Drilling Tools International (DTI) - 2023 Q3 - Quarterly Report

Cautionary Note Regarding Forward-Looking Statements This section highlights the inherent uncertainties and risks associated with forward-looking statements, which are based on current expectations - The report contains forward-looking statements regarding future expectations, hopes, beliefs, intentions, or strategies, identified by words like "anticipate," "believe," "estimate," "expect," "plan," "project," "will," and similar expressions[8] - Key factors influencing forward-looking statements include demand for products and services (influenced by oil and gas activity), customer retention, ability to source tools, market competitiveness, acquisition integration, new technology adoption, potential liabilities, global conflicts (Russia-Ukraine, Israel-Hamas), and regulatory impacts[8][11] - These statements are based on current expectations and beliefs, but actual results may differ materially due to various risks and uncertainties, including those detailed in Part II, Item 1A. "Risk Factors"[9] PART I. Financial Information This part presents the Company's unaudited condensed consolidated financial statements and management's discussion and analysis Item 1. Condensed Consolidated Financial Statements (Unaudited) This section presents the unaudited condensed consolidated financial statements, including balance sheets, income statements, statements of changes in equity, and cash flows, along with detailed notes explaining significant accounting policies, the impact of the recent merger, and other financial details for the periods ended September 30, 2023, and December 31, 2022 Condensed Consolidated Balance Sheets This section presents the Company's condensed consolidated balance sheets, detailing assets, liabilities, and equity as of September 30, 2023, and December 31, 2022 | (In thousands) | September 30, 2023 (Unaudited) | December 31, 2022 (Audited) | | :--------------- | :----------------------------- | :-------------------------- | | ASSETS | | | | Total current assets | $45,619 | $40,155 | | Property, plant and equipment, net | $64,569 | $44,154 | | Total assets | $131,436 | $105,218 | | LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY | | | | Total current liabilities | $23,893 | $36,240 | | Total liabilities | $46,572 | $56,116 | | Redeemable convertible preferred stock | $— | $17,878 | | Total shareholders' equity | $84,864 | $31,224 | | Total liabilities, redeemable convertible preferred stock and shareholders' equity | $131,436 | $105,218 | - Total assets increased by $26.2 million (24.9%) from December 31, 2022, to September 30, 2023, primarily driven by an increase in property, plant and equipment, net[13] - Total liabilities decreased by $9.5 million (17.0%) due to a significant reduction in the revolving line of credit balance from $18.3 million to zero, partially offset by increases in accrued expenses and deferred tax liabilities[13] - Shareholders' equity significantly increased by $53.6 million (171.7%) due to the conversion of redeemable convertible preferred stock to common stock and additional paid-in capital from the Merger and PIPE Financing[13] Condensed Consolidated Statements of Income and Comprehensive Income This section presents the Company's condensed consolidated statements of income and comprehensive income, detailing revenue, operating income, net income, and earnings per share for the three and nine months ended September 30, 2023, and 2022 | (In thousands, except share and per share data) | Three months ended September 30, 2023 | Three months ended September 30, 2022 | Nine months ended September 30, 2023 | Nine months ended September 30, 2022 | | :---------------------------------------------- | :------------------------------------ | :------------------------------------ | :----------------------------------- | :----------------------------------- | | Revenue, net | $38,138 | $36,547 | $116,845 | $92,896 | | Operating income | $7,132 | $8,077 | $23,371 | $17,327 | | Net income | $4,287 | $6,996 | $10,925 | $14,263 | | Basic earnings per share | $0.14 | $0.56 | $0.57 | $1.12 | | Diluted earnings per share | $0.14 | $0.36 | $0.46 | $0.72 | - Total revenue, net, increased by $1.6 million (4.3%) for the three months ended September 30, 2023, compared to the same period in 2022, and by $23.9 million (25.8%) for the nine months ended September 30, 2023, compared to the same period in 2022[15] - Net income decreased by $2.7 million (38.7%) for the three months ended September 30, 2023, and by $3.3 million (23.4%) for the nine months ended September 30, 2023, primarily due to higher operating costs, increased other expenses (including transaction fees and stock-based compensation related to the Merger), and higher income tax expense[15] - Diluted EPS decreased significantly from $0.36 to $0.14 for the three months and from $0.72 to $0.46 for the nine months ended September 30, 2023, reflecting lower net income and a substantial increase in diluted weighted-average common shares outstanding due to the Merger[15] Condensed Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Shareholders' Equity This section details the changes in the Company's redeemable convertible preferred stock and shareholders' equity, particularly highlighting the impact of the Merger on the equity structure - The Merger on June 20, 2023, led to the cancellation of all redeemable convertible preferred stock