goes through a really rigorous Inspection process and then repair process and we just don't hand that off to anybody and so We have been in talks with with companies that would like to support it Our bandwidth just hasn't allowed us to get too aggressive with it You know when when companies are run a tool down there, which we've done, and they've worked very well. Then they're faced with shipping the tool back to the states and having us repair it, and it kills that opportunity. So we are running, we're going to be sending some tools down to Guyana on a test well down there for a large company. I think we'll be shipping those tools out this month, actually. And so we've got four tools going down on an experimental well that this large customer wanted to run that as part of this exploratory process. And we can update you on our next earnings call on that.
spk08: Great. Great. Thanks very much. Good luck. You bet.
spk01: Our next question is from Matt Reiner with Adirondack Funds. Please proceed. Hi, guys.
spk08: Hi, Matt.
spk06: My first question is on the capacity. Obviously, you're making some big investments in it this quarter. And how much, or I guess what can you share with us about what your current capacity is and what these extra investments will add to it?
spk03: okay well our current capacity what it is we've got machines you know that that's not that's not what's holding our capacity back it's been the human uh capital side of things uh and and i say that but we're going to be investing in machines as well because of the opportunity to for turnkey processes, and also to facilitate more capacity with units coming through. So that probably sounds real wishy-washy, but what I mean is if you look at our 750, you know, if you look at the machines that make the drilling reams, we have two machines that produce those tools, and they're very unique machines. The large tools, we only have one machine that produces those tools. So once you start getting over a 10-inch size range, they all get made on this one machine. It's called the B750. And we're going to duplicate that. Our goal is to get that duplicated in place before year end. We'd like to have that done. And what that does is it... It supports the 750 that we currently have. If it goes down for any reason, whether it's operator error or maintenance, we're not stuck with increasing our backlog or delivery time. But also, that machine can be run simultaneously with an operator running both machines. So that's why I said we're building another machine. But the same operator can run bulk machines. So that's a big benefit. The human side of capital that we're looking at, well, let me go back to also your turnkey process, that machine there that we've put in place. Right now we have one manager that's working all the bugs out and designing and manufacturing the jigs and fixtures that we need for this turnkey process. And once that gets going, now we're going to run three shifts. We're looking at going 24-7. And so the people that will be supporting that machine is going to be the growth in our human capital. If you look at the current machines that we have, we run, I would imagine, not imagine, but we do run When we get into second and third shift, we're running about 40% capacity on those machines. And that's because we don't have the operators standing in front of all those machines. We have more operators on day shift that have been doing that, and it's been handling the workload that we've had to this point. But the demand has become so strong that we now got to look at running all those machines and putting people in front of them, looking more on a 24-7 on those as well. So our capacity will increase a bunch on the existing equipment that we have by putting more people in front of them on more shifts. And then we also will be increasing our capacity by the additional 750 that we're looking at, as well as the... the big maze at turning center that we just put in place. So we're going to be increasing our capacity quite a bit.
spk07: Yeah. Okay.
spk06: So I guess, and maybe this is a question for Chris, but so looking at from a, you know, a free cashflow perspective or whatnot, as we, as we look out, you know, at least for the second half of 22, you know, clearly the, with the large order in the third quarter, you know, your adjusted EBITDA, you know, if we even go at the midpoint of that, that's a fairly healthy adjusted EBITDA. You're also looking at, you know, roughly 6 million in CapEx in the back half. So I'm assuming some of that is going to get eaten up by the CapEx. And then I was curious as to how much gets eaten up by working capital or, so however you want to answer that, either if you could tell me how much free cash flow you expect to generate from in the third quarter in the back half, or if you, I want to approach it from a working capital and break it down that way. Either way is fine for me.
spk04: Yeah, just think in terms of doubling our existing cash balance. So another way of saying that is we're about $3 million right now, June 30th. As you just noted, we've got the large order in Q3, and we'll be collecting on that. And just as a point of reference, That's existing. Those are existing tools, existing fleet of tools that we have on our balance sheets. So that's monetizing an asset. So that sale will go right to the cash line. But we do have some capex that we're putting in place. So that's why I say, you know, just think in terms of doubling the cash balance from three to six by the end of the year.
spk07: Okay. Okay.
spk06: And you were saying that you may, so besides the hard rock note, you may look at taking out some high interest rate debt. I assume some of that extra cash can go towards that. And how high is the interest rate on that extra debt?
spk04: It's prime plus, and with some fees, it's about ten and a half right now.
spk08: Okay. Okay.
spk04: All right. That's why we'll probably take that out. It's not much money. It's about a million dollars. Okay. But we'd like to pay that out.
