Drilling Tools International - Q1 2024

Transcript

Operator (participant)

Greetings and welcome to the Drilling Tools International 2024 first quarter earnings conference call. At this time, all participants are on a listen-only mode. A brief 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 Dennard. Thank you. Please go ahead.

Ken Dennard (Head of Investor Relations)

Thank you, operator, and 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 to review 2024 first quarter results. With me today are Wayne Prejean, Chief Executive Officer, and David Johnson, Chief Financial Officer. Following my remarks, management will provide a high-level commentary of its 2024 first quarter results and outlook before opening the call for your questions. There'll be a replay of today's call, and it'll be available by webcast on the company's website at drillingtools.com, and there'll also be a telephonic recorded replay until May 17th.

Please note that any information reported on this call speaks only as of today, May 10th, 2024, and therefore you are advised that time-sensitive information may no longer be accurate as 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, 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 the 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 will also include certain non-GAAP financial measures, including but not limited to adjusted EBITDA and adjusted free cash flow. We provide these non-GAAP results for informational purposes, and they should not be considered in isolation from the most directly comparable GAAP measures. A discussion of why we believe these 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 and in our filings with the SEC. Now with that behind me, I'd like to turn the call over to Wayne Prejean, DTI's Chief Executive Officer. Wayne.

Wayne Prejean (CEO)

Thank you, Ken, and good morning, everyone. It has only been six weeks since our last call when we reported our 2023 fourth quarter and year-end. Not much has changed in that short span of time relative to our results, messaging, or outlook. Today, I will begin my remarks with a quick overview of our integration activities, make a few observations, and then hand off the call to David to go through the financials and our 2024 outlook. To begin, we have been extremely busy integrating Deep Casing Tools since we acquired them in mid-March. We have also been working diligently on pre-closed activities related to the SDP transaction, including the S-4 filing and integration planning. Once we close on SDP, we believe the combination of these two acquisitions creates a step change for DTI by offering current and prospective customers' proprietary products into expanding markets, both domestic and international.

In addition to driving incremental revenue, we will also be eliminating duplicate costs and improving margins. We will provide more details on the positive financial impacts and potential synergies after we close on SDP, but as I have said before, both of these transactions are outstanding examples of how we are expanding DTI's growth opportunities, both domestically and internationally, with a particular focus on our presence in the Middle East. For those of you that have listened to our conference calls since becoming public, you'll note that I provided a longer form history of DTI during our first conference call in November and then gave an overview of our company during our year-end call on March 28th. If you haven't listened to or read the transcripts of our first two public calls, you can access those webcast replays on our website.

Here's a quick overview for our new investors and those following the company since our last call. DTI is an industrial service company whose differentiated business model combines tools, technology, and equipment rental along with in-house manufacturing capabilities. We primarily serve the oil and gas upstream industry with downhole tools in the wellbore construction process. Our tools also serve the emerging geothermal and carbon capture sectors. We operate from our headquarters in Houston, Texas, and from 16 service and support centers across North America and maintain 7 international service and support centers across Europe and the Middle East. Many of our service locations have machining, inspection, and repair capabilities that enable us to efficiently service our equipment, which results in improved customer satisfaction, reliability, and efficient utilization of our assets. 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 or damaged equipment charges, allows us to sustain our fleet, which enables us not only to remain relevant but also generate positive adjusted free cash flow throughout the energy industry cycles. Lastly, the recent Deep Casing Tools acquisition brings high-margin product sale revenues with it, requires comparatively low capital expenditures to support, and allows our adjusted free cash flow margin profile to expand. We support the needs of blue-chip customers like Aramco, ADNOC, Baker Hughes, BP, Chevron, ConocoPhillips, EOG, Exxon, Oxy, SLB, and many other prominent firms in our industry.

These customers prefer to rent downhole tools because it would not be efficient to own and maintain their own fleet due to the many assorted configurations, hole sizes, geographies, and engineering requirements. There are just too many variables in our dynamic industry that make it inefficient for customers to own all of their own tools. 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. Additionally, our E&P customers have continued their record pace of consolidation, so we occasionally find ourselves working for customers on both sides of the larger deals. We have generally aligned ourselves with the industry consolidators and have extensive business relationships in place to meet their growing rental tool and service demands.

Plus, our sales and operations teams make certain to maintain the continuity of business relationships across the industry to mitigate changes in our customer base. We have an enviable revenue stream from multiple product lines and numerous geographic locations, covering every significant onshore and offshore oil and gas producing region in North America, Europe, and the Middle East. In a steady-state environment, our business consistently delivers 30+% Adjusted EBITDA margins and double-digit adjusted free cash flow margins. We are proud of the progress and track record that we built. In fact, the company has been EBITDA positive every single year during the last 10 years, including 2020 during the depths of COVID. Although we prefer a market that is stable and upward, we view downturns as opportunities to strengthen our business, and we have done so in each cycle.

