Drilling Tools International Corporation

Greetings and welcome to the Drilling Tools International Conference call. 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ken Denaard. Sir, the floor is yours.

Thank you, operator. Good morning, everyone. We appreciate you joining us for Drilling Tools International, or more commonly referred to in the industry as DTI. We welcome you to DTI's conference call and webcast. With me today are Wayne Prejean, Chief Executive Officer, David Johnson, Chief Financial Officer, and Jameson Parker, VP of Corporate Development. Following my remarks, management will provide a high-level commentary of the benefits of the DSDP acquisition, a review of the 2024 second quarter results, and updated outlook before we turn the call to you for your questions. There will be a replay of today's call. It will be available by webcast on the company's website at drillingtools.com, and there will be a telephonic recorded replay feature available until August 13th. Please note that any information reported on this call speaks only as of today, August 6, 2024, and therefore you're advised that time-sensitive information may no longer be accurate of the time of any replay listening or transcript reading. Also, comments on this call will contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of DTI's management. However, various risks and uncertainties and contingencies could cause actual results, performance, or achievements to differ materially from those expressed in the statements made by management. The listener or reader is encouraged to read DTI's annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K to understand certain of those risks, uncertainties, and contingencies. The comments today may also include certain non-GAAP financial measures, including not limited to adjusted EBITDA and adjusted free cash flow. These non-GAAP results are informational purposes and they should not be considered in isolation from the most directly comparable GAAP measures. A discussion of why we believe the non-GAAP measures are useful to investors, certain limitations of using these measures, and reconciliations to the most directly comparable GAAP measures can be found in the earnings release, which is on our filings page or with the SEC. And now with that behind me, I'd like to turn the call over to Wayne Prejean, DTI's Chief Executive Officer. Wayne.