and its exchange for DTIC common stock, significantly impacting the equity structure[19] - Total shareholders' equity increased from $31.2 million at December 31, 2022, to $84.9 million at September 30, 2023, primarily due to the Merger, PIPE Financing, and stock-based compensation[19] | (In thousands, except share data) | Redeemable Convertible Preferred Stock (Amount) | Common Stock (Amount) | Additional Paid-In Capital | Accumulated Deficit | Total Shareholders' Equity | | :-------------------------------- | :---------------------------------------------- | :-------------------- | :------------------------- | :------------------ | :------------------------- | | BALANCE, December 31, 2022 | $17,878 | $1 | $52,388 | $(21,054) | $31,224 | | BALANCE, September 30, 2023 | $— | $3 | $95,218 | $(10,129) | $84,864 | Condensed Consolidated Statements of Cash Flows This section presents the Company's condensed consolidated statements of cash flows, summarizing cash generated from or used in operating, investing, and financing activities | (In thousands) | Nine Months Ended September 30, 2023 | Nine Months Ended September 30, 2022 | | :--------------- | :----------------------------------- | :----------------------------------- | | Net cash flows from operating activities | $17,484 | $5,641 | | Net cash from investing activities | $(20,027) | $1,073 | | Net cash from financing activities | $4,297 | $(5,927) | | Net Change in Cash | $1,637 | $701 | | Cash at End of Period | $3,989 | $753 | - Net cash from operating activities significantly increased to $17.5 million for the nine months ended September 30, 2023, from $5.6 million in the prior year, driven by higher net income and non-cash adjustments[22][232] - Net cash used in investing activities increased to $20.0 million in 2023 from net cash provided of $1.1 million in 2022, primarily due to a substantial increase in purchases of property, plant, and equipment[22][233][234] - Net cash from financing activities turned positive at $4.3 million in 2023, compared to net cash used of $5.9 million in 2022, largely due to proceeds from the Merger and PIPE Financing, partially offset by a net decrease in revolving line of credit[22][235][236] Notes to Condensed Consolidated Financial Statements (Unaudited) This section provides detailed explanations of the Company's significant accounting policies, the impact of the recent merger, and other financial details NOTE 1 – Summary of Significant Accounting Policies This note outlines the Company's business operations, the impact of the recent merger, key revenue recognition policies, and segment reporting - Drilling Tools International Corporation (DTIC) manufactures, rents, inspects, and refurbishes downhole drilling tools for the oil and natural gas industry, operating in the U.S. and Canada[23][25] - The Company completed a merger transaction on June 20, 2023, with ROC Energy Acquisition Corp., resulting in DTIC's common stock trading on Nasdaq under 'DTI'[24] - Revenue is primarily derived from tool rental services (operating leases, recognized straight-line) and product sales (recognized at point of control transfer, e.g., for damaged/lost tools or made-to-order products)[38][39][40][41][45][46][48] - The Company operates in one operating and reportable segment, with 91-92% of total revenues generated within the United States for the three and nine months ended September 30, 2023 and 2022[50][103] Allowance for Doubtful Accounts | As of | Amount (in thousands) | | :---------------- | :-------------------- | | September 30, 2023 | $1,800 | | December 31, 2022 | $1,500 | NOTE 2 - Merger This note details the merger transaction, its accounting treatment, and the resulting changes in the Company's equity structure - The merger between Drilling Tools International Holdings, Inc. (DTIH) and ROC Energy Acquisition Corp. (ROC) was completed on June 20, 2023, with ROC changing its name to Drilling Tools International Corporation (DTIC)[105][156] - The merger was accounted for as a reverse recapitalization, treating ROC as the acquired company for financial reporting purposes, with its net assets recorded at historical cost[107] - The transaction resulted in the issuance of 29,768,568 shares of DTIC Common Stock, including exchanges for DTIH common and preferred stock, conversion of ROC rights, PIPE Financing, and stock-based compensation[105][108][109] - Proceeds from the Merger and PIPE Financing, net of transaction costs, totaled $23.2 million[106] NOTE 3 – Investments – Equity Securities This note provides details on the Company's equity securities investments, including their cost, unrealized gains or losses, and fair value | (In thousands) | Cost | Unrealized Loss | Fair Value | | :--------------- | :--- | :-------------- | :--------- | | September 30, 2023 | $999 | $(4) | $995 | | (In thousands) | Cost | Unrealized Gain | Fair Value | | :--------------- | :--- | :-------------- | :--------- | | December 31, 2022 | $999 | $144 | $1,143 | - Unrealized holding losses on equity securities were approximately $0.5 million for the three months ended September 30, 2023, and $0.1 million for the nine months ended September 30, 2023[110] NOTE 4 – Balance Sheet Details - Current Assets and Current Liabilities This note provides a detailed breakdown of the Company's inventories, prepaid expenses, other current assets, accrued expenses, and other current liabilities Inventories, net (in thousands) | Component | September 30, 2023 | December 31, 2022 | | :------------------ | :----------------- | :---------------- | | Raw materials | $6,638 | $3,377 | | Finished goods | $108 | $115 | | Total inventories | $6,746 | $3,492 | | Allowance for obsolete inventory | $(160) | $(211) | | Inventories, net | $6,586 | $3,281 | Prepaid expenses and other current assets (in thousands) | Component | September 30, 2023 | December 31, 2022 | | :------------------------ | :----------------- | :---------------- | | ERC benefits receivable | $— | $2,117 | | Deposits on inventory | $2,040 | $680 | | Prepaid income tax | $565 | $— | | Prepaid insurance | $1,621 | $358 | | Interest rate swap asset | $— | $476 | | Total | $4,976 | $4,381 | Accrued expenses and other current liabilities (in thousands) | Component | September 30, 2023 | December 31, 2022 | | :-------------------------------------- | :----------------- | :---------------- | | Accrued compensation and related benefits | $5,306 | $3,392 | | Accrued transaction advisory fees | $1,500 | $— | | Income tax payable | $2,129 | $1,780 | | Total | $11,864 | $7,299 | NOTE 5 – Property, Plant and Equipment, Net This note provides details on the Company's property, plant, and equipment, net, including changes in rental tools and equipment and depreciation expense | (In thousands) | September 30, 2023 | December 31, 2022 | | :----------------------------- | :----------------- | :---------------- | | Rental tools and equipment | $186,042 | $160,973 | | Total property, plant and equipment | $195,834 | $169,682 | | Less: accumulated depreciation | $(131,265) | $(125,537) |\ | Property, plant and equipment, net | $64,569 | $44,154 | - Property, plant and equipment, net, increased by $20.4 million (46.2%) from December 31, 2022, to September 30, 2023, primarily due to increased investment in rental tools and equipment[114] - Total depreciation expense for the three months ended September 30, 2023, was $5.3 million, up from $4.8 million in 2022, and for the nine months, it was $15.0 million, up from $14.7 million in 2022[115] NOTE 6 – Intangible Assets, Net This note provides details on the Company's intangible assets, net, including total assets, accumulated amortization, and amortization expense | (In thousands) | September 30, 2023 | December 31, 2022 | | :----------------------- | :----------------- | :---------------- | | Total intangible assets | $1,550 | $1,550 | | Less: accumulated amortization | $(1,322) | $(1,287) | | Intangible assets, net | $228 | $263 | - Intangible assets, net, decreased slightly from $263 thousand at December 31, 2022, to $228 thousand at September 30, 2023, due to ongoing amortization[117] - Amortization expense was approximately $12 thousand for the three months ended September 30, 2023, and $35 thousand for the nine months ended September 30, 2023[117] NOTE 7 – Revolving Credit Facility This note describes the Company's revolving credit facility, including its maximum borrowing amount, recent amendments, and compliance with covenants - The Company has a Credit Facility with PNC Bank, National Association, providing a revolving line of credit with a maximum borrowing amount of $60.0 million[118] - On June 20, 2023, the Credit Facility Agreement was amended, modifying terms, removing unfunded capital expenditure requirements, and changing the legal debtor to DTIC[119] - As of September 30, 2023, there were no amounts drawn against the line of credit, and the Company was in compliance with all restrictive covenants[120][121] - The Credit Facility includes a contingent interest embedded derivative liability (Default Rate Derivative) that is bifurcated and accounted for at fair value, which was negligible as of September 30, 2023, and December 31, 2022[123][124] NOTE 8 – Income Taxes This note provides details on the Company's income tax expense and effective tax rates, explaining the factors contributing to differences from the federal statutory rate Income Tax Expense (in thousands) | Period | Income Tax Expense | | :-------------------------------------- | :----------------- | | Three months ended September 30, 2023 | $2,102 | | Three months ended September 30, 2022 | $626 | | Nine months ended September 30, 2023 | $5,201 | | Nine months ended September 30, 2022 | $2,846 | Effective Tax Rate | Period | Effective Tax Rate | | :-------------------------------------- | :----------------- | | Three months ended September 30, 2023 | 32.9% | | Three months ended September 30, 2022 | 8.2% | | Nine months ended September 30, 2023 | 32.3% | | Nine months ended September 30, 2022 | 16.6% | - The effective tax rates differed from the Federal Statutory rate of 21.0% primarily due to permanent differences, including disallowed transaction expenses, state taxes, and foreign income taxes[126] - There was no change to the valuation allowance for deferred tax assets during the periods presented, and the Company has no uncertain tax positions[127][128] NOTE 9 – Stock-Based Compensation This note describes the Company's stock-based compensation plans, including the 2023 Omnibus Incentive Plan, the exchange of stock options, and recognized compensation expenses - The Company adopted the 2023 Omnibus Incentive Plan on June 20, 2023, allowing for the issuance of shares up to 10% of outstanding common stock, with an automatic annual increase of 3%[128] - In connection with the Merger, all outstanding DTIH stock options were exchanged for 2,361,722 Company