Drilling Tools International Corporation — Q3 2023 Form 10-Q
Business context and reporting period
For the quarter and nine months ended September 30, 2023. DTI rents, manufactures, inspects and refurbishes downhole drilling tools for oil and gas customers. The June 20, 2023 merger with ROC Energy Acquisition Corp. completed the company’s public listing; its shares began trading on Nasdaq as DTI on June 21.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $38.1m | $36.5m | $116.8m | $92.9m |
| Operating income | $7.1m | $8.1m | $23.4m | $17.3m |
| Net income | $4.3m | $7.0m | $10.9m | $14.3m |
| Diluted EPS | $0.14 | $0.36 | $0.46 | $0.72 |
| Adjusted EBITDA (non-GAAP) | $12.7m | $13.0m | $40.8m | $28.1m |
- Q3 revenue increased 4%; tool rental revenue rose 9% to $29.4m, while product sales fell 10% to $8.8m. Nine-month revenue increased 26%, with rental revenue up 29% and product sales up 16%.
- Gross margin was approximately 76.0% in Q3 versus 75.5% a year earlier; nine-month gross margin was approximately 76.5% versus 73.8%. Operating margin was 18.7% in Q3 versus 22.1%; nine-month operating margin improved to 20.0% from 18.7%.
- Q3 net income declined 39%, despite higher revenue, as SG&A, depreciation and tax expense increased. Nine-month net income declined 23%; transaction costs and merger-related stock compensation contributed to the comparison.
- Operating cash flow was $17.5m for the nine months, versus $5.6m. Capital expenditures were $36.8m, resulting in negative free cash flow of $19.3m, compared with negative $10.6m in 2022.
- Cash was $4.0m at September 30. The $60m revolving facility was undrawn; borrowings were zero, with approximately 8.32% stated borrowing rate at quarter-end. Facility maturity is December 2025; the company reported covenant compliance. Operating lease liabilities totaled $19.7m.
- Current assets were $45.6m and current liabilities $23.9m. Total assets were $131.4m and total liabilities $46.6m. Shareholders’ equity was $84.9m.
Material changes, outlook and risks
- The merger and PIPE financing generated $23.2m net of transaction costs. The merger eliminated $17.9m of preferred stock and increased shares outstanding; shares outstanding were 29.8m at September 30. Per-share comparisons are affected by this change in share count.
- Merger-related items included $6.0m of transaction expenses and $2.3m of stock compensation recorded in other expense, plus $1.7m of accelerated option compensation in SG&A. Nine-month SG&A also reflects the absence of $4.3m of employee retention credits recorded in 2022.
- Management expects existing cash, operating cash generation and available revolver capacity to meet working capital needs and anticipated capital expenditures for at least the next 12 months. It expects business performance to benefit from drilling investment, but provides no quantified revenue or earnings guidance.
- Management cited higher drilling activity and customer pricing as revenue drivers, while noting inflation in personnel and operating costs. It expects near-term cost increases, but said pricing increases had so far helped offset inflation. Oil and gas prices, rig activity, recession risk, inflation, interest rates, supply disruptions and geopolitical conflicts could affect demand and costs.
- Two customers accounted for 28% of revenue in both the quarter and nine-month period; receivables from them were $8.4m. The company does not hedge foreign currency exposure.
- Disclosure controls were ineffective and a material weakness in internal control over financial reporting remained unremediated. The company is implementing staffing, systems and review-process improvements but gave no assurance these will fully remediate the weakness.
- DTI disclosed a petition against its subsidiary Premium Tools LLC and a former employee overtime claim. Management believes neither will have a material adverse effect. The filing also notes potential audit or recapture risk for prior employee retention credits.
Important facts for investors to verify
- Whether revenue growth and pricing can sustain margins as labor, repair and public-company costs rise.
- Capital spending, rental-tool recovery proceeds and the trajectory of free cash flow; nine-month free cash flow was negative $19.3m.
- Availability under the revolver, covenant headroom and liquidity needs if operating performance weakens.
- Progress toward remediating the material weakness and establishing effective disclosure and financial-reporting controls.
- Customer concentration, receivable collections, and the status and potential cost of disclosed legal matters.