Thanks, Ken, and good morning, everyone. I will begin my remarks with a quick review of our superior drilling products acquisition and synergies, observations on second quarter results, and discuss how we are dealing with the market's softness in North America. After that, I will hand off the call to David to go through the financials and our revised 2024 outlook. Also on hand today is our VP of Corporate Development, Jamison Parker, available during Q&A for comments on our recent acquisitions. Starting with SDP, we believe this acquisition, along with deep casing tools completed in March, has created a step change for DTI to offer current and prospective customers proprietary products into expanding markets, both domestic and international. These two transactions are outstanding examples of how we are showcasing DTI's growth opportunities with a particular focus on our presence in the Middle East. Our rationale for the SDP acquisition is quite compelling. Over the next 12 months, we expect to realize an excess of $4.5 million in identifiable SG&A synergies and realizable NOL tax benefits. In addition, there are vertical and horizontal integration synergies that include approximately 60% capex savings on new DNR tools and 45% margin capture on repairing and maintenance of our global drilling ring assets. Superior is headquartered in Vernal, Utah. The team and -the-art facility adds to DTI's offering additional engineering and product development, PDC cutter brazing and bit repair expertise, a substantial manufacturing facility with precision machining capabilities, and of course, our ongoing drill and ring repair center. In addition, after a significant investment and three years of trials and development, a fully staffed and operational PDC bit and drill and ring repair facility in Dubai, UAE, a local bit repair contract with ongoing revenues, as well as several hundred -for-purpose DNR tools on the ground across the Middle East. This provides us fuel in the tank to serve our clients in the region. While our vertical and horizontal integration synergies are activity and backdrop driven, we believe they will prove to be quite significant once market activity stabilizes and the recount improves into 2025 and beyond. Adding to these synergies, we also gained an approximately $6.6 million receivable from the selling party to extinguish a note which will accrue to DTI's benefit, effectively reducing the total purchase price of the transaction from $32.2 million to $25.6 million, subject to purchase price accounting adjustments. As you can see, the SG&A synergies of $4.5 million, the capex and cost reduction, the note due of $6.6 million, and millions in previously invested rentable assets and infrastructure add up to a very meaningful long-term accretive value to DTI. Moving now to our 2024 second quarter operating results, the U.S. rig count experienced continued softness in the quarter compared to our flat rig count outlook earlier this year. So what have we done to adjust to the softer market conditions and recount decline? First, we have implemented a cost reduction program for an annualized savings of $2.4 million in overall cost. We will continue to appropriately scale our operations to adjust for the activity levels in North America, but we'll continue with our growth initiatives in other markets where opportunities are available. Currently, our cost adjustment decisions are focused more on the near-term environment, realizing that our current and short-term needs must be met with a lower cost structure while still keeping our eye on the long term. Additionally, we were able to manage capital expenditures during the quarter and improved our adjusted free cash flow by $3.2 million compared to last year's second quarter. Our unique business model enables us to generate returns despite a decline in North American land activity. As a result, we are maintaining our adjusted free cash flow guidance range from $20 million to $25 million for the full year. David will add more commentary to our updated outlook shortly. And now, some observations of the market and what has transpired over the last few months as oil and gas customers have reduced activity. Our customers, the operators, and oil field service providers became very focused in improving efficiency and producing more with less. It appears E&P mega mergers have begun to slow, and operators have turned their attention to integrating, executing, and rationalizing their drilling programs. In essence, these operators are utilizing their best rigs as efficiently as possible by deploying their best crews to drill longer laterals with more producing footage all the time. Also important, they are much more efficient with a focus on minimizing drilling mistakes like loss and hole events. Operators will look to redeploy additional rigs when demand picks up. And we believe demand will eventually rise and should require more drilling and producing activity. Certainly, things have changed over the last decade, and although oil and gas operations are much more efficient, producing wells typically peak early in their life, then decline year by year. If we believe demand will continue to rise, then more wells will be needed to meet that demand. For the next few months, and likely through mid 2025, we expect a soft activity pace for North America and are confident rig counts and well counts should rise in 2025. International markets should be flat to upwards with less volatility. Due to the current North America market softness, we have had to align our core rental tool business to remain more competitive. As our customer landscape shifts with mergers and our customers rotate oil field service suppliers to find best cost and value, we have had to be more flexible by adjusting commercial terms to meet our customers' changing needs. Although we have strategic modes for these events, we are not immune to this type of request and have installed key initiatives to deal with this transitory trend. In some product lines, we have adjusted to pricing reflective of footage drilled as opposed to price per day. And yes, it's challenging, but we will prevail and be more vibrant coming out of this downturn like we have during so many other market downturns. As we have previously stated, in a steady state environment, our business consistently delivers 30 plus percent adjusted EBITDA margins and mid to high teens adjusted free cash flow margins. While we have taken measures to adjust to lower demand, we believe we will be well positioned to come out stronger when the market recovers. Although we have acquired some new revenue streams with product sales, such as deep casing and service repair revenue, superior drilling products, our business model has historically relied mostly on rental, repair, and recovery revenues. Our customers count on us to maintain a relevant and sustainable fleet of equipment. The rental and repair income provides the basis for our rental model. The tool recovery revenue, also known as lost and damaged equipment charges, allows us to sustain our fleet, which enables us to not only remain relevant, but also generate positive adjusted free cash flow throughout the energy industry cycles. This is one of those cycles. As I said previously, our Bluechip customers prefer to rent down-hole tools because it would not be efficient to own and maintain their own fleet due to the many extorted configurations, hole sizes, geographies, and engineering requirements. Bottom line, our customers rent tools from DTI because we provide high quality service and value along with our substantial fleet of tools to best serve their needs. This, along with our acquired new products and revenue opportunities, positions us to continue to capture a greater share of the industry on a global scale. Longer term demand trends remain robust. Agencies such as the EIA expect oil demand to continue to grow through 2050. In addition, many industry experts are forecasting that the medium to long term natural gas demand outlook is very strong, particularly with the new LNG capacity slated to come online in 2025 and 2026 and with electricity demand rising rapidly to accommodate the anticipated growth of data centers. DTI is well positioned for this industry trend. We have been extremely active in the M&A market since going public in June 2023. As we work to position DTI for future growth, which is what we said we would do. And we continue to believe that there are meaningful consolidation opportunities that exist in our sector. It is our stated goal to make thoughtful acquisitions a significant part of our growth strategy. We have established an M&A framework and robust M&A pipeline that will allow us to selectively and strategically consolidate numerous oil field service, product, and rental tool companies that meet the criteria for our growth plan. With that, I will turn it over to our CFO, David Johnson, for a review of our financial results and outlook. David?

