Business context and reporting period
Drilling Tools International Corporation (Nasdaq: DTI) rents, manufactures, inspects and refurbishes downhole drilling tools for the oil and gas industry. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2023. The June 20 merger with ROC Energy Acquisition Corp. closed during the quarter; the company began Nasdaq trading on June 21. The merger was accounted for as a reverse recapitalization.
Key financial metrics
Amounts are in millions of U.S. dollars except per-share data. Comparisons are with the corresponding 2022 periods.
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $37.9 | $30.4 | $78.7 | $56.3 |
| Operating income | $6.6 | $8.0 | $16.2 | $9.3 |
| Net income | $0.9 | $5.9 | $6.6 | $7.3 |
| Diluted EPS | $0.05 | $0.30 | $0.33 | $0.37 |
| Adjusted EBITDA (non-GAAP) | $13.3 | $8.8 | $28.1 | $15.1 |
Revenue grew 25% in Q2 and 40% in the first half. Tool rental revenue was $29.0 million in Q2 (+26%) and $61.3 million in the first half (+41%); product sales were $8.9 million (+21%) and $17.4 million (+35%), respectively. Approximate gross margin, calculated from reported revenue less tool-rental and product-sale costs, was 76.7% in Q2 and 76.8% in the first half. Operating margin was approximately 17.5% in Q2 versus 26.5% a year earlier, and 20.6% for the first half versus 16.4%.
Cash from operations was $14.1 million for the first half, compared with $2.2 million. Capital expenditures were $24.6 million, producing negative free cash flow of $10.6 million (non-GAAP), versus negative $7.0 million. Cash at June 30 was $7.2 million. Current assets were $51.8 million and current liabilities $36.0 million. The $60 million revolving facility had no balance drawn at quarter-end; the company reported covenant compliance. Operating lease liabilities totaled $20.5 million. Total liabilities were $57.8 million.
Material changes versus the prior comparable period
- Q2 net income declined to $0.9 million from $5.9 million despite higher revenue; first-half net income was $6.6 million versus $7.3 million.
- Q2 SG&A increased 87% to $17.7 million. The comparison was affected by $4.3 million of employee retention credits recognized in 2022, as well as higher personnel costs and merger-related stock compensation. First-half SG&A rose 59% to $34.4 million.
- Q2 other expense was $4.4 million, including $1.8 million of transaction fees and $2.3 million of stock-based compensation related to the transaction services agreement. First-half transaction expense and accelerated stock compensation materially reduced reported earnings.
- Merger and PIPE financing proceeds, net of transaction costs, were $23.1 million. Common shares outstanding rose to 29.8 million from 12.0 million at December 31, 2022; preferred stock was exchanged or canceled in the transaction.
- Property, plant and equipment, net, increased to $64.5 million from $44.2 million at year-end, alongside substantial first-half capital spending.
Outlook, commentary, risks and unusual items
The company gave no quantified revenue or earnings guidance. Management expects performance to depend on drilling activity, customer pricing and market share, and believes its cash, operating cash flow and available credit will meet working-capital needs and anticipated capital expenditures for at least 12 months. Management expects near-term cost inflation, but says customer price increases have so far helped offset it; it anticipates modest gross-margin improvement as activity grows, while public-company, sales and marketing costs are expected to rise.
Management cited volatile oil and gas prices, inflation, higher interest rates and recession concerns as potential pressures on customer activity and costs. The company is exposed to customer concentration, foreign exchange movements and supply-chain and cybersecurity risks, and does not hedge currency exposure. Two customers generated approximately 29% of Q2 revenue under the financial-statement note; the MD&A separately states 33%, a discrepancy to review. The company reported no pending litigation claims. ERC claims may be subject to audit or recapture. A material weakness in internal control over financial reporting was identified, involving control environment, risk assessment, monitoring, and IT controls; remediation is underway, with no assurance it will be completed successfully. On July 12, 2023, the company terminated its interest-rate swap and received $0.4 million from PNC.
Important facts for investors to verify
- Reconcile the Q2 customer-concentration disclosures of 29% and 33%, and assess reliance on major customers and vendors.
- Review the merger/PIPE terms, transaction expenses, equity issuance and potential dilution, including outstanding options.
- Assess whether operating cash generation can support planned capital spending, given first-half negative free cash flow.
- Confirm the status of material-weakness remediation and the effect of higher public-company costs on recurring profitability.
- Monitor drilling activity, commodity-price and inflation trends, credit-facility covenants and liquidity; the facility is secured by substantially all company assets and matures December 31, 2025.