Options to purchase DTIC Common Stock, with adjusted exercise prices and identical vesting schedules[130] - During the nine months ended September 30, 2023, the Company recognized $1.7 million in stock-based compensation expense due to the accelerated vesting of performance-based stock options upon Merger completion[134] - An additional $2.3 million in stock-based compensation expense was recognized for the nine months ended September 30, 2023, related to the issuance of shares under a transaction services agreement with HHLLC[135] NOTE 10 – Other Expenses, Net This note details the components of other expenses, net, including stock-based compensation, transaction fees, and interest income, highlighting significant changes Other Expense, Net (in thousands) | Component | Three months ended Sep 30, 2023 | Three months ended Sep 30, 2022 | Nine months ended Sep 30, 2023 | Nine months ended Sep 30, 2022 | | :------------------ | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | HHLLC stock-based compensation | $— | $— | $(2,339) | $— | | Transaction fees | $(124) | $— | $(3,623) | $— | | Other, net | $(11) | $(114) | $(256) | $(209) | | Interest income | $— | $— | $48 | $— | | Total other expense, net | $(135) | $(114) | $(6,170) | $(209) | - Total other expense, net, increased significantly to $6.2 million for the nine months ended September 30, 2023, from $0.2 million in the prior year, primarily due to $6.0 million in transaction fees and HHLLC stock-based compensation related to the Business Combination[137][218] NOTE 11 – Related Party Transactions This note describes the Company's transactions with related parties, including management fees, rent expenses, and the settlement of convertible promissory notes Management Fees Paid to Hicks Holdings Operating LLC (in thousands) | Period | Management Fees | | :-------------------------------------- | :-------------- | | Three months ended September 30, 2023 | $300 | | Three months ended September 30, 2022 | $200 | | Nine months ended September 30, 2023 | $900 | | Nine months ended September 30, 2022 | $400 | - The Company paid rent expense of $13 thousand for both the three months ended September 30, 2023 and 2022, and $38 thousand for both the nine months ended September 30, 2023 and 2022, to Cree Investments, LLC, a shareholder[139] - Convertible promissory notes totaling $4.2 million issued to an affiliate of the ROC Sponsor were paid off upon the Merger through the issuance of DTIC Common Stock in connection with the PIPE Financing[141] NOTE 12 – Leases This note provides information on the Company's lease agreements, including total lease costs, remaining lease terms, discount rates, and future undiscounted lease payments Total Lease Cost (in thousands) | Period | Total Lease Cost | | :-------------------------------------- | :--------------- | | Three months ended September 30, 2023 | $1,654 | | Three months ended September 30, 2022 | $1,524 | | Nine months ended September 30, 2023 | $4,855 | | Nine months ended September 30, 2022 | $4,518 | - The Company leases various facilities and vehicles under noncancelable operating lease agreements, with remaining lease terms ranging from 1 month to 14 years[143] - The weighted-average remaining lease term is 6.65 years, and the weighted average discount rate is 5.79% as of September 30, 2023[145] Future Undiscounted Lease Payments (in thousands) | Year | Amount | | :-------- | :----- | | 2023 | $1,283 | | 2024 | $4,835 | | 2025 | $4,036 | | 2026 | $3,476 | | 2027 | $2,439 | | Thereafter | $7,545 | | Total lease payments | $23,614 | NOTE 13 – Employee Benefits This note describes the Company's 401(k) defined contribution plan and the associated expenses recognized for employee benefits - The Company has a 401(k) defined contribution plan, with a 150% match on the first 3% of employee contributions (up to $2 thousand per participant annually) reinstated on January 1, 2022[146] - Total expense for the 401(k) plan was approximately $0.1 million for both the three months ended September 30, 2023 and 2022, and $0.4 million for both the nine months ended September 30, 2023 and 2022[146] NOTE 14 – Commitments and Contingencies This note outlines the Company's involvement in legal proceedings, indemnification obligations, and ongoing management fee commitments - The Company is involved in legal proceedings, including a petition against Premium Tools LLC by Exco Resources Inc. and a former employee's FLSA claim for overtime payment[148][150] - Management believes the ultimate resolution of these legal matters will not have a material adverse effect on the Company's financial statements[150] - The Company has indemnification obligations to third parties for certain losses, but the maximum potential liability is not determinable due to limited history and unique circumstances[149] - A monthly management fee is paid to a shareholder, based on a percentage of the Company's trailing twelve months' earnings before interest, taxes, and accumulated depreciation[151] NOTE 15 – Earnings Per Share This note provides a detailed breakdown of basic and diluted earnings per share calculations, including the impact of the Merger on weighted-average common shares outstanding Basic and Diluted EPS (in thousands, except share and per share data) | Metric | Three months ended Sep 30, 2023 | Three months ended Sep 30, 2022 | Nine months ended Sep 30, 2023 | Nine months ended Sep 30, 2022 | | :-------------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Net income attributable to common shareholders — basic | $4,287 | $6,702 | $10,611 | $13,380 | | Basic earnings per share | $0.14 | $0.56 | $0.57 | $1.12 | | Diluted earnings per share | $0.14 | $0.36 | $0.46 | $0.72 | | Weighted-average common shares outstanding — basic | 29,768,568 | 11,951,137 | 18,608,708 | 11,951,137 | | Weighted-average common shares outstanding — diluted | 30,043,546 | 19,677,507 | 23,554,593 | 19,677,507 | - Basic and diluted EPS decreased significantly in 2023 compared to 2022, primarily due to lower net income and a substantial increase in weighted-average common shares outstanding following the Merger[154] - Potentially dilutive securities, including time-based and performance-based stock options, were considered in diluted EPS calculations, with some excluded if anti-dilutive[154] NOTE 16 – Subsequent Events This note confirms that no subsequent events requiring disclosure occurred after the reporting period through the date the financial statements were issued - There were no subsequent events reported after September 30, 2023, through the date the financial statements were available to be issued[155] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides a detailed discussion and analysis of the Company's financial condition and results of operations, highlighting key performance drivers, market factors, recent trends, and a comparison of financial results for the three and nine months ended September 30, 2023, and 2022. It also includes non-GAAP financial measures and information on liquidity and capital resources Overview This section provides an overview of Drilling Tools International Corporation's business, its operations, and key financial highlights for the reported periods - Drilling Tools International Corporation (DTIC) is a leading oilfield services company that rents downhole drilling tools for horizontal and directional drilling in the oil and natural gas industry[159] - The Company operates from 16 service centers in North America and four international locations, maintaining a large fleet of rental equipment[159] Key Financial Highlights (in thousands) | Metric | Three months ended Sep 30, 2023 | Three months ended Sep 30, 2022 | Nine months ended Sep 30, 2023 | Nine months ended Sep 30, 2022 | | :-------------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Total revenue, net | $38,138 | $36,547 | $116,845 | $92,896 | | Net income | $4,287 | $6,996 | $10,925 | $14,263 | | Cash and cash equivalents (as of Sep 30) | $4,000 | $753 | N/A | N/A | | Accumulated deficit (as of Sep 30) | $(10,100) | $(27,871) | N/A | N/A | Market Factors This section discusses the market factors influencing the Company's demand for services and products, primarily driven by oil and gas industry activity and commodity prices - Demand for the Company's services and products is primarily driven by the overall activity level in the oil and gas industry, including active drilling rigs, wells drilled, completions, and capital spending by oil and natural gas companies[162] - Tool rental revenues depend on drilling activity and market share, while product sales revenues are influenced by lost or damaged tools and the need for drilling contractors to replace aging products[163] - These factors are influenced by investor sentiment, capital availability, and volatile global oil and gas prices[162] Recent Developments and Trends This section outlines recent developments and trends in the oil and natural gas markets, including commodity price volatility, geopolitical conflicts, drilling activity, and inflationary pressures - Oil prices (WTI) have been volatile, declining to $67 per barrel in March 2023 due to banking turmoil, then recovering to approximately $89 per barrel by September 30, 2023, following OPEC+ production cuts[166] - Natural gas prices (Henry Hub) decreased from $7.88/MMBtu in September 2022 to $2.64/MMBtu in September 2023, despite some increases in Q3 2023 due to weather-driven demand and inflationary pressures[168] - The ongoing conflicts in Ukraine and Israel-Hamas contribute to uncertainty in oil and natural gas markets, potentially causing stock price volatility, supply chain disruptions, and higher inflation[169] - U.S. onshore drilling activity increased despite commodity price volatility, with the weekly average rig count at 627 for Q3 2023 and 689 for the nine months ended September 30, 2023[170] - The Company is experiencing global inflation impacts on personnel and goods/services costs, but has been able to offset these with customer price increases to date[171] How We Evaluate Our Operations This section describes the key financial and non-GAAP measures the Company uses to evaluate its business performance, including revenue, Adjusted EBITDA, and Free Cash Flow - The Company uses revenue, net, and non-GAAP measures such as Adjusted EBITDA and Free Cash Flow to evaluate business performance[173] - Adjusted EBITDA is used to analyze core operations by excluding non-cash and non-recurring items[175] - Free Cash Flow, defined as net cash from operating activities minus capital expenditures, assesses the ability to fund capital programs, service debt, and pay dividends[176] Key Components of Results of Operations This section outlines the key components of the Company's results of operations, including revenue generation, cost and expense categories, and other income and expense items - Revenue is