spk08: Yep. Yep. Okay. All right. That's my questions for now. Thanks, guys. Thank you.
spk01: As a reminder, this is Star 1 on your telephone keypad if you would like to ask a question. Our next question is from Brett Davidson, private investor. Please proceed.
spk10: Well, good morning for you guys. Good afternoon here out on the East Coast. I'm relatively new to the company, and I'm pretty ignorant as far as operations, excuse me, and so on. So you'll have to excuse me if some of these are a little simplistic on my side here. Cost of goods sold. I believe you indicated that the equipment that was delivered in the had already been manufactured and was existing equipment. How is that going to impact cost of goods sold in this quarter?
spk04: Favorably, our carrying value on that equipment had been depreciated quite a bit. So those carrying costs would become COGS when we monetize this asset. And so it'll be an improvement to the margin, gross margin.
spk10: Okay, so would you have a ballpark idea, maybe 25% depreciated?
spk08: Yeah, something like that.
spk10: All right, yeah, good enough. Yeah, I'm not too interested in the precision. All right, the machine tools you guys have on order, and how are the delivery times looking on those? Are you guys getting the stuff in a timely fashion, or has that been impacted by supply chain?
spk03: You know, we've been very fortunate. Our procurement group are still purchasing. We have a very good team there that's been out in front of this. continually buying at good prices and Looking ahead, you know, we're constantly looking for opportunities to buy You know mill runs what's not not a full mill run, but what's left of a mill run? You know, we look at we look at mills high-end mills globally whether it's you know out of South Korea or Ohio or Brazil or or Spain, Germany, we tap into all of them. And so our team has done a fantastic job there. So the steel hasn't been an issue. We've had a couple of scares, but nothing has tripped us up. The supplies, when you look at The PDC cutters, that's the next big component and probably most expensive, the diamond cutters we put in products. Been very fortunate there that we've kept, you know, enough suppliers of that product online so that, again, we've had a couple scares. More so in 2020. No, 2021. than we have this year. The toughest thing for us when we try to predict a manufacturing time is probably, well, the hardest area for us is definitely the Mideast. You know, how do we get things over there And we can always put it on a jet at a very high expense. Seacans are pretty much out of the question right now because of the backup. But we haven't been hurt with the supply chain, but it has caused a lot of scares. Let me put it that way. But we haven't been hurt with it yet.
spk10: So the supply chain... The hang-up is all live bodies with pulses in.
spk03: It just takes a lot more effort on our part. When you go to place an order, this supplier doesn't have it because of these reasons, and so we've got to start really kicking bushes and trying to find what else we can get in a timely manner. And, of course, you've got to increase your inventory, which isn't which isn't something we like to do, but we do.
spk10: And, and switching back to the, to the production side. Um, so, so the existing equipment was sold. Um, that's already booked. Are you currently producing products for the, the Middle East customer for, uh, ship this quarter or at some point next quarter is additional production already, you know, in place?
spk03: No, we have, uh, there's some tools here that we have, we plan on selling in another stage of this agreement that are, that we need to finish just the, putting the cutters on and then getting them over there. That was, we were looking at that in stage three. But most of those tools are, have been done and sitting over there. As they get their feet under them and start calling on customers, I'm quite certain we'll have a demand for new drill and ream tools. But right now, as we prepared for this, we built up an inventory. We've got them in place in various countries. And there was... There was a method to our madness, and it's very beneficial for us now.
spk10: So then for the remaining portion of this contract, how do you see it playing out? I mean, is it going to start production in fourth quarter for the add-on tools, or it might extend out further before you guys need to step up and start producing new equipment?
spk03: Well, think of the three ways that we get – that contract, how we get our revenue from that contract, we still get a percentage of every time the tools run, we get our percentage of that revenue. When we repair those tools over in the Mideast, we get paid for that. And then on top of that, when we get into next year, and you might see a little bit this year of new tool purchases, but we're not banking on it. But when you start getting into Q1, Q2 of next year and they've got their customer base growing, that's when we see that there's going to be a need for new products.
spk10: Got it. So you guys got a little cushion before you have to worry about an onslaught of new revenue from a new production.
spk03: Correct. And again, you heard me mention earlier the additional – D750 machining center, that's also what that's for.
spk10: Got it. All right. Thanks so much. I appreciate the time. Hey, thank you, Brett. Thank you.
spk01: We have reached the end of our question and answer session. I would like to turn the conference back over to management for closing comments.
spk03: Again, thanks, everybody, for joining us. And we appreciate the support. that we get from you. We're looking forward to visiting again in November regarding Q3, and we've got a lot of opportunity ahead of us, and we're going to do our best to capitalize on it. So thanks again. We appreciate you. Thank you.
spk01: Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.
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