Drilling Tools International Corp: Form 10-Q for the period ended Sep 30, 2023

Drilling Tools International Holdings, Inc. (“DTIH”) entered into a business combination agreement (the “Agreement”) with ROC Energy Acquisition Corp. (“ROC”) on February 13, 2023. The transactions contemplated by the Agreement (the “Business Combination”) were completed on June 20, 2023, and in conjunction therewith ROC changed its name to Drilling Tools International Corporation (“DTIC” and, together with its subsidiaries, “DTI”, the “Company”, “we”, “us” or “our”, unless the context otherwise requires).

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited interim financial statements and the related notes included under Part I, Item 1 of this Quarterly Report on Form 10-Q (the “Report”) as well as DTIH’s audited consolidated financial statements and notes thereto included in the prospectus/proxy statement/consent solicitation statement, dated May 12, 2023, and filed with the SEC. The following discussion contains forward-looking statements based upon current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the sections titled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” or in other parts of this Report. Our historical results are not necessarily indicative of the results that may be expected for any period in the future. All dollar amounts are expressed in thousands of United States dollars (“$”), unless otherwise indicated.

Capitalized terms used in this section, but not otherwise defined, have the meanings ascribed to them in the Report.

Overview

We are a leading oilfield services company, based on the percentage of active rigs to which we supply tools in the geographies in which we are active, that rents downhole drilling tools used in horizontal and directional drilling of oil and natural gas. We operate from 16 service centers, shops, distribution and repair centers in North America and four international locations in Europe and the Middle East and maintain a large fleet of rental equipment consisting of drill collars, stabilizers, crossover subs, wellbore conditioning tools, drill pipe, hevi‑wate drill pipe and tubing. We also rent surface control equipment such as blowout preventers and handling tools and provide downhole products for producing wells.

Our business model primarily centers on revenue generated from tool rentals and product sales. We generated revenue from total tool rentals and product sales of $38.1 million and $36.5 million for the three months ended September 30, 2023 and 2022, respectively, and had net income of $4.3 million and $7.0 million for those same periods. Additionally, we generated revenue from tool rentals and product sales of $116.8 million and $92.9 million for the nine months ended September 30, 2023 and 2022, respectively, and had net income of $10.9 million and $14.3 million for those same periods, respectively. As of September 30, 2023, we had cash and cash equivalents of $4.0 million, and an accumulated deficit of $10.1 million.

We believe our future financial performance will be driven by continued investment in oil and gas drilling following years of industry underinvestment.

Market Factors

Demand for our services and products depends primarily upon the general level of activity in the oil and gas industry, including the number of active drilling rigs, the number of wells drilled, the depth and working pressure of these wells, the number of well completions, the level of well remediation activity, the volume of production and the corresponding capital spending by oil and natural gas companies. Oil and gas activity is in turn heavily influenced by, among other factors, investor sentiment, availability of capital and oil and gas prices locally and worldwide, which have historically been volatile.

Our tool rental revenues are primarily dependent on drilling activity and our ability to gain or maintain market share with a sustainable pricing model.

Our product sales revenues are primarily dependent on oil and gas companies paying for tools that are lost or damaged in their drilling programs as well as the drilling contractors need to replace aging or consumable products and our ability to provide competitive pricing.

All of these factors may be influenced by the oil and gas region in which our customers are operating. While these factors may lead to differing revenues, we have generally been able to forecast our product needs and anticipated revenue levels based on historic trends in a given region and with a specific customer.

Recent Developments and Trends

Industry Update

In 2020 and early 2021, demand for oil significantly declined as a result of the COVID-19 pandemic and other factors. Oil prices have since increased due in part to an increase in demand and measured production increases by OPEC+ members. However, prices remained volatile through 2022. In the first half of 2022, West Texas Intermediate (“WTI”) oil prices and volatility thereof increased dramatically, in large part due to Russia’s invasion of Ukraine. Russia has since been subject to a host of sanctions, some of which limit its ability to export crude oil and other petroleum products. The anticipated impact on supply drove WTI oil prices above $106 per barrel in June 2022.