In addition to our positive financial results throughout these industry cycles, our safety, quality, and reliability of performance continue to be the hallmark of DTI. As we stated on our last call, we believe that the North America rig count bottomed in the fourth quarter of 2023 and is expected to remain relatively flat throughout 2024. Longer-term demand trends remain robust, with projections from 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 demand slated to come online in 2025 and 2026 and electricity demand rising rapidly. As an example, the expected growth of AI data centers. We detailed while going public last year that there are meaningful consolidation opportunities that exist in our sector.

It is our stated goal that by making thoughtful acquisitions, we believe it is possible we can double or triple the size of the company in the near future. We have established an M&A framework and robust M&A pipeline that will allow us to selectively and strategically consolidate numerous oilfield service product and rental tool companies that meet the criteria for our growth plan. I hope this quick overview was helpful in providing basic background information for our current investors and our prospective investors. We have been extremely active in the M&A market since going public to position DTI for future growth, which is what we said we would do and believe we are poised to make additional accretive acquisitions in the future. With that, I'll turn it over to our CFO, David Johnson, for a review of our financial results and outlook. David.

David Johnson (CFO)

Thanks, Wayne, and thank you, everyone, for joining us today. In yesterday's earnings release, we provided detailed financial tables, so today I'll offer further insight into specific financial metrics for the first quarter. DTI generated total consolidated revenue of $37 million in the first quarter of 2024. First quarter tool rental net revenue was approximately $30 million, and product sales net revenue totaled $7 million. First quarter operating expenses were $31.8 million, and operating income was $5.1 million. Adjusted net income for the first quarter was $3.8 million. First quarter adjusted EBITDA was $10.9 million, and adjusted free cash flow was $4.7 million. As of March 31st, 2024, we had approximately $14 million of cash, net debt of $11 million, and an undrawn $80 million ABL credit facility.

We saw a sequentially flat U.S. land rig count during the first quarter of 2024 and a 19% decline in rig count compared to the first quarter a year ago. Despite this decline in rig count and activity, our revenues in the first quarter of 2024 are up 5% over the prior quarter and have declined by only 9% compared to the same period of 2023. We attribute this outperformance to our tier-one customer base, our wide distribution, service, and support network, and new product offerings that have gained market traction. As I explained on our last call, I want to discuss our capital expenditures and the offsetting benefits of our tool recovery business model that obtains payment for lost or damaged tools. As a downhole rental tool company, 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 ending March 31st, 2024, maintenance CapEx was approximately 9% of total consolidated revenue. This portion of our capital investments is trending lower than it has over the past couple of years, and some of this has already been factored into our gross capital expenditure considerations. Now, moving on to our outlook, we are reaffirming our 2024 outlook, which includes Deep Casing Tools' estimated impact on full-year results but does not include any contribution from the pending acquisition of Superior Drilling Products. We will update 2024 guidance for SDP's impact once we close the transaction. We expect 2024 revenue to be in the range of $170-$185 million.

We expect Adjusted EBITDA to be within the range of $50-$58.5 million. Gross capital expenditures are expected to be between $30-$33 million. Adjusted net income for the full year is expected to be between $15.6-$21.9 million. And finally, we expect adjusted free cash flow to more than double prior-year adjusted free cash flow and be in the range of $20-$25.5 million for 2024. Please note, we have substituted adjusted net income for net income in the guidance grid since we now have non-recurring acquisition and related one-time charges in 2024. This change will help normalize that portion of our guidance as we execute on our M&A strategy. That concludes my financial review and outlook section. Now, let me turn it back over to Wayne to provide some summary comments before Q&A.

Wayne Prejean (CEO)

Thank you, David. Before opening up the line for Q&A, I am pleased to say that first-quarter results came in as expected, and we have reaffirmed our 2024 outlook. RotoSteer and Drill-N-Ream product revenue continues to grow, and we continue to expand our scope of tools and services in existing product lines through technological advancements. We are furthering our customer penetration by growing rentals with our expanded capabilities, new tools, and services. The Deep Casing integration is going well, and we will have a full quarter of results to report to you in the second quarter. We are working as quickly as possible to get all filings and regulatory portions of the SDP deal administered and are still on track to close in the third quarter. We expect to continue our market-leading strategy throughout 2024 and expand our customer base as we move into 2025.

