Drilling Tools International Corp: Form 10-Q for the period ended Mar 31, 2025

The following discussion and analysis should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes as of March 31, 2025, and for the three months ended March 31, 2025 and 2024, included elsewhere herein. For additional information pertaining to our business, including risk factors which should be considered before investing in our common stock, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2024. Our historical results are not necessarily indicative of the results that may be expected for any period in the future. All dollar amounts are expressed in thousands of United States dollars (“$”), unless otherwise indicated. Capitalized terms used in this section, but not otherwise defined, have the meanings ascribed to them in the Report.

Overview

We are a global oilfield services company that designs, engineers, manufactures and provides a differentiated, rental-focused offering of tools for use in onshore and offshore horizontal and directional drilling operations, as well as other cutting-edge solutions across the well life cycle. We operate from 15 locations in North America and 11 international service and support centers in Europe, the Middle East, and Asia-Pacific.

Our revenues are derived from two sources: tool rental and product sales. Tool rental revenues are derived from the rental of tools used in bottom hole assemblies (“BHA”), various wellbore optimization tools, and tubular goods for drilling, workover, and completion operations. Additionally, tool rental revenue consists of the repair and inspection of such tools. Product sale revenues are derived from the sale of target depth technologies, the manufacturing and repair of tools for external customers, and tool recovery revenue. During the three months ending March 31, 2025, we derived 81% of total revenues from tool rentals and 19% from product sales. During the three months ending March 31, 2024, we derived 81% from tool rentals and 19% from product sales.

We operate out of 2 reporting segments, split by geography, consisting of the Western Hemisphere operations and the Eastern Hemisphere operations.

Market Factors

Demand for our services and products depends primarily upon the general level of activity in the oil and gas industry, including the number of active drilling rigs, the number of wells drilled, the depth and working pressure of these wells, the number of well completions, the level of well remediation activity, the volume of production and the corresponding capital spending by oil and natural gas companies. Oil and gas activity is in turn heavily influenced by, among other factors, investor sentiment, availability of capital and oil and gas prices locally and worldwide, which have historically been volatile.

Our product sales revenues are primarily dependent on oil and gas companies paying for tools that are lost or damaged in their drilling programs as well as the customers need to replace aging or consumable products and our ability to provide competitive pricing. With the addition of Deep Casing Tools, we now sell tools to the end users for use in constructing their wells.

Our product sales revenues are primarily dependent on oil and gas companies paying for tools that are lost or damaged in their drilling programs as well as the customers need to replace aging or consumable products and our ability to provide competitive pricing.

All of these factors may be influenced by the oil and gas region in which our customers are operating. While these factors may lead to differing revenues, we have generally been able to forecast our product needs and anticipated revenue levels based on historic trends in a given region and with a specific customer.

Recent Developments and Trends

Industry Update

In the first quarter of 2025, the oil and gas market witnessed a dynamic interplay of geopolitical tensions, shifting demand dynamics, and evolving geopolitical and economic factors. U.S. oil production reached record highs, averaging 13.5 million barrels per day, driven by the Permian Basin and offshore developments. However, this surge in supply coincided with an increasing surplus in global oil supply over demand, leading to downward pressure on prices. Crude oil prices experienced declines, specially WTI, whose quarterly average decreased from $78.41 per barrel to $71.84 per barrel from the fourth quarter of 2024 to the first quarter of 2025. Despite the high volatility in spot oil prices described above, our customers tend to be more focused on medium-term and long term commodity prices when making investment decisions due to the longer lead times for offshore projects.

In the first quarter of 2025, U.S. natural gas prices experienced a notable rebound following the record lows of 2024. The Henry Hub spot price averaged approximately $4.15 per million British thermal units (MMBtu) during the first quarter, or a 70% increase compared to the fourth quarter of 2024, reflecting seasonal increases due to heightened heating demand during colder-than-average weather in January. This uptick in demand is expected to outpace any expected growth in U.S. production, leading to a tightening of inventories and supporting higher prices through the remainder of 2025

Notwithstanding the significant commodity price volatility over the past several years, we have seen decreases both the Western and Eastern Hemisphere. During the three months ended March 31, 2025, the weekly average Western Hemisphere rig count, as reported by Baker Hughes, was 930 compared to 995 for the three months ended March 31, 2024. Additionally, during the three months ended March 31, 2025, the weekly average Eastern Hemisphere rig count, as reported by Baker Hughes, was 757 compared to 725 for the three months ended March 31, 2024. However, notwithstanding the impact of longer laterals, improved rig efficiencies have partially offset the impact of this reduction.

Inflation and Increased Costs

We are experiencing the impacts of global inflation, both in increased personnel costs and the prices of goods and services required to operate our rigs and execute capital projects. While we are currently unable to estimate the ultimate impact of rising prices, we do expect that our costs will continue to rise in the near term and will impact our profitability.