generated from tool rental services (operating leases, recognized straight-line) and product sales (for damaged/lost tools or made-to-order products)[179][180] - Costs and expenses include cost of revenue (direct and indirect expenses for tool rental and product sales), selling, general, and administrative (personnel, professional services, insurance, marketing), and depreciation and amortization[182][183][186][188][190] - The Company anticipates increases in total cost of tool rental and product sale revenue, selling and marketing expenses, and operating expenses due to growth and public company operations[184][187][189] - Other income (expense), net, includes interest income/expense, gain on property sales, unrealized gains/losses on securities, and miscellaneous items[191] Results of Operations This section provides a detailed comparison of the Company's financial results for the three and nine months ended September 30, 2023, and 2022, analyzing changes in revenue, costs, and expenses Comparison of the Three Months Ended September 30, 2023 and 2022 This section compares the Company's financial performance for the three months ended September 30, 2023, against the same period in 2022, detailing changes in revenue, costs, and other financial metrics Revenue, Net (in thousands) | (In thousands) | 2023 | 2022 | Change Amount | Change % | | :------------- | :------ | :------ | :------------ | :------- | | Tool rental | $29,361 | $26,837 | $2,524 | 9% | | Product sale | $8,777 | $9,710 | $(933) | (10)% | - Tool rental revenue increased by $2.5 million (9%) due to increased market activity and customer pricing, particularly in the Directional Tool Rentals (DTR) and Wellbore Optimization Tools (WOT) divisions[194] - Product sale revenue decreased by $0.9 million (10%) due to higher-than-average rental tool recovery events in the prior year[195] Costs and Expenses (in thousands) | (In thousands) | 2023 | 2022 | Change Amount | Change % | | :--------------------------------- | :------ | :------ | :------------ | :------- | | Cost of tool rental revenue | $7,956 | $7,586 | $370 | 5% | | Cost of product sale revenue | $1,195 | $1,372 | $(177) | (13)% | | Selling, general, and administrative expense | $16,552 | $14,692 | $1,860 | 13% | | Depreciation and amortization expense | $5,303 | $4,820 | $483 | 10% | - Selling, general, and administrative expense increased by $1.9 million (13%), driven by higher insurance, personnel-related, rent, and monitoring fees[200][202] - Interest expense, net, increased by $28 thousand (62%) due to increased amortization of deferred financing fees and the absence of an unrealized gain on interest rate swap, partially offset by no interest on the revolving line of credit[202] - Unrealized loss on equity securities increased by $0.1 million (34%) due to unfavorable market valuations[204] Comparison of the Nine Months Ended September 30, 2023 and 2022 This section compares the Company's financial performance for the nine months ended September 30, 2023, against the same period in 2022, detailing changes in revenue, costs, and other financial metrics Revenue, Net (in thousands) | (In thousands) | 2023 | 2022 | Change Amount | Change % | | :------------- | :------- | :------ | :------------ | :------- | | Tool rental | $90,639 | $70,277 | $20,362 | 29% | | Product sale | $26,206 | $22,619 | $3,587 | 16% | - Tool rental revenue increased by $20.4 million (29%) due to increased market activity and customer pricing, particularly in the WOT and Premium Tools (PTD) divisions[207] - Product sale revenue increased by $3.6 million (16%) due to increased market activity and customer pricing, impacting other products and services and rental tool recovery sales[208] Costs and Expenses (in thousands) | (In thousands) | 2023 | 2022 | Change Amount | Change % | | :--------------------------------- | :------- | :------ | :------------ | :------- | | Cost of tool rental revenue | $23,785 | $20,578 | $3,207 | 16% | | Cost of product sale revenue | $3,655 | $3,785 | $(130) | (3)% | | Selling, general, and administrative expense | $50,999 | $36,424 | $14,575 | 40% | | Depreciation and amortization expense | $15,035 | $14,782 | $253 | 2% | - Selling, general, and administrative expense increased by $14.6 million (40%), driven by higher personnel-related expenses, the absence of ERC benefits received in 2022, stock-based compensation from the Merger, and increased monitoring fees[212][213] - Interest expense, net, increased by $1.0 million (2327%) due to the settlement of the interest rate swap in July 2023, resulting in no unrealized gain compared to $0.9 million in 2022[215] - Other expense, net, increased by $6.0 million (2852%) primarily due to $6.0 million in transaction fees incurred with the Business Combination[218] Non-GAAP Financial Measures This section presents the Company's non-GAAP financial measures, Free Cash Flow and Adjusted EBITDA, along with their reconciliations to the most directly comparable GAAP measures - The Company uses non-GAAP financial measures, Free Cash Flow and Adjusted EBITDA, to supplement GAAP financial statements and provide insights into core operating performance and liquidity[219][220][221][222] Free Cash Flow Reconciliation (in thousands) | (In thousands) | Nine Months Ended September 30, 2023 | Nine Months Ended September 30, 2022 | | :--------------------------------- | :----------------------------------- | :----------------------------------- | | Net