Thanks, Wayne, and thank you everyone for joining us today. In today's earnings release, we provided detailed financial tables, so I will use this time to offer further insight into specific financial metrics for the second quarter. DTI generated total consolidated revenue of $37.5 million in the second quarter of 2024. Second quarter tool rental net revenue was $28.3 million, and product sales net revenue totaled $9.2 million. Second quarter operating expenses were $35.3 million, and income from operations was $2.2 million. Adjusted net income for the second quarter was $3 million, or adjusted diluted EPS of $0.10 per share. Second quarter adjusted EBITDAO was $9 million, and adjusted free cash flow was negative $1.1 million, a $3.2 million improvement compared to the second quarter of 2023. As of June 30, 2024, we had approximately $6.8 million of cash, net debt of $17.4 million, and an undrawn $80 million ABO credit facility. As Wayne mentioned, we saw the U.S. land recount down sequentially during the second quarter. Recount was down roughly 15% over the last 12 months. Despite this decline in recount and activity, our revenues in the second quarter of 2024 were flat over the second quarter of 2023. Our acquisition of deep casing, our Tier 1 customer base, our wide distribution service and support network, and new product offerings have been integral in managing this challenging cycle. Moving to maintenance capex, as a reminder of what I have shared on previous calls, we are a down-hole rental tool company, and our maintenance capital is funded by tool recovery revenue. The customer is responsible for all lost or damaged tools while the tools are in their care, custody, or control. This tool recovery component of our rental model helps keep our rental tool fleet relevant and sustainable. For the three-month period into June 30, 2024, maintenance capex was approximately 7% of total consolidated revenue. This portion of our capital investments is trending lower due to the decline in recount, and our customers' focus on efficiencies that have translated into fewer -in-hole and -beyond-repair events. Now, moving on to our outlook, we are updating our 2024 ranges, which includes the estimated impacts of deep casing tools and superior drilling products on full-year results. We expect 2024 revenue to be in the range of $155 to $170 million. We expect adjusted EBITDA to be within the range of $41 to $47 million. Gross capital expenditures are expected to be between $21 and $22 million. Adjusted net income for the full year is expected to be between $9.9 and $13.5 million. Finally, since a majority of our capex was incurred in the first half of this year, and we have curtailed or deferred other planned capex, we are maintaining our adjusted free cash flow to be between $20 to $25 million for 2024, which is more than double the adjusted free cash flow in 2023. That concludes my financial review and outlook section. Let me turn it back over to Wayne to provide some summary comments before Q&A.

Thank you, David. Before opening up the line for Q&A, I'd like to reiterate we are extremely pleased to welcome SDP's talented team to the DTI family and add SDP's products, service, and world-class manufacturing expertise into our broad-reaching and expanding global sales channels. In conclusion, I would like to reemphasize that, one, we are very pleased to have closed in our two acquisitions in five months, and we believe we will see significant cost synergies as well as vertical and horizontal integration synergies from the SDP acquisition that will lower our cost and improve our margins. Two, we have implemented an annualized $2.4 million internal cost reduction program to adjust to the softer market conditions. Three, we are competitive and profitable despite the soft market and are well positioned to combat pricing pressures. Four, our rotor-steer technology continues to make positive commercial traction but at a slower pace than we anticipated late last year when the market outlook was flat to upward. We expect to have continued growth in this important technology but have tempered our fleet development plans and deferred -to-quarter increases to adjust our CAPEX and fleet utilization. I am highly confident this product line will continuously grow. Stay tuned for updates as this exciting opportunity develops. And finally, we believe additional thoughtful consolidation opportunities exist in oilfield services that will supplement our organic growth initiatives. Throughout industry cycles, our focus on safety, quality, and reliability continue to be the hallmark of DTI. I would again like to express my sincerest gratitude to every member of the DTI, Deep Casing, and most recent edition Superior Team for their continuous dedication to safety, customer service, and the successful execution of our strategic initiatives. The commitment of our employees has been critical in driving our success and I extend my heartfelt appreciation for their contributions. With that, we

will now take your questions. Operator.

Thank you. We will now be conducting a question and answer session. 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 1. If you would like to remove yourself in the queue. Participate participants using speaker equipment is necessary to pick up your hands up before pressing the star key. Thank you. Our first question comes from Jeff Cramp from Alliance Global Partners. Go ahead, Jeff. Your line is open.

