Drilling Tools International Corp current report, 20 June 2023

Business Context and Reporting Period

Drilling Tools International Corporation (DTIC), formerly ROC Energy Acquisition Corp., filed this Form 8-K on June 26, 2023, reporting the closing of its business combination with Drilling Tools International Holdings, Inc. (DTIH) on June 20, 2023. DTIH became a wholly owned subsidiary of DTIC, which ceased to be a shell company and began trading on Nasdaq under the symbol DTI on June 21, 2023.

DTI is an oilfield services company that rents downhole drilling tools and sells related products. It operates from 18 North American locations and four international locations. The financial results discussed below cover the three months ended March 31, 2023, compared with the three months ended March 31, 2022, and relate to DTIH before the business combination.

Key Financial Metrics

Metric	Three months ended March 31, 2023	Three months ended March 31, 2022	Change
Total revenue	$40.8 million	$26.0 million	+57%
Tool rental revenue	$32.3 million	$20.4 million	+58%
Product sale revenue	$8.5 million	$5.6 million	+53%
Operating income	$7.9 million	$1.2 million	+560%
Net income	$5.7 million	$1.3 million	+328%
Adjusted EBITDA	$14.8 million	$6.3 million	+134%
Cash flow from operations	$11.3 million	$2.0 million	+464%
Capital expenditures	$10.8 million	$3.6 million	+203%
Free cash flow	$0.5 million	$(1.6) million	Improved by $2.1 million

Gross profit was approximately $31.4 million in 2023 versus $18.5 million in 2022. Calculated margins were approximately 76.9% gross, 19.4% operating and 14.0% net in 2023, compared with approximately 70.2%, 4.6% and 5.1%, respectively, in 2022.

Cash and cash equivalents were $0.8 million at March 31, 2023, compared with $2.4 million at December 31, 2022. Net cash used in investing activities was $5.4 million, while net cash used in financing activities was $7.5 million, primarily reflecting debt repayment. The filing states that DTI used part of the business combination proceeds to repay all amounts outstanding under its then-existing revolving credit facility.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven by increased market activity and customer pricing, particularly in the Directional Tool Rentals and Premium Tools divisions.
SG&A expense increased 51% to $18.4 million, including $2.9 million of additional personnel costs, $2.0 million of additional accounting, legal and professional fees related to transaction preparation, and $0.3 million of higher bad debt expense.
Operating income and net income increased substantially as revenue growth outpaced increases in cost of revenue and SG&A.
Interest income changed to $0.6 million of expense, compared with $0.2 million of income in the prior-year period, primarily due to changes in the unrealized value of an interest rate swap.
Capital expenditures increased significantly to support the rental fleet and replacement or improvement of tools. Free cash flow nevertheless improved to $0.5 million from negative $1.6 million.
Two customers represented 28% of first-quarter 2023 revenue, and accounts receivable from those customers totaled approximately $7.8 million, compared with 25% of revenue and $8.6 million of receivables from two customers in the prior comparable disclosures.

Transaction, Capitalization and Liquidity

The PIPE financing raised $25.9 million through the issuance of 2,560,396 shares at $10.10 per share.
Two ROC promissory notes with aggregate principal of $4.14 million were converted into 409,901 shares.
DTIC issued 2,042,181 exchange shares in lieu of $10.8 million of merger consideration otherwise payable in cash.
ROC shareholders redeemed 20,541,379 shares for an aggregate of $217.6 million, or $10.53 per share. Approximately $1.7 million remained in the trust account and was released to DTIC.
After the transaction, 29,768,535 shares were outstanding. An additional 2,361,730 shares were issuable upon exercise of fully vested options, primarily at exercise prices of $3.72 and $8.76 per share.
The amended revolving credit facility provides for maximum revolving advances of $60.0 million. Borrowings bear interest at an applicable margin plus a base rate linked to the Overnight Bank Funding Rate or SOFR.
The credit agreement requires minimum liquidity of $6.0 million and contains restrictions on additional debt, investments, liens, mergers, dividends and distributions. The filing does not provide a clear amount drawn under the new facility at the closing date.
Management stated that cash on hand, operating cash flow and available borrowings were expected to satisfy working capital and anticipated capital expenditure needs for at least the next 12 months.

Guidance, Outlook, Commentary and Risks

Management expects rental revenue to benefit from higher drilling activity and customer pricing, and expects product sales to benefit from tools being lost or damaged and from replacement demand.
Management expects gross margins to improve slightly as existing infrastructure is leveraged and customer price increases offset cost inflation.
Operating expenses are expected to increase as DTIC incurs public-company costs, including legal, accounting, tax, insurance, compliance, governance, cybersecurity and internal-control expenses.
Management expects continued investment in sales and marketing to expand the global customer base and brand awareness.
Demand is highly dependent on oil and natural gas prices, drilling activity, rig counts, customer capital spending and broader economic conditions. Commodity prices and natural gas prices were volatile during the periods discussed.
Inflation, higher interest rates, recession risk, supply-chain disruptions, geopolitical events and foreign currency movements could adversely affect costs, demand, profitability and cash flows.
The company had an accumulated deficit of $15.4 million at March 31, 2023, despite reporting quarterly net income. Management cautions that historical results may not be indicative of future performance.
The company has federal net operating loss carryforwards that are expected to reduce cash taxes, but cash tax obligations could increase if the carryforwards are forfeited or used more quickly than expected.
Forward-looking projections included in the proxy statement were unaudited and were not compiled, examined or subjected to assurance procedures by the independent auditors.
Lock-up agreements generally restrict certain major stockholders from transferring covered shares until the earlier of 180 days after closing or an authorized waiver.

Important Facts for Investors to Verify

Review the unaudited March 31, 2023 financial statements and pro forma financial information filed as Exhibits 99.1 and 99.2.
Confirm the amount drawn, applicable interest margins, maturity provisions, collateral and covenant calculations under the $60.0 million credit facility.
Assess whether the reported operating cash flow was supported by recurring earnings or by temporary working-capital changes, including a $6.0 million increase in accounts payable and accrued expenses.
Evaluate customer concentration, including the two customers contributing 28% of first-quarter revenue and approximately $7.8 million of receivables.
Monitor dilution from 2.36 million outstanding options, the 2.98 million-share incentive plan reserve, registration rights and potential resale activity by major stockholders.
Review the transaction costs, reverse-recapitalization accounting and post-closing share ownership, including HHEP-Directional’s reported 53.5% ownership and ROC Holdings’ reported 21.1% ownership.
Verify subsequent filings for actual post-combination results, liquidity, debt utilization, covenant compliance and any changes in the company’s stated outlook.