cash from operating activities | $17,484 | $5,641 | | Less: Purchases of property, plant and equipment | $(36,776) | $(16,235) | | Free Cash Flow | $(19,292) | $(10,594) | Adjusted EBITDA Reconciliation (in thousands) | (In thousands) | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | | :--------------------------------- | :------------------------------ | :------------------------------ | | Net income (loss) | $4,287 | $6,996 | | Add (deduct): Income tax expense | $2,102 | $626 | | Depreciation and amortization | $5,303 | $4,820 | | Interest expense, net | $73 | $45 | | Monitoring fees | $295 | $123 | | Gain on sale of property | $— | $(102) | | Unrealized (gain) loss on equity securities | $535 | $398 | | Transaction expense | $124 | $— | | Other expense, net | $10 | $114 | | Adjusted EBITDA | $12,729 | $13,020 | Adjusted EBITDA Reconciliation (in thousands) | (In thousands) | Nine Months Ended September 30, 2023 | Nine Months Ended September 30, 2022 | | :--------------------------------- | :----------------------------------- | :----------------------------------- | | Net income (loss) | $10,925 | $14,263 | | Add (deduct): Income tax expense | $5,201 | $2,846 | | Depreciation and amortization | $15,035 | $14,782 | | Interest (income) expense, net | $995 | $41 | | Stock option expense | $1,661 | $— | | Monitoring fees | $773 | $294 | | Gain on sale of property | $(68) | $(107) | | Unrealized gain on equity securities | $148 | $75 | | Transaction expense | $5,963 | $— | | ERC credit received | $— | $(4,272) | | Other expense, net | $207 | $209 | | Adjusted EBITDA | $40,840 | $28,131 | Liquidity and Capital Resources This section discusses the Company's liquidity position, primary sources of capital, capital expenditure strategy, and the impact of net operating loss carryforwards on tax obligations - As of September 30, 2023, the Company had $4.0 million in cash and cash equivalents, with primary liquidity sources being cash on hand, operating cash flows, and borrowings under the Credit Facility Agreement[226] - Management believes existing cash, operating cash flow, and available credit will be sufficient to meet working capital and capital expenditure requirements for at least the next 12 months[226] - Capital expenditures are incurred to increase/maintain rental/repair capacity, extend asset useful life, and acquire/upgrade IT, influenced by demand, tool recovery, refurbishment schedules, and cash flow[228] - The Company has federal net operating loss carryforwards expected to reduce cash tax payments, but forfeiture or faster depletion could increase tax obligations[230] Cash Flows This section summarizes the Company's cash flow activities, including net cash provided by operating, used in investing, and provided by financing activities for the nine months ended September 30, 2023, and 2022 Cash Flow Summary (in thousands) | (In thousands) | Nine Months Ended September 30, 2023 | Nine Months Ended September 30, 2022 | | :--------------------------------- | :----------------------------------- | :----------------------------------- | | Net cash provided by operating activities | $17,484 | $5,641 | | Net cash used in investing activities | $(20,027) | $1,073 | | Net cash provided by financing activities | $4,297 | $(5,927) | | Net increase in cash and cash equivalents | $1,637 | $701 | - Operating cash flow increased significantly in 2023 due to higher net income and non-cash adjustments, partially offset by cash outflows from accounts receivable, operating lease liabilities, and inventories[232] - Investing activities used $20.0 million in 2023, primarily for property, plant, and equipment purchases, compared to a net inflow in 2022[233][234] - Financing activities provided $4.3 million in 2023, driven by Merger and PIPE Financing proceeds, partially offset by a net decrease in revolving credit and deferred financing costs[235][236] Critical Accounting Policies and Estimates This section highlights the critical accounting policies and estimates that require significant management judgment and can materially impact the Company's financial statements - The preparation of financial statements requires management to make subjective estimates and judgments that are inherently uncertain and can materially impact financial condition and results of operations[237][238] - There have been no material changes to the Company's critical accounting policies and estimates compared to those described in the Current Report on Form 8-K filed on June 27, 2023[239] Recently Issued and Adopted Accounting Standards This section refers to the discussion of recent accounting pronouncements included in the notes to the interim financial statements - A discussion of recent accounting pronouncements is included in Note 1, Summary of significant accounting policies, of the Interim Financial Statements[240] JOBS Act Accounting Election This section explains the Company's election as an "emerging growth company" under the JOBS Act, allowing for an extended transition period for new accounting standards and reduced disclosure requirements - As an 'emerging growth company' under the JOBS Act, the Company has irrevocably elected to use the extended transition period for complying with new or revised accounting standards, delaying adoption until private companies are required to comply[241] - The Company will also take advantage of certain reduced disclosure and other requirements applicable to