By the end of December 2022, WTI oil prices declined to approximately $80 per barrel due in part to high inflation rates and fears of a global recession that could negatively impact oil demand. WTI oil prices declined further during the first quarter of 2023, reaching a low of $67 per barrel in the middle of March, following turmoil in the banking sector, which escalated fears of a global recession and a concomitant decline in oil demand. However, in April 2023, WTI oil prices returned to the low-$80s per barrel range, due in part to OPEC+’s decision to further cut production by approximately 1.2 million barrels per day. This production cut was effective as of May 2023 and is expected to continue through the end of the year. As of September 30, 2023, the WTI oil price was approximately $89 per barrel.

Despite the high volatility in spot oil prices described above, our customers tend to be more focused on medium-term and long‑term commodity prices when making investment decisions due to the longer lead times for offshore projects. These forward prices have experienced far less volatility in 2022 and 2023 and have maintained levels which are highly constructive for offshore project demand.

Prices for natural gas have increased somewhat throughout the third quarter of 2023 relative to the second quarter of 2023 in the United States due to several factors, including an increase in weather driven demand as well as inflationary pressures and supply risks. Henry Hub natural gas spot prices have decreased from an average of $7.88 per one million British Thermal Units (“MMBtu”) in September 2022 to $5.53 per MMBtu for December 2022 and $2.64 per MMBtu in September 2023.

The ongoing conflict in Ukraine and the evolving Israel-Hamas conflict have caused uncertainty in the oil and natural gas markets, and the financial markets, both globally and in the United States. Such uncertainty already has and could continue to cause stock price volatility and supply chain disruptions as well as higher oil and natural gas prices. These could result in higher inflation worldwide, impact consumer spending and negatively impact demand for our goods and services. Moreover, additional interest rate increases by the U.S. Federal Reserve to combat inflation could further increase the probability of a recession.

Notwithstanding the significant commodity price volatility over the past several years, we have seen increases in United States onshore drilling activity. During the three and nine months ended September 30, 2023, the weekly average U.S. onshore rig count as reported by Baker Hughes was 627 and 689 rigs, respectively, compared to 741 and 688 rigs for the three and nine months ended September 30, 2022, respectively. Current rig activity remains significantly reduced from 2019 levels when the weekly average rig count for the three and nine months ended September 30, 2019 was 894 and 959, respectively. However, notwithstanding the impact of longer laterals, improved rig efficiencies have partially offset the impact of this reduction.

Inflation and Increased Costs

We are experiencing the impacts of global inflation, both in increased personnel costs and the prices of goods and services required to operate our rigs and execute capital projects. While we are currently unable to estimate the ultimate impact of rising prices, we do expect that our costs will continue to rise in the near term and will impact our profitability. To date, we do not believe that inflation has had a material impact to our financial condition or results of operations because we have been able to increase the prices we receive from our customers.

How We Evaluate Our Operations

We use a number of financial and operational measures to routinely analyze and evaluate the performance of our business, including revenue, net and non-GAAP measures Adjusted EBITDA and Free Cash Flow.

Revenue, net

We analyze our performance by comparing actual monthly revenue to revenue trends and revenue forecasts by product line as well as tool activity trends for each month. Our revenue is primarily derived from tool rental and product sales.

Adjusted EBITDA

We regularly evaluate our financial performance using Adjusted EBITDA. Our management believes Adjusted EBITDA is a useful financial performance measure as it excludes non-cash charges and other transactions not related to our core operating activities and allows more meaningful analysis of the trends and performance of our core operations.

Free Cash Flow

We define Free Cash Flow as net cash provided by (used in) operating activities, reduced by purchases of property, plant and equipment. Free Cash Flow is a supplemental non-GAAP financial measure that is used by our management and other external users of our financial statements, such as industry analysts, investors, lenders, rating agencies and others to assess our ability to internally fund our capital program, service or incur additional debt and to pay dividends. We believe Free Cash Flow is a useful liquidity measure because it allows us and others to compare cash flow provided by operating activities across periods and to assess our ability to internally fund our capital program, fund acquisitions and pay dividends to our stockholders whereas applicable.