Good morning, everyone. One of the first start on the Superior integration here now that we've closed, I understand we're only in the first week here, but do you guys have any kind of preliminary estimate for when you could potentially see some traction or signs of success on the revenue synergy sub-site, particularly in the Middle East and elsewhere internationally? Is that a 2024 event where you guys could maybe see some green shoots of success or is that more of a 2025 event we should stay tuned for?

Thanks, Jeff. This is Wayne Prajan. We expect to see some green sprouts starting to occur throughout the remainder of this year. We've been slowly having discussions between our team and their team on how we might integrate post-closing. Now that that has happened, we're ready to implement some of those initiatives and accelerate the efforts between our commercial team and their teams and get things really ramping up in that market. Probably more of a 2025 event to see the true traction. Quarter by quarter, we expect to make steady progress.

Great. Thank you. On the revised guidance slide in your updated deck, and you touched a bit on this in the prepared remarks as well, Wayne, on M&A, five near-term priority targets, as you guys call it, can you shed a bit more light on those perhaps in terms of geographic focus, product line, maybe size in terms of what size businesses these are to the extent you can kind of ring-fence some of these opportunities in any broad strokes?

Thanks, Jeff. I've invited James in our corporate M&A DBP to comment on some of that. James?

Yeah. Speaking to the pipeline, Jeff, we have everything from product-specific tuck-ins that are identified and we're working on, single product line companies, all the way up to significant mergers of equal or even larger. We're constantly plumbing the depths of the market to find the thoughtful consolidation opportunities that we speak to in the deck. I would say that that funnel is very real when we speak to the opportunity set and the near-term opportunities that we're actively working on.

Okay, great. If I could just tack a follow-up on that, Jameson, what's kind of relative to the last call a few months ago? How would you guys kind of characterize bid-ask spreads, seller sentiment? What is that overall market like today versus a few months ago?

Yeah, I think I, you know, in one of our kind of introductory calls spoke to, you know, valuations being very range-bound still in oil field service. There is not, I think the bid-ask spread continues to narrow and we've seen the complete departure of the private equity bidder in most of these processes and some of these processes that we're doing are not, you know, the broadly marketed deals. These are individual founder-driven companies that we've known or worked with for a long time and the timing is right to take their products commercial. So, you know, I think that the acquisition landscape for consolidation remains robust for oil field service. We need to do what our customer base is doing and get larger and leaner.

Great. I appreciate those comments. I'll turn it back. Thank you,

guys. Thanks. Thank you. And our next question comes from Steve Farzani from Sudhokti. Go ahead, Steve.

Morning, Wayne. Morning, everyone. Appreciate the detail on the call.

Wanted

to ask about the updated guidance because it now includes SDPI. Is there any kind of detail you can give us on the breakout of what you're expecting the contribution from SDPI is on the

market? I mean, we only speak to the percent contribution by the product lines that you're in. I mean, they were public prior and you can see some of the results and we spoke to the kind of margin capture and improvement by being vertically integrated. That's kind of where things are trending now.

Can you say if SDPI, your outlook on SDPI in terms of trends are similar to your legacy business?

Yeah. We see they have some bit repair business opportunities in the Middle East that are starting to get traction. So we anticipate that contribution. And also, we have assets on the ground, rentable assets on the ground that we can put to work, we believe, as things kind of continue ramp up as we integrate our efforts. So we factored in an appropriate amount of what we believe is sticky activity so that we feel like we feel pretty good about our guidance. There's certainly potential for more opportunity in the future. So we'll just have to gauge that quarter as we integrate these two businesses.

Fair enough. When we think about the updated guidance, obviously, rig count has continued to soften, but we're down about 20 rigs last quarter and I know we're continuing to decline this quarter. But when I see the updated guidance and you touched on it in your comments, there seems to be maybe a more severe pricing impact or maybe it's utilization. And I'm trying to figure out how much consolidation is playing into that even though you're probably the incumbent of the acquirer in a lot of these cases. Are you getting more pricing pressure from consolidation or is it more just the slower rig count?

So you know, when the rig count, the slow bleed of the rig count

over the last 18 months has been kind of an interesting phenomenon within our industry where it didn't go down just rapidly, just kind of chipped away at a slow leak, if you will. And the industry's had to learn how to adjust to that slow burn rate of rig activity. And as that's happened, operators have had a chance to A, consolidate, B, what I spoke to in the press release was the rotation of different vendors trying different ways to cut costs and put compressive pricing on different service providers and so on. And that's affected us because we've seen some of our core customers get shuffled around from this operator to that operator and we've had to shuffle as well. So we've made those adjustments. As I spoke earlier, we have strategic moats built in. Those strategic moats are having the proper fleet, the most relevant types of connections and things in the industry that gives us the strongest sticking power. But as I've said previously in calls and with the different investors, no one is immune to a compression of the market by our customers. So yeah.

