Drilling Tools International (DTI) - 2023 Q4 - Annual Report

PART I Business Overview DTIC provides global oilfield equipment and services, including downhole tool rentals, machining, and inspection, focusing on rental profitability and expansion - DTIC provides oilfield equipment and services, including downhole tool rentals, machining, and inspection, to the oil and natural gas sectors in North America, Europe, and the Middle East[16] - The company completed a merger transaction on June 20, 2023, with ROC Energy Acquisition Corp. changing its name to Drilling Tools International Corporation[18] Revenue Growth (2012-2023) | Metric | 2012 (Millions) | 2023 (Millions) | Growth % | | :----- | :-------------- | :-------------- | :------- | | Revenue | $35 | $152 | 334% | - The company is a market leader in North American land drilling and Gulf of Mexico deepwater drilling operation tool rentals[19] 2023 Revenue Contribution by Division | Division | 2023 Revenue Contribution | | :---------------------------- | :------------------------ | | Directional Tool Rentals (DTR) | ~61% | | Premium Tools Division (PTD) | ~19% | | Wellbore Optimization Tools (WOT) | ~17% | | Other Products & Services | ~3% | - Strategic goals include maximizing core rental tool profitability, commercializing new high-value tools, extending reach into completion and production, and geographical expansion[26] - Key competitive strengths include an experienced management team, partnerships for exclusive tools (e.g., Drill-N-Ream, RotoSteer), a large rental tool fleet, Master Service Agreements (MSAs) with leading customers, a wide distribution network, and the proprietary COMPASS inventory management system[28][30] 2023 Revenue by Customer Type | Customer Type | 2023 Revenue Contribution | | :-------------------------------- | :------------------------ | | Diversified Oilfield Service Companies (OSCs) | ~50% | | E&P Operators | ~47% | | Oil and Gas Equipment Manufacturers | ~3% | - The company has 394 full-time employees and contractors and has reduced its total recordable incident rate from 2.3 in 2018 to 1.23 in 2023 through its 'Safety Now' program[32] Risk Factors The company faces significant risks from oil and gas industry volatility, operational challenges, regulatory compliance, and internal control deficiencies - Demand for products and services is highly dependent on the general level of activity in the oil and gas industry, which is influenced by volatile oil and natural gas prices and capital spending[38] Revenue Concentration from Largest Customers | Year | Revenue from Two Largest Customers | | :--- | :--------------------------------- | | 2023 | 28.2% | | 2022 | 27.6% | - The company's distribution rights for Drill-N-Ream are no longer contractually exclusive, posing a risk of increased competition[46] - The company is an 'emerging growth company' and 'smaller reporting company,' which allows for reduced disclosure requirements but may affect comparability with other public companies[50][55] - Inflation has led to increased freight, materials, vehicle, and personnel costs, which the company has so far offset with price increases, but future impacts are uncertain[57][58] - Restrictive covenants in the Credit Facility Agreement limit the company's ability to incur additional indebtedness, make investments, and pay dividends[76][77] - The company's IT systems, including COMPASS, are vulnerable to damage from cyberattacks, hardware/software failures, and intellectual property claims[84][85] - Compliance with environmental laws and regulations, particularly those related to greenhouse gases and climate change, could increase costs and reduce demand for oil and natural gas[91][93] - Management concluded that disclosure controls and procedures were not effective as of December 31, 2023, due to a material weakness in internal control over financial reporting, stemming from limited accounting personnel and resources as a private company[446][447][448] - The company has no current plans to pay cash dividends on its Common Stock for the foreseeable future, intending to retain earnings for operations, expansion, and debt repayment[132] Unresolved Staff Comments The company has no unresolved comments from the SEC staff - There are no unresolved staff comments[140] Cybersecurity The company manages cybersecurity risks through a formal policy, assessments, and third-party support, with Board oversight - The company has a Cybersecurity Risk Management Policy governing risk identification, evaluation, treatment, reporting, and ongoing management[141] - Risks are identified through annual assessments, penetration tests, incident response tabletop exercises, vulnerability scans, and reviews of critical third-party vendor engagements[141] - The company is not aware of any cybersecurity risks that have materially affected or are reasonably likely to materially affect its business strategy, results of operations, or financial condition[142] - The company engages an IT Managed Service Provider, a Cybersecurity Advisory firm, and has Incident Response retainer services[144] - The Audit Committee oversees management's execution of the cybersecurity risk management program, with in-depth updates discussed quarterly[150] Properties As of December 31, 2023, the company operated 16 leased service and manufacturing facilities across 13 locations in the U.S. and Canada - As of December 31, 2023, the company operated 16 facilities in 13 locations[153] - All operating facilities are leased and include service centers and manufacturing facilities[153] - Locations include 12 in the United States (e.g., Bakersfield, Broussard, Houston, Midland, Odessa) and one in Canada (Nisku)[153] Legal Proceedings The company is routinely involved in legal proceedings, but management believes no pending litigation will materially affect its financial condition or operations - The company is involved in routine litigation, disputes, or claims related to its business activities, such as workers' compensation and employment disputes[154] - Management believes no pending litigation will have a material adverse effect on results of operations, financial condition, or cash flows[154] Mine Safety Disclosures This item is not applicable to the company - This item is not applicable[155] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's Common Stock is listed on Nasdaq under "DTI", with no cash dividends paid, as earnings are retained for operations, expansion, and debt repayment - The Common Stock is listed on Nasdaq under the symbol "DTI"[158] Common Stock Information (as of Dec 2023) | Metric | Value | | :----------------- | :---------- | | Closing Price (Dec 29, 2023) | $3.20 per share | | Holders of Record (Dec 31, 2023) | ~86 | - The company has not paid any cash dividends on the Common Stock and currently intends to retain any future earnings for operations, expansion, and debt repayment[159] Selected Financial Data This item is reserved and no selected financial data is presented - This item is reserved[161] Management's Discussion and Analysis of Financial Condition and Results of Operations DTIC's 2023 revenue increased, but net income decreased due to higher expenses, with liquidity supported by cash and credit, and critical accounting estimates impacting financial reporting - The company is a leading oilfield service company that rents downhole drilling tools for horizontal and directional drilling, operating from 16 locations in North America and 4 international stocking points[164] Key Financial Performance (2023 vs. 2022) | Metric | 2023 (Millions) | 2022 (Millions) | Change (Millions) | % Change | | :----------------- | :-------------- | :-------------- | :---------------- | :------- | | Total Revenue, net | $152.0 | $129.6 | $22.4 | 17.4% | | Net Income | $14.7 | $21.1 | $(6.4) | -30.0% | - Demand for services is heavily influenced by oil and gas industry activity, investor sentiment, capital availability, and volatile commodity prices[167] U.S. Onshore Rig Count (Weekly Average) | Year | Rig Count | | :--- | :-------- | | 2023 | 667 | | 2022 | 705 | | 2020 | 418 | - Selling, general, and administrative expenses increased by $16.7 million (32%) in 2023, primarily due to personnel-related expenses and costs associated with becoming a public company[206] Non-GAAP Financial Measures (2023 vs. 2022) | Metric | 2023 (Thousands) | 2022 (Thousands) | | :-------------- | :--------------- | :--------------- | | Free Cash Flow | $(20,416) | $(10,694) | | Adjusted EBITDA | $51,042 | $41,163 | - Net cash from operating activities increased to $23.3 million in 2023, while net cash used in investing activities significantly increased to $23.9 million due to higher capital expenditures[223][224][225] - Net cash provided by financing activities was $4.3 million in 2023, driven by proceeds from the Merger and PIPE Financing, partially offset by the paydown of the Credit Facility Agreement[227][228] - The company has federal net operating loss carryforwards that are expected to substantially reduce cash tax payments over the next several years[222] Quantitative and Qualitative Disclosures About Market Risk The company faces market risks including credit, customer/vendor concentration, foreign currency, and inflation, with cost increases currently offset by price adjustments - Credit risk primarily stems from cash and accounts receivable; cash is held with major financial institutions, and an allowance for doubtful accounts is maintained for receivables[261] Customer and Vendor Concentration (2023) | Metric | 2023 Concentration | | :---------------------- | :----------------- | | Revenue from three customers | 39% | | Vendor purchases from two vendors | 23% | - Foreign exchange risk arises from transactions denominated in currencies other than the U.S. dollar, mainly Canadian dollars, but has not had a material effect to date; no hedging arrangements are currently in place[263][264] - The company expects continued inflationary pressures on its cost structure, which have been offset by price increases to date, but sustained inflation and recession concerns could negatively impact demand[265] Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for 2023 and 2022, with an unqualified opinion, reflecting significant changes from the June 2023 Merger - Weaver and Tidwell, L.L.P. issued an unqualified opinion on the consolidated financial statements for the years ended December 31, 2023 and 2022, stating they present fairly in conformity with U.S. GAAP[271] Consolidated Balance Sheet Highlights (Thousands) | Metric | Dec 31, 2023 | Dec 31, 2022 | | :---------------------- | :----------- | :----------- | | Total Assets | $132,498 | $105,218 | | Total Liabilities | $43,808 | $56,116 | | Total Shareholders' Equity | $88,690 | $31,224 | Consolidated Income Statement Highlights (Thousands) | Metric | Year Ended Dec 31, 2023 | Year Ended Dec 31, 2022 | | :----------------- | :---------------------- | :---------------------- | | Total Revenue, net | $152,034 | $129,556 | | Operating Income | $27,899 | $25,277 | | Net Income | $14,748 | $21,080 | | Basic EPS | $0.67 | $1.66 | | Diluted EPS | $0.59 | $1.07 | Consolidated Cash Flow Highlights (Thousands) | Metric | Year Ended