Please refer to the section titled “Non-GAAP Financial Measures” for a reconciliation of Adjusted EBITDA to net (loss) income, the most directly comparable financial performance measure calculated and presented in accordance with GAAP and a reconciliation of free cash flow to net cash provided by (used in) operating activities, the most directly comparable liquidity measure calculated and presented in accordance with GAAP.

Key Components of Results of Operations

The discussion below relating to significant line items from our interim unaudited consolidated statements of income and comprehensive income are based on available information and represent our analysis of significant changes or events that impact the comparability of the reported amount. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where reasonably practicable, we have quantified the impact of such items.

Revenue, net

We currently generate our revenue, net from tool rental services and product sales. Tool rental services consist of rental services, inspection services, and repair services is accounted for under Topic 842. We recognize revenues from renting tools on a straight-line basis. Our rental contract periods are daily, monthly, per well, or based on footage. As part of this straight-line methodology, when the equipment is returned, we recognize as incremental revenue the excess, if any, between the amount the customer is contractually required to pay, which is based on the rental contract period applicable to the actual number of days the drilling tool was out on rent, over the cumulative amount of revenue recognized to date.

The rental tool recovery component of product sales revenue is recognized when a tool is deemed to be lost-in-hole, damaged-beyond-repair, or lost-in-transit while in the care, custody, or control of the customer. Other made to order product sales revenue is recognized when the product is made available to the customer for pickup at our shipping dock.

We expect our tool rental services revenue to increase over time as a function of an increase in drilling activity and customer pricing.

We expect our product sales revenue to increase over time as a function of oil and gas companies drilling faster and harder thereby pushing the limits of downhole drilling tools and often contributing to tools being lost-in-hole or damaged-beyond-repair. In addition, product sales revenue should increase as drilling contractors replace aged and consumable products to maintain or increase capacity.

Costs and Expenses

Our costs and expenses consist of cost of revenue, selling, general, and administrative expense, and depreciation and amortization expense.

Cost of Revenue

Our cost of revenue consists primarily of all direct and indirect expenses related to providing our tool rental services offering and delivering our product sales, including personnel-related expenses and costs associated with maintaining the facilities.

We expect our total cost of tool rental revenue and our total cost of product sale revenue to increase in absolute dollars in future periods, corresponding to our anticipated growth in revenue and employee headcount to support our customers and to maintain the manufacturing, operations and field service team with some expected cost inflation.

We expect that gross margins will continue to improve slightly as we leverage our existing cost structure to support an increase in our business activity. In addition, we expect that customer price increases will help offset cost inflation.

Selling, General and Administrative

General and administrative expenses consist primarily of personnel-related expenses, including salaries, benefits and stock-based compensation for personnel and outside professional services expenses including legal, audit and accounting services, insurance, other administrative expenses and allocated facility costs for our administrative functions.

We expect our operating expenses to increase in absolute dollars for the foreseeable future as a result of operating as a public company. In particular, we expect our legal, accounting, tax, personnel-related expenses and directors’ and officers’ insurance costs reported within general and administrative expense to increase as we establish more comprehensive compliance and governance functions, increased security and IT compliance, review internal controls over financial reporting in accordance with the Sarbanes-Oxley Act of 2002, as amended, and prepare and distribute periodic reports as required by the rules and regulations of the U.S. Securities and Exchange Commission. As a result, our historical results of operations may not be indicative of our results of operations in future periods.

Selling expenses consist primarily of personnel-related expenses, including salaries, benefits and stock-based compensation for personnel, direct advertising, marketing and promotional material costs, sales commission expense, consulting fees and allocated facility costs for our sales and marketing functions.

We intend to increase investments in our sales and marketing organization to drive additional revenue, expand our global customer base, and broaden our brand awareness. We expect our sales and marketing expenses to continue to increase in absolute dollars for the foreseeable future.

Depreciation and amortization expense

Depreciation and amortization expense relates to the consumption of our property and equipment, which consists of rental tools, shop equipment, computer equipment, furniture and fixtures and leasehold improvements, and the amortization of our intangible assets mainly related to customer relationships, software and partnerships.