How much can this reverse as we start seeing, I think you mentioned it, and certainly we all think there's some recovery next year without the LNG export capacity coming. How positive are you on some recovery on pricing and margins if we get a recovery?

I think it's just a matter of time that our customers do put more activity in play because they have a desire to grow their business as well, meaning the oil and gas customers. As far as pricing rising back up, what we've done, we make every effort to maintain our pricing points, but we modify our commercial terms with utilization, use tools and things like that, and standby rates and things like that when you have extra tools to utilize. So our goal is to modify our commercial terms and then move our utilization efforts back to where the activity supports a better pricing model. We think we'll be in a competitive position to offer better products and more relevant products for the future.

Perfect. Last one for me. The international outlook as we come out of the first half, listening to some of the bellwether conference calls, the international outlook remains really, really healthy. A lot of people calling for a multi-year cycle here with particular strengths in the Middle East. Can you touch on how that's your strategy with SDPI deep casing? Can you give a little bit of picture on how that affects your international strategy and how that will play into this international potential multi-year upcycle?

Deep casing, for example, has product lines that's very contributory and beneficial to many of your Middle East and international offshore players. We see that business slowly growing and evolving and making them more effective. Significant contribution. Now that we have the SDP acquisition, we've joined forces with them. We're no longer serving two masters. We're now aligned and working together in unison. I think we can help that platform rapidly expand and set up repair centers in other locations and expand that product line so the opportunities are there. In addition to that, Jameson didn't give you any real color on because he's reserving his comments, but I'll add to it is one of the criteria for M&A strategies is to place a high emphasis on what international impact and component these M&A deals can do for us. We pretty much look at that as a higher value proposition than maybe just some tuck-in and bolt-ons in the North American market, which many could be attractive, but we're focused and we're aiming more towards technology and Middle East and international expansion as far as when we make an M&A deal, that needs to make a significant contribution to our long-term strategy.

Fantastic. Thanks, Wayne.

Our next question comes from John Daniel from John Daniel MG Partners. Go ahead.

Wayne, your margins

are already better than a lot of your peers. I was just noteworthy when I saw the cost reduction efforts, the $2.4 million. Can you elaborate on what you guys are doing? With regard to our

cost

reduction? So, is it regional or how are you approaching that?

So, one thing interesting about our business is we can scale our business according to activity that's very challenging, but some of it's labor-centric, some of it's deferring certain aspirational costs. So, we've made those appropriate adjustments in North America. We have a tenured management team in all of our facilities, which is unique, and they all understand what is required of them quarter to quarter, year to year, and how the industry helps them flow. So, we've made those variable cost adjustments, but we are a public company now, so we've had to take on some public company burdens that we're all aware of. So, we've been mindful of managing that escalation as we grow and build muscle to take on more and more M&A and larger, broader enterprises. But most of it's been the variable cost component in North America, where we see the lever of ebb and flow of activity. And if the activity raises or rises to a level that requires more support, we're prepared to make those increases if needed to support the business.

And then just a follow-up, unrelated, but the press release calls out the bit repair facility in the UAE. I'm just curious, when you have a facility like that, what's the opportunity for additional roofline there, and how quickly could you start taking other product services into a facility like that? You could just expand. It would be helpful.

Okay, yeah, thanks. The facility that's set up now was centrally located in the UAE, and that serves our needs for now. But we're looking at how to put something possibly in Saudi. The roofline that we currently have could add support for some of our other product lines in the Middle Eastern market. So, it's expandable. The bit repair business can be expanded. The we have some machining capability that's being loaded into there to add more repair capabilities to support real fleets. So, we're going to go for a while.

Good. Okay, that's all I had. Thank you for including me.

Thank you. This does conclude the question and answer session. I would now like to turn it to management for any closing remarks.

Well, thanks everybody for your interest in DTI. It's been a challenging year, but we've once again overcome those challenges, and we see a pretty bright outlook going forward, and we look forward to keeping you posted on those events. Thanks for your interest.

Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.