We believe additional thoughtful consolidation opportunities exist in oilfield services that will supplement our organic growth initiatives already in motion. To close, I would again like to express my sincerest gratitude to every member of the DTI team for their continuous dedication to safety, customer service, and the successful execution of our strategic initiatives. The commitment of our team members has been critical to driving our success, and I extend my heartfelt appreciation for their contributions. With that, we will now take your questions. Operator.

Operator (participant)

Thank you. The floor is now open for questions. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Again, that's star one to register a question at this time. Today's first question is coming from Jeff Grampp of Alliance Global Partners. Please go ahead.

Jeff Grampp (Senior Analyst)

Morning, guys. Good morning. Question on the guidance for revenue. It looks like kind of implication is we should see some sequential increases in revenue going forward. Just hoping you could comment on kind of how you see the pace of progression throughout the rest of 2024 and kind of the main drivers for the growth. Thanks.

Wayne Prejean (CEO)

This is Wayne. We feel like our guidance that we've given publicly is achievable throughout the rest of the year. Some of our growth initiatives were a little backloaded, and they depend on market being as expected. So we feel like those are still very achievable, and we can continue to grow these new product lines and some of these new initiatives we have. So we feel pretty confident about that going forward.

Jeff Grampp (Senior Analyst)

Okay, great. And for my follow-up with respect to Deep Casing, can you just touch on the integration process there? I know it's only been a couple of months, but just update us on how you feel that integration process is going. And then also curious if you could touch on maybe some of the revenue synergy opportunities that you guys see with bringing that into the DTI platform.

Wayne Prejean (CEO)

Sure. Yeah, great. The integration is going well. They have a really fine team. The Deep Casing Tools division now of DTI is integrating well. We are starting to work as a group on our Middle Eastern and international execution strategies, expanding to different markets and further taking advantage of what's already in motion in the Middle East and assisting them with more inventory and other support functions and removing some of their overhead and administrative burdens so they're now part of our team, and that makes it easier for them to execute. We've had a number of team meetings and discussions on how to expand into the Western Hemisphere, which we can greatly assist them with that. So all of those things are in motion, and we hope to report some of those results here in the very, very near future, so.

Jeff Grampp (Senior Analyst)

Okay, great. Look forward to it. Thank you, guys.

Operator (participant)

Thank you. The next question is coming from Steve Ferazani of Sidoti & Company. Please go ahead.

Steve Ferazani (Senior Equity Analyst)

Morning, Wayne. Morning, David. I did want to follow up on the Deep Casing Tools question. Your EBITDA margin, solid, but was at the lower end of your guidance range. Should we think, and I know you only had a couple of weeks of Deep Casing Tools in the quarter. I'm assuming you expect Deep Casing Tools to be margin accretive. Is that a mix of synergies, or are there some higher margins from that acquisition?

Wayne Prejean (CEO)

Well, we're hoping for both. I think we're planning for some of that, but we also have to absorb some full-year PubCo cost. And so it does provide some free cash flow benefit because it's a product sale platform and less of a rental time and return component. So we're happy about that. And we're kind of helping them deploy more and more inventory and more and more resources to get the product sale activity momentum in the direction that we want. They've done a really good job pre-closing, and we had already planned post-closing on how to accelerate that, and that's kind of what we're relying on. So the synergies between the two should give us that upward momentum we see to kind of offset the current run rate, so.

Steve Ferazani (Senior Equity Analyst)

Makes sense. Makes sense. Appreciate that. You talked about the fact that, again, this quarter, we didn't see the same kind of your revenue decline was far better than the decline of the rig count, which says you're outpacing activity. You noted your significant business with tier-one operators, which certainly makes sense. It's helping. Does that help? I would assume it does in terms of the significant consolidation we're getting among operators and how you think that's going to play out on your business moving forward.

Wayne Prejean (CEO)

Well, we think we're in a good position to mitigate all the changes. And that's part of how we operate our business, right? Have a plan one and plan two, plan A, plan B. So if things happen, you implement plan B and then plan C. So I think we've done a pretty good job of mitigating a linear decline relative to the general activity by implementing some new products, some new things in our offering that help us remain above the linear decline. I think we've done a good job of that, and we'll continue to do that. Bigger operators want bigger rental partners. They want more substantial providers that have a substantial and significant fleet of equipment. So I think that plays into our hands, so.

Steve Ferazani (Senior Equity Analyst)

Great. David, I'm not sure if you gave this, but for the CapEx guidance for the year, did you provide the split on maintenance versus growth?

David Johnson (CFO)

Yeah, I think we mentioned kind of the percentage of maintenance of consolidated revenue. We do have that breakout in our investor presentation, which will be online or is online. But as I mentioned there, we're seeing just a slight decline in our trend from prior years in that maintenance percentage of consolidated revenue, and all that has been factored into our CapEx considerations for the full year.