Other income (expense), net

Our other income (expense), net is primarily comprised of interest income (expense), gain on sale of property, unrealized gain (loss) on securities, and other miscellaneous income and expense unrelated to our core operations.

Results of Operations

The following table set forth our results of operations for the periods presented (in thousands):

Comparison of the Three Months Ended September 30, 2023 and 2022

Revenue, net

Our revenue, net consists of tool rental and product sale revenues.

(In thousands)

Tool rental revenue increased $2.5 million, or 9%, to $29.4 million for the three months ended September 30, 2023 as compared to $26.8 million for the three months ended September 30, 2022. The increase was primarily driven by increased market activity and customer pricing across all divisions, especially in relation to our Directional Tool Rentals (“DTR”) division, the revenue of which increased $1.6 million and the Wellbore Optimization Tools ("WOT") division, the revenue of which increased $0.9 million.

Product sale revenue decreased $0.9 million, or 10%, to $8.8 million for the three months ended September 30, 2023 as compared to $9.7 million for the three months ended September 30, 2022. The decrease was primarily driven by higher than average rental tool recovery events in the three months ended September 30, 2022.

Costs and Expenses

Cost of revenue

Our cost of revenue consists of cost of tool rental revenue and cost of product sale revenue.

(In thousands)

32

Cost of tool rental revenue increased $0.4 million, or 5%, to $8.0 million for the three months ended September 30, 2023 as compared to $7.6 million for the for the three months ended September 30, 2022. Across all divisions, the increase in cost of tool rental revenue was primarily driven by increased labor costs as well as increased repair costs due to increased rental activity.

Cost of product sale revenue decreased $0.2 million, or 13%, to $1.2 million for the three months ended September 30, 2023 as compared to $1.4 million for the for the three months ended September 30, 2022. The decrease in cost of product sale revenue was primarily driven by a decrease in rental tool recovery revenue.

Selling, General, and Administrative Expense

(In thousands)

Selling, general, and administrative expense increased $1.9 million, or 13%, to $16.6 million for the three months ended September 30, 2023 as compared to $14.7 million for the three months ended September 30, 2022. This increase was primarily driven by a:

• $0.4 million increase in insurance expenses,
• $0.2 million increase in expenses related to supplies, equipment, licenses and vehicles,
• $0.2 million increase in rent expenses,
• $0.2 million increase in repairs,
• $0.6 million increase in personnel-related expenses, and
• $0.2 million increase in monitoring fees.

No other driver of this increase was individually significant.

Depreciation and Amortization expense

(In thousands)

Depreciation and amortization expenses increased $0.5 million, or 10%, to $5.3 million for the three months ended September 30, 2023 as compared to $4.8 million for the three months ended September 30, 2022. The increase was primarily due an increase in depreciation expense resulting from a higher property, plant and equipment balance as of September 30, 2023.

Other expense, net

Interest Expense, net

(In thousands)

Interest expense increased $28 thousand, or 62%, to $0.1 million for the three months ended September 30, 2023 as compared to $45 thousand for the three months ended September 30, 2022 primarily due to an increase in the amortization of deferred financing fees of $46 thousand and the settlement of the interest rate swap on July 10, 2023 caused there to be no unrealized gain for the three months ended September 30, 2023 as compared to an unrealized gain of $0.4 million for the three months ended September 30, 2022. These increases were partially offset by no interest on the revolving line of credit being incurred during the three months ended September 30, 2023 as compared to $0.3 million incurred during the three months ended September 30, 2022.

Gain on Sale of Property

(In thousands)

Gain on the sale of property decreased $0.1 million, or 100%, to nil for the three months ended September 30, 2023 as compared to $0.1 million for the three months ended September 30, 2022. The decrease is due to there being no sales of property during the three months ended September 30, 2023.