Results of Operations

We have two operating segments consisting of the Western Hemisphere and Eastern Hemisphere. Our results of operations are evaluated by the Chief Executive Officer on a consolidated basis as well as at the segment level. The performance of our operating segments is primarily evaluated based on segment operating income (in addition to other measures), which is defined as income before taxes and before interest expense, net, other income (expense), net and corporate and other expenses not allocated to the operating segments.

Comparison of the Three Months Ended March 31, 2025 and 2024

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Western Hemisphere

Western Hemisphere revenue was $41.2 million for the three months ended March 31, 2025, an increase of $2.9 million, or 8%, compared to the three months ended March 31, 2024. The increase in revenues was driven by the addition of our Diamond Products Division ("DPD") in August of 2024. The increase in Western Hemisphere operating income was not meaningful quarter over quarter due to higher personal related costs as a result of acquisitions.

Eastern Hemisphere

Eastern Hemisphere revenue was $5.1 million for the three months ended March 31, 2025, an increase of $3.8 million, or 305%, compared to the three months ended March 31, 2024. The increase was primarily a result of acquisitions to rental businesses located within the Eastern Hemisphere. Eastern Hemisphere operating loss was $0.2 million for the three months ended March 31, 2025, a decrease of $0.6 million, or 145% compared to the three months ended March 31, 2024. The decrease was driven by increased headcount as a result of the acquisitions and an activity decline seen in the Middle Eastern market.

Corporate and Other

Corporate and other represents various expenses not directly attributable to our segments as well as expenses not used in the measurement of segment profitability. Corporate and other expenses for the three months ended March 31, 2025 were $10.1 million, an increase of $1.3 million or 15%, compared to the three months ended March 31, 2024. The increase was primarily attributable to increased depreciation expense as a result of acquired property, plant, and equipment balances.

Interest expense, net

Interest expense net was $1.3 million for the three months ended March 31, 2025, an increase of $1.1 million, or 619%, compared to the three months ended March 31, 2024. The increase was primarily a result of interest on the term loan, entered into in March 2024, interest on amounts drawn on the credit facility, and interest on the promissory note, entered into in September 2024.

Other income (expense), net

Other income (expense), net represents various one time and non-recurring expenses Other income (expense), net was $1.9 million for the three months ended March 31, 2025, an increase of $0.8 million, or 72%, compared to three months ended March 31, 2024. This increase was driven by software implementation costs and additional transaction costs incurred during the three months ended March 31, 2025.

Non-GAAP Financial Measures

To supplement our unaudited interim consolidated financial statements, which are prepared and presented in accordance with U.S GAAP, we use certain non-GAAP financial measures, as described below, to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with U.S. GAAP.

We use the non-GAAP financial measure Adjusted EBITDA, which is defined as net income (loss); excluding interest income; interest expense; other income (expense), net; income tax benefit (expense); depreciation and amortization; and certain other non-cash or non-recurring items impacting net income (loss) from time to time. We believe that Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude in Adjusted EBITDA.

This non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures compared to the closest comparable GAAP measure. Some of these limitations are that:

• Adjusted EBITDA excludes certain recurring, non-cash charges such as depreciation of fixed assets and amortization of acquired intangible assets and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA excludes income tax benefit (expense).

The following tables present a reconciliation of Adjusted EBITDA to net income (loss) for the three months ended March 31, 2025 and 2024 (non-recurring transaction expenses recorded to other (income) expense are presented separately within Adjusted EBITDA):

(In thousands)

Liquidity and Capital Resources

At March 31, 2025, we had $2.8 million of cash and cash equivalents. Our primary sources of liquidity and capital resources are cash on hand, cash flows generated by operating activities, the term loan, and, if necessary, borrowings under the Credit Facility Agreement. We may use additional cash generated to execute strategic acquisitions or for general corporate purposes. We believe that our existing cash on hand, cash generated from operations and available borrowings under the Credit Facility Agreement will be sufficient for at least the next 12 months to meet working capital requirements and anticipated capital expenditures.

Credit Facility Agreement

Reference is made to the disclosure set forth under the heading “Revolving Credit Facility” in Note 8, Revolving Credit Facility, of the notes to the unaudited condensed consolidated financial statements included elsewhere in this Report (the ”Interim Financial Statements").

Capital Expenditures

Our capital expenditure relates to capital additions or improvements that add to our rental or repair capacity or extend the useful life of our drilling tools and related infrastructure. Also, our capital expenditures replace tools that are lost or damaged by a customer and these are funded by a rental tool recovery sale amount from the customer. We regularly incur capital expenditures on an on-going basis in order to (i) increase or maintain our rental tool fleet and equipment, (ii) extend the useful life of our rental tools and equipment and (iii) acquire or upgrade computer hardware and software. The amount of our capital expenditures is influenced by, among other things, demand for our services, recovery of lost or damaged tools, schedules for refurbishing our various rental tools and equipment, cash flow generated by our operations, expected rates of return and cash required for other purposes.