Steve Ferazani (Senior Equity Analyst)

Great. When we look at what you reported on Q1, the sales of the lost downhole tools almost completely replaced CapEx, and you ended up generating pretty good cash flow considering the working capital was a negative, and your guidance is solid. So can you sort of walk through the mix and how you think that plays out through the year?

David Johnson (CFO)

Yeah, I mean, we've got basically our CapEx slate is on order, and as those come in, we'll see that affect the rest of the year. But we're supporting, obviously, our organic growth strategy, particularly with the RotoSteer product line and our CapEx spend. And again, as you can see, as you kind of look at the chart in the investor presentation, we are focused on the free cash flow component. So we're managing that growth portion of our CapEx and our free cash flow component of our EBITDA to kind of show that we can generate that free cash flow component this year compared to last year because we spent some money investing in top-line growth last year. So we're seeing that come to fruition in 2024.

Steve Ferazani (Senior Equity Analyst)

I mean, in a normalized year where you wouldn't be making the investments in RotoSteer, and understandable why you would given the demand, does the sale of the lost downhole tools largely offset maintenance CapEx if you're in a pure maintenance CapEx year?

David Johnson (CFO)

Yes, absolutely. Yeah, that's the beauty of the downhole rental business model is that tool recovery component supports all of our maintenance CapEx. And again, the lever between free cash flow and growth CapEx is something that we can control up or down. So yeah, that's what we like about this particular business model.

Great. Thanks, Wayne. Thanks, David.

Wayne Prejean (CEO)

Thank you.

Operator (participant)

Thank you. Our next question is coming from John Daniel of Daniel Energy Partners. Please go ahead.

John Daniel (Founder and President)

Hey, guys. Thanks for including me. Wayne, I was hoping you could elaborate a little bit more on the international opportunity set and, if at all possible, maybe frame for us sort of within your guidance, what the expectation would be for year-over-year growth in international in 2024 and then what type of visibility you might have into 2025.

Wayne Prejean (CEO)

Great. Thanks, John. So as an example, our 2023 international revenue was less than 1% of our total. In 2024, we expect that to be in a double-digit, 10%-11% range, or at least double-digit. And that does not include the SDPI revenue that we anticipate closing and onboarding later in the year. Hopefully, sooner than later. And we see that percentage of our total growing in 2025 and beyond in a more significant fashion. So we're allocating capital resources and acquisition strategies to execute on that component of our growth. So yeah, so.

John Daniel (Founder and President)

Fair enough. Here's another one. Let's assume you've got a potential new client, international, that signs up. From the time you sign an agreement with them to start providing services, how long until the revenue actually shows up? Any color there would be appreciated.

Wayne Prejean (CEO)

That's a good question. With our current relationships and commercial paths with our acquired partners, we've been able to accelerate that into more near term. But if it's a complete new product or a complete new area, that could be 3 to 6 to 9 months depending on the product and the timeline to get full approval and meet all the requirements of the local NOC. So it's quite a lengthy process, much lengthier than the U.S., but it has greater sticking power, so.

John Daniel (Founder and President)

Okay. And I guess this is somewhat of a leading question, so I apologize. But it seems to me that all else being equal, the rate of growth 2025 over 2024 should be better than 2024 over 2023 for international. Is that within the realm of reason?

Wayne Prejean (CEO)

It is, but we're not getting.

John Daniel (Founder and President)

Okay. I know you're not getting formal guidance. I understand. I'm just trying to. But just big picture. Okay.

Wayne Prejean (CEO)

We put a general guidance out there, and we can give more clarity to that as we make the rest of these close the deals. We're bullish on international, so I think that's what we're doing.

John Daniel (Founder and President)

Right. That's what I was asking.

Wayne Prejean (CEO)

Yeah, we're going to stay focused on that. Yeah.

John Daniel (Founder and President)

Okay. Thanks, guys.

Wayne Prejean (CEO)

Thank you.

Operator (participant)

Thank you. That concludes our question and answer session. I will turn it over to Mr. Prejean for closing comments.

Wayne Prejean (CEO)

All right. Thank you. Thanks, everyone, for joining and listening in and showing your interest. We're pretty enthused about where we're at and how we're competing and where we're going. As you heard, we're bullish on international. We still and continue to have and will continue to have a solid balance sheet, a healthy income stream, a solid customer base, a talented group of employees, and we're making strategic investments and capital allocation in the areas that we think will provide the best returns. We continue to believe and will continue to focus on all those initiatives that we've laid out publicly. Thank you for your interest in DTI, and we look forward to the next call.

Operator (participant)

Ladies and gentlemen, this concludes today's event. You may disconnect your lines at this time or lock off the webcast and enjoy the rest of your day.