Unrealized Loss on Equity Securities

(In thousands)

Unrealized loss on equity securities increased by $0.1 million, or 34%, to $0.5 million for the three months ended September 30, 2023 as compared to $0.4 million for the three months ended September 30, 2022 primarily due to unfavorable market valuations in the third quarter of 2023 as compared to the third quarter of 2022.

Other Expense, net

(In thousands)

Other expense for the three months ended September 30, 2023 was $0.1 million, an increase of $21 thousand, or 18%, compared to the three months ended September 30, 2022. The increase was primarily due to transaction costs with no comparable activity in the third quarter of 2022.

Comparison of the Nine Months Ended September 30, 2023 and 2022

Revenue, net

Our revenue, net consists of tool rental and product sale revenues.

(In thousands)

Tool rental revenue increased $20.4 million, or 29%, to $90.6 million for the nine months ended September 30, 2023 as compared to $70.3 million for the nine months ended September 30, 2022. The increase was primarily driven by increased market activity and customer pricing across all divisions, especially in relation to our WOT division, the revenue of which increased $15.0 million and our Premium Tools ("PTD") division, the revenue of which increased $6.5 million.

Product sale revenue increased $3.6 million, or 16%, to $26.2 million for the nine months ended September 30, 2023 as compared to $22.6 million for the nine months ended September 30, 2022. The increase was primarily driven by increased market activity and customer pricing across all divisions, which collectively increased other products and services by $2.0 million. The increased market activity and customer pricing also impacted our rental tool recovery sales revenue, which collectively increased $1.3 million.

Costs and Expenses

Cost of revenue

Our cost of revenue consists of cost of tool rental revenue and cost of product sale revenue.

(In thousands)

Cost of tool rental revenue increased $3.2 million, or 16%, to $23.8 million for the nine months ended September 30, 2023 as compared to $20.6 million for the for the nine months ended September 30, 2022. Across all divisions, the increase in cost of tool rental revenue was primarily driven by increased labor costs as well as increased repair costs due to increased rental activity.

Cost of product sale revenue decreased $0.1 million, or 3%, to $3.7 million for the nine months ended September 30, 2023 as compared to $3.8 million for the for the nine months ended September 30, 2022. The decrease in cost of product sale revenue was primarily driven by a decrease in the average net book value of tools lost or damaged during the period.

Selling, General, and Administrative Expense

(In thousands)

Selling, general, and administrative expense increased $14.6 million, or 40%, to $51.0 million for the nine months ended September 30, 2023 as compared to $36.4 million for the nine months ended September 30, 2022. This increase was primarily driven by a:

• $5.0 million increase in personnel-related expenses,
• $4.3 million related to ERC Benefits we qualified for during the nine months ended September 30, 2022 related to the COVID-19 Coronavirus Aid, Relief, and Economic Security Act. These ERC Benefits were included in selling, general, and administrative expense as an offset to the related compensation expenses,
• $1.7 million increase in stock-based compensation expense as a result of the Merger.
• $0.5 million increase in monitoring fees,
• $0.5 million increase in insurance expense,
• $0.4 million increase in professional services,
• $0.4 million increase in rent expense
• $0.4 million increase in expenses for repairs,
• $0.3 million increase in bad debt expense,
• $0.3 million increase in freight expense
• $0.3 million increase in credit card transaction fees, and
• $0.3 million increase in expenses for supplies, equipment, licenses and vehicles

No other driver of this increase was individually significant.

Depreciation and Amortization expense

(In thousands)

35

Depreciation and amortization expenses increased $0.3 million, or 2%, to $15.0 million for the nine months ended September 30, 2023 as compared to $14.8 million for the nine months ended September 30, 2022. The increase was primarily due to an increase in depreciation expense resulting from a higher property, plant and equipment balance as of September 30, 2023.

Other (expense) income

Interest Expense, net

(In thousands)

For the nine months ended September 30, 2023 we had interest expense of $1.0 million as compared to interest expense of $41 thousand for the nine months ended September 30, 2022. This change of $1.0 million or 2327% was primarily due to the settlement of the interest rate swap on July 10, 2023 resulting in there being no unrealized gain on the interest rate swap for the nine months ended September 30, 2023 whereas there was an unrealized gain on the interest rate swap of $0.9 million for the nine months ended September 30, 2022.