Contractual Obligations and Commitments

Our material contractual obligations arise from leases of facilities and vehicles under non-cancelable operating leases agreements. See Note 15, Commitments and contingencies, of the notes to the Interim Financial Statements.

Tax Obligations

We currently have available federal net operating loss carryforwards to offset our federal taxable income, and we expect that these carryforwards will substantially reduce our cash tax payments over the next several years. If we forfeit these carryforwards for any reason or deplete them faster than anticipated, our cash tax obligations could increase substantially. For additional information, see Note 9, Income Taxes, of the notes to the Interim Financial Statements.

Cash Flows

The following table sets forth our cash flows for the period indicated:

(In thousands)

Cash Flows (Used In) Provided by Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2025 was $2.4 million, the driver being a net loss of $1.7 million offset by non-cash charges of $7.2 million and a decrease in net working capital of $3.1 million. We will continue to evaluate our capital requirements for both short-term and long-term liquidity needs, which could be affected by various risks and uncertainties, including, but not limited to, the effects of the current inflationary environment, rising interest rates, and other risks detailed in the section of this Report entitled “Risk Factors.”

Net cash provided by operating activities for the three months ended March 31, 2024 was $3.3 million, the driver being net income of $3.1 million, including non-cash charges of $3.9 million, offset by a decrease in net working capital of $3.7 million.

Cash Flows (Used In) Provided by Investing Activities

Net cash used in investing activities for the three months ended March 31, 2025 was $7.3 million. Purchases of property, plant, and equipment of $5.0 million, purchases of intangible assets of $0.7 million, and the acquisition of Titan for $5.6 million were partially offset by proceeds from rental tool recovery sales of $4.0 million.

Net cash used in investing activities for the three months ended March 31, 2024 was $19.6 million. Purchases of property, plant, and equipment of $6.2 million and the acquisition of Deep Casing Tools for $18.3 million were partially offset by proceeds from rental tool recovery sales of $5.0 million.

Cash Flows (Used In) Provided by Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2025 was $1.4 million resulting from net proceeds on from the revolving line of credit of $2.9 million, offset by payments on the term loan of $1.3 million and payments on the Promissory Note of $0.2 million.

Net cash used in financing activities for the three months ended March 31, 2024 was $24.6 million resulting from proceeds on the term loan on $25.0 million, offset by payments of deferred financing fees of $0.3 million.

Critical Accounting Policies and Estimates

The Interim Financial Statements included in this Report have been prepared in accordance with U.S. GAAP. The preparation of these Interim Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities. We also make estimates and assumptions that affect the reported amounts and related disclosures for the periods presented. Our estimates are based on our historical experience and other factors that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly. Additionally, changes in assumptions, estimates or assessments due to unforeseen events or other causes could have a material impact on our financial position or results of operations.

For a description of our critical accounting policies and estimates, see our Annual Report on Form 10-K for the fiscal year ended December 31, 2024.

Recently Issued and Adopted Accounting Standards

A discussion of recent accounting pronouncements is included in Note 1, Summary of significant accounting policies, to the Interim Financial Statements included elsewhere in this report.

JOBS Act Accounting Election

In April 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” may take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Therefore, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected to avail ourselves of this extended transition period and, as a result, we will not adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies. In addition, as an emerging growth company, we may take advantage of certain reduced disclosure and other requirements that are otherwise applicable generally to public companies. DTI will take advantage of these exemptions until such earlier time that it is no longer an emerging growth company. DTI would cease to be an emerging growth company on the date that is the earliest of (i) the last day of the fiscal year following the fifth anniversary of the date of the completion of this offering (ii) the last day of the fiscal year in which its total annual gross revenue is equal to or more than $1.23 billion (iii) the date on which it has issued more than $1.0 billion in nonconvertible debt during the previous three years or (iv) the date on which it is deemed to be a large accelerated filer under the rules of the Securities and Exchange Commission.

Credit risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. We maintain cash and cash equivalents with major and reputable financial institutions. Deposits held with the financial institutions may exceed the amount of insurance provided by the Canadian Deposit Insurance Corporation and the Federal Deposit Insurance Corporation on such deposits but may be redeemed upon demand. We perform periodic evaluations of the relative credit standing of the financial institutions. With respect to accounts receivable, we monitor the credit quality of our customers as well as maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments.

Concentration risk

During the three months ended March 31, 2025 and 2024, 29.0% and 30.0%, respectively of our total revenue was earned from two customers. Amounts due from these customers included in accounts receivable at March 31, 2025 and December 31, 2024 were approximately $5.3 million and $5.4 million, respectively.