emerging growth companies until it no longer qualifies for this status[241] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section discusses the Company's exposure to various market risks, including credit risk, concentration risk, foreign currency risk, inflation risk, and cybersecurity risk, and outlines management's approach to monitoring and mitigating these risks - The Company faces credit risk primarily from cash and accounts receivable, with deposits potentially exceeding insured limits and an allowance for doubtful accounts maintained for customer receivables[242] - Concentration risk exists as two customers accounted for 28% of total revenue for both the three and nine months ended September 30, 2023, and significant amounts were due from these customers[244] - Foreign currency risk arises from transactions in currencies other than the U.S. dollar, mainly Canadian dollars, but the Company has not entered into hedging arrangements to date[245] - Inflation risk is expected to continue impacting costs, though the Company has offset this with price increases; however, sustained inflation and recession concerns could negatively affect demand[247] - Cybersecurity risk is addressed through controls, testing, training, and an incident response plan, though these efforts do not guarantee full mitigation[248] Item 4. Controls and Procedures This section reports on the effectiveness of the Company's disclosure controls and procedures and internal control over financial reporting, identifying a material weakness and outlining remediation efforts - Management, including the CEO and CFO, concluded that disclosure controls and procedures were not effective as of September 30, 2023, due to un-remediated findings from the 2022 audit[250][251] - A material weakness in internal control over financial reporting was identified, stemming from: (1) failure to promote effective internal control, (2) failure to develop effective risk assessment controls, (3) ineffective monitoring activities, and (4) inadequate documentation and monitoring of IT general controls and cybersecurity processes[252][253] - Remediation efforts include hiring qualified staff, implementing software to enhance the IT environment, and devoting senior management time to review procedures and enforce accountability[253] - No changes in internal control over financial reporting materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting during the most recently completed fiscal quarter[254] PART II. Other Information This part provides disclosures on legal proceedings, risk factors, equity sales, defaults, mine safety, and exhibits Item 1. Legal Proceedings This section refers to Note 14 of the consolidated financial statements for details on legal proceedings and commitments and contingencies - Information regarding legal proceedings is incorporated by reference from Note 14, 'Commitments and Contingencies,' in the consolidated financial statements[256] Item 1A. Risk Factors This section states that there have been no material changes to the risk factors previously disclosed in the Company's proxy statement/prospectus/consent solicitation statement filed with the SEC on May 12, 2023 - There have been no material changes in the risk factors from those described in the proxy statement/prospectus/consent solicitation statement filed on May 12, 2023[257] - Additional unknown or currently immaterial risks and uncertainties may also materially and adversely affect the business[257] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section reports that there were no unregistered sales of equity securities or use of proceeds during the period - No unregistered sales of equity securities or use of proceeds occurred during the reporting period[258] Item 3. Defaults Upon Senior Securities This section confirms that there were no defaults upon senior securities during the reporting period - There were no defaults upon senior securities during the reporting period[259] Item 4. Mine Safety Disclosures This section states that mine safety disclosures are not applicable to the Company - Mine safety disclosures are not applicable to the Company[260] Item 5. Other Information This section reports that no directors or officers adopted, terminated, or modified Rule 10b5-1 trading arrangements or non-Rule 10b5-1 trading arrangements during the quarter ended September 30, 2023 - No directors or officers adopted, terminated, or modified Rule 10b5-1 trading arrangements or non-Rule 10b5-1 trading arrangements during the quarter ended September 30, 2023[261] Item 6. Exhibits This section lists all exhibits filed as part of, or incorporated by reference into, the Form 10-Q report, including merger agreements, organizational documents, subscription agreements, credit facility agreements, and certifications - The report includes various exhibits such as the Agreement and Plan of Merger, Amended and Restated Certificate of Incorporation and Bylaws, Form of Subscription Agreement, Amended and Restated Revolving Credit, Term Loan and Security Agreement, and certifications of principal executive and financial officers[263][266] Signatures This section confirms the official signing of the report by the Chief Financial Officer on behalf of the Company - The report is duly signed on behalf of Drilling Tools International Corporation by David R. Johnson, Chief Financial Officer (Principal Financial and Accounting Officer), on November 14, 2023[268][269]