Gain on Sale of Property

(In thousands)

Gain on the sale of property decreased $39 thousand, or 36%, to $68 thousand for the nine months ended September 30, 2023 as compared to $0.1 million for the nine months ended September 30, 2022. The immaterial decrease is driven by an increase in the selling price of the property sold compared to its net book value in 2022 that was less significant in 2023.

Unrealized Loss on Equity Securities

(In thousands)

Unrealized loss on equity securities increased by $73 thousand, or 97%, to $148 thousand for the nine months ended September 30, 2023 as compared to $75 thousand for the nine months ended September 30, 2022 primarily due to unfavorable market valuations through the first three quarters of 2023 as compared to the first three quarters of 2022.

Other Expense

(In thousands)

Other expense for the nine months ended September 30, 2023 was $6.2 million, an increase of $6.0 million, or 2852%, compared to the nine months ended September 30, 2022. The increase was primarily due to $6.0 million of transaction fees that were incurred with the Business Combination for which we had no comparative activity during the nine months ended September 30, 2022.

Non-GAAP Financial Measures

To supplement our unaudited interim consolidated financial statements, which are prepared and presented in accordance with GAAP, we use certain non-GAAP financial measures, as described below, to understand and evaluate our core operating performance. These non-GAAP financial measures, which may be different than similarly titled measures used by other companies, are presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.

We use the non-GAAP financial measure Free Cash Flow, which is defined as net cash provided by (used in) operating activities, reduced by purchases of property, plant and equipment. We believe Free Cash Flow is an important liquidity measure of the cash that is available, after capital expenditures, for operational expenses and investment in our business and is a key financial indicator used by management. Free Cash Flow is useful to investors as a liquidity measure because it measures our ability to generate or use cash. Once our business needs and obligations are met, cash can be used to maintain a strong balance sheet and invest in future growth.

We use the non-GAAP financial measure Adjusted EBITDA, which is defined as net income (loss); excluding interest income; interest expense; other income (expense), net; income tax benefit (expense); depreciation and amortization; and certain other non-cash or non-recurring items impacting net income (loss) from time to time. We believe that Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude in Adjusted EBITDA.

These non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures compared to the closest comparable GAAP measure. Some of these limitations are that:

• Free Cash Flow does not reflect our future contractual commitments;
• Adjusted EBITDA excludes certain recurring, non-cash charges such as depreciation of fixed assets and amortization of acquired intangible assets and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA excludes income tax benefit (expense).

The following table presents a reconciliation of Free Cash Flow to net cash provided by (used in) operating activities for the nine months ended September 30, 2023 and 2022:

(In thousands)

The following tables present a reconciliation of Adjusted EBITDA to net income (loss) for the three and nine months ended September 30, 2023 and 2022 (non-recurring transaction expenses recorded to other (income) expense are presented separately within Adjusted EBITDA):

(In thousands)

37

(In thousands)

Liquidity and Capital Resources

At September 30, 2023, we had $4.0 million of cash and cash equivalents. Our primary sources of liquidity and capital resources are cash on hand, cash flows generated by operating activities and, if necessary, borrowings under the Credit Facility Agreement. We may use additional cash generated to execute strategic acquisitions or for general corporate purposes. We believe that our existing cash on hand, cash generated from operations and available borrowings under the Credit Facility Agreement will be sufficient for at least the next 12 months to meet working capital requirements and anticipated capital expenditures.

Credit Facility Agreement

Reference is made to the disclosure set forth under the heading “Revolving Credit Facility” in Note 7, Revolving Credit Facility, of the notes to the unaudited condensed consolidated financial statements included elsewhere in this Report (the ”Interim Financial Statements).