Dec 31, 2023 | Year Ended Dec 31, 2022 | | :----------------------------- | :---------------------- | :---------------------- | | Net cash from operating activities | $23,334 | $13,994 | | Net cash from investing activities | $(23,864) | $(2,530) | | Net cash from financing activities | $4,295 | $(9,337) | | Cash at End of Period | $6,003 | $2,352 | Notes to the Consolidated Financial Statements These notes detail accounting policies, financial statement revisions, the June 2023 Merger, balance sheet changes, related party transactions, and subsequent events like planned acquisitions and credit facility refinancing - The company's revenue recognition policies are based on Topic 842 for tool rental services (operating leases, straight-line basis) and Topic 606 for product sales (recognized upon control transfer or notification of lost/damaged tools)[304][307][313] - The Merger, completed on June 20, 2023, involved the exchange of DTIH common and preferred stock for DTIC Common Stock and a $30.0 million PIPE Financing, resulting in 29,768,568 shares of DTIC Common Stock outstanding[382][383][385] - The company identified and corrected errors in its previously issued consolidated statements of cash flows for 2022, primarily related to lease accounting and inventory/property, plant, and equipment, which were deemed not material to the overall financial statements[370][380] Property, Plant and Equipment, Net (Thousands) | Metric | Dec 31, 2023 | Dec 31, 2022 | | :----- | :----------- | :----------- | | PP&E, net | $65,800 | $44,154 | - The company's revolving credit facility with PNC Bank has a maximum borrowing amount of $60.0 million, maturing December 31, 2025, with no amounts drawn as of December 31, 2023[398][400][401] Income Tax Expense and Effective Tax Rate | Metric | 2023 (Thousands) | 2022 (Thousands) | | :----------------- | :--------------- | :--------------- | | Total Income Tax Expense | $5,046 | $3,698 | | Effective Tax Rate | 25.5% | 14.5% | - The company recognized $1.7 million in stock-based compensation expense in 2023 for accelerated vesting of executive performance-based options and $2.3 million for shares issued under a transaction services agreement[418][419] - Subsequent events include agreements to acquire Casing Technologies Group Limited (March 18, 2024) and Superior Drilling Products, Inc. (March 6, 2024), issuance of stock options to management (February 14, 2024), and refinancing of the credit facility to $80 million with a $25 million term loan (March 15, 2024)[439][440][441][442] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its independent accountants on accounting and financial disclosure matters - There have been no changes in or disagreements with accountants on accounting and financial disclosure[444] Controls and Procedures Management concluded disclosure controls were ineffective as of December 31, 2023, due to a material weakness in internal control over financial reporting, with remediation efforts underway - Disclosure controls and procedures were not effective as of December 31, 2023, due to un-remediated findings from the 2022 audit[446][447] - A material weakness in internal control over financial reporting was identified, stemming from failures in promoting effective internal control, developing risk assessment controls, monitoring activities, and inadequate IT general controls[447][448] - Remediation efforts include hiring qualified staff, enhancing IT systems, implementing a risk assessment process, strengthening segregation of duties, and engaging external specialists[449] - No material changes in internal control over financial reporting occurred during the most recently completed fiscal quarter[450] Other Information This item is not applicable - This item is not applicable[451] Disclosure Regarding Foreign Jurisdictions that Prevent Inspections This item is not applicable - This item is not applicable[452] PART III Directors, Executive Officers and Corporate Governance The information required for this item is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference to the company's Proxy Statement[455] Executive Compensation The information required for this item is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference to the company's Proxy Statement[456] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required for this item is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference to the company's Proxy Statement[457] Certain Relationships and Related Transactions, and Director Independence The information required for this item is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference to the company's Proxy Statement[458] Principal Accounting Fees and Services The information required for this item is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference to the company's Proxy Statement[459] PART IV Exhibits, Financial Statement Schedules This section includes consolidated financial statements and the audit report, omits schedules as information is in notes, and provides an index to various exhibits - The consolidated financial statements and the Report of Independent Registered Public Accounting Firm are included in Part II, Item 8 of this Annual Report[462] - All financial statement schedules have been omitted because they are not applicable or the required information is presented in the financial statements or the notes thereto[463] - An index to exhibits is provided, listing documents such as merger agreements, organizational documents, and various certifications[464][467][468] Form 10-K Summary This item is not applicable - This item is not applicable[470]