Foreign currency risk

Our customers are primarily located in the United States, Canada and throughout Europe and the Middle East. Therefore, foreign exchange risk exposures arise from transactions denominated in currencies other than the United States dollar, which is our functional and reporting currency. To date, a majority of our sales have been denominated in United States, British pound sterling ("GBP") and Canadian dollars. As we expand our presence in international markets, our results of operations and cash flows may increasingly be subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. To date, we have not entered into any hedging arrangements to minimize the impact of these fluctuations in the exchange rates. We will periodically reassess our approach to manage our risk relating to fluctuations in currency rates.

We do not believe that foreign currency risk had a material effect on our business, financial condition, or results of operations during the periods presented.

Inflation Risk

Rising international tariffs, including any tariffs applied to goods traded between the U.S. and China, the U.S. and Mexico and the U.S. and Canada, could materially and adversely affect our business and results of operations. The U.S. government has previously and now again recently imposed tariffs on certain foreign goods from a variety of countries and regions that it perceives as engaging in unfair trade practices. Foreign governments have imposed, and may impose in the future, retaliatory tariffs on goods that their countries import from the U.S. Such changes can make it difficult or costly for us to do business in, or import our products from, those countries.

With certain tariff exclusions ending and with any new tariffs, it could further negatively impact global trade and economic conditions in many of the regions where we do business. It may also adversely impact demand for our products in certain locations. It may be time-consuming and costly for us to modify our business operations to adapt to or comply with such tariffs. If we become unable to recover a substantial portion of any increased tariff related costs, the recent or increased international tariffs could materially and adversely affect our business, financial condition and results of operations.

Cybersecurity Risk

We continue to monitor technology hardware and software solutions, regular testing of the resiliency of our systems including penetration and disaster recovery testing as well as regular training sessions on cybersecurity risks and mitigation strategies. We have established an incident response plan and team to take steps it determines are appropriate to contain, mitigate and remediate a cybersecurity incident and to respond to the associated business, legal and reputation risks. There is no assurance that these efforts will fully mitigate cybersecurity risk and mitigation efforts are not an assurance that no cybersecurity incidents will occur.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures in effect as of March 31, 2025, the end of the period covered by this Report. As a result of management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of March 31, 2025, or as of the date of the filing of this Report.

Our disclosure controls and procedures were not effective as of March 31, 2025 because all findings in connection with our preparation and the audit of our consolidated financial statements as of and for the year ended December 31, 2022 and December 31, 2023, have not been fully remediated despite ongoing projects and improvements made in the current year. As a result, we were not able to rely upon the disclosure controls and procedures that were in place as of March 31, 2025 and we continue to have a material weakness in our internal control over financial reporting. This material weakness is described in more detail below.

Prior to going public, we had been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. In connection with our preparation and the audit of our consolidated financial statements as of and for the year ended December 31, 2023, we identified deficiencies in the design or operation of our internal controls to be a material weakness relating to inadequate documentation and monitoring of information technology (“IT”) general controls and cybersecurity processes within the Company’s IT environment, including access controls and segregation of duties between key IT functions.

We have made progress towards remediation of the remaining material weakness with the following steps:

• Developing a plan to monitor and assess the established control environment;
• Developing and implementing a periodic testing plan to assess the design of implemented controls covering all material business processes and systems;
• Executing the testing plan as designed; and
• Reporting results of testing to management and the Board of Directors.

Through the work performed in 2024, management has identified the below areas for improvement to fully remediate the fourth material weakness:

• Employees should be trained on Information Produced by Entity (IPE) and IPE procedures should be built into internal controls and tested;
• Provide greater precision of evidence related to the performance of both the business process and IT controls;
• Continue to implement, refine and assess controls over gaps identified from previous years and during our remediation efforts; and
• Monitor the execution of IT and business process controls throughout the year.

The process of maintaining effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. The elements of our remediation plan can only be accomplished over time, and we can offer no assurance that these initiatives will ultimately have the intended effects.

Changes in Internal Control over Financial Reporting

On March 15, 2024, we acquired Deep Casing Tools. As the acquisition date has exceeded one year, we are now required to assess on the internal controls over financial reporting. Additionally, on January 2, 2025, we completed the acquisition of Titan Tools. We are permitted to omit an assessment of an acquired business' internal control over financial reporting from our assessment of internal control over financial reporting for a period not to exceed one year from the date of the acquisition. Accordingly, we have excluded the internal control over financial reporting of Titan Tools from management's assessment of internal control over financial reporting as of March 31, 2025.

Our Annual Report filed with the SEC on March 14, 2025, describes important risk factors that could cause our business, financial condition, results of operations and growth prospects to differ materially from those indicated or suggested by forward-looking statements made in this Report or presented elsewhere by management from time to time. There have been no material changes in the risk factors that appear in the Annual Report. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business.