Capital Expenditures

Our capital expenditure relates to capital additions or improvements that add to our rental or repair capacity or extend the useful life of our drilling tools and related infrastructure. Also, our capital expenditures replace tools that are lost or damaged by a customer and these are funded by a rental tool recovery sale amount from the customer. We regularly incur capital expenditures on an on-going basis in order to (i) increase or maintain our rental tool fleet and equipment, (ii) extend the useful life of our rental tools and equipment and (iii) acquire or upgrade computer hardware and software. The amount of our capital expenditures is influenced by, among other things, demand for our services, recovery of lost or damaged tools, schedules for refurbishing our various rental tools and equipment, cash flow generated by our operations, expected rates of return and cash required for other purposes.

Contractual Obligations and Commitments

Our material contractual obligations arise from leases of facilities and vehicles under noncancelable operating leases agreements. See Note 14, Commitments and contingencies, of the notes to the Interim Financial Statements.

Tax Obligations

We currently have available federal net operating loss carryforwards to offset our federal taxable income, and we expect that these carryforwards will substantially reduce our cash tax payments over the next several years. If we forfeit these carryforwards for any reason or deplete them faster than anticipated, our cash tax obligations could increase substantially. For additional information, see Note 8, Income Taxes, of the notes to the Interim Financial Statements.

Cash Flows

The following table sets forth our cash flows for the period indicated:

(In thousands)

Cash Flows (Used In) Provided by Operating Activities

Net cash provided by operating activities for the nine months ended September 30, 2023 was $17.5 million resulting from our net income of $10.9 million, adjusted for non-cash charges of $18.5 million in depreciation and amortization, including amortization of right of use assets and deferred financing costs, $4.0 million of stock-based compensation expense as a result of the Merger, $0.5 million of bad debt expense and $3.7 million in deferred tax expense. This was partially offset by a $14.0 million gain on rental tool recovery sales and $6.7 million in net changes from operating assets and liabilities. The $6.7million in cash used in operating assets and liabilities is primarily due to a $0.5 million cash outflow in accounts receivable associated with an increase in sales and higher revenues during the first nine months of 2023 compared to the first nine months of 2022, a $3.3 million cash outflow from operating lease liabilities as we increase right-of-use assets on hand and a $2.9 million cash outflow from inventories due to purchased inventory related to our attempt to reduce risk and uncertainties in our supply chain. This was partially offset by a $0.1 million cash inflow in accounts payable and accrued expenses due to differences in the timing of disbursements. We will continue to evaluate our capital requirements for both short-term and long-term liquidity needs, which could be affected by various risks and uncertainties, including, but not limited to, the effects of the current inflationary environment, rising interest rates, and other risks detailed in the section of this Report entitled “Risk Factors.”

Net cash provided by operating activities for the nine months ended September 30, 2022 was $5.6 million resulting from our net income of $14.3 million, adjusted for non-cash charges of $18.0 million in depreciation and amortization, including amortization of right of use assets, deferred financing costs, and debt discounts, $0.2 million of bad debt expense and $0.7 million in deferred tax expense. This was partially offset by a $12.6 million gain on rental tool recovery sales, $14.0 million in net changes from operating assets and liabilities, a $0.1 million unrealized gain on equity securities and a $1.4 million unrealized gain on interest rate swaps. The $14.0 million in cash used from operating assets and liabilities is primarily due to an $8.5 million cash outflow in accounts receivable associated with an increase in sales and higher revenue during the first nine months of 2022, $0.3 million purchased inventory related to our attempt to reduce risk and uncertainties in our supply chain, $2.0 million net cash outflow in accounts payable and accrued expenses due to differences in the timing of disbursements, $5.5 million cash outflow in prepaid expenses due to differences in the timing of repayments and a $3.1 million cash outflow from increasing our right-of-use assets.

Cash Flows (Used In) Provided by Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2023 was $20.0 million. Purchases of property, plant, and equipment of $36.7 million were partially offset by proceeds from rental tool recovery sales of $16.6 million and proceeds from sale of property of $0.1 million.

Net cash used in investing activities for the nine months ended September 30, 2022 was $1.1 million. Purchases of property, plant, and equipment of $16.2 million were partially offset by proceeds from rental tool recovery sales of $16.3 million and proceeds from the sale of property of $0.1 million.

Cash Flows (Used In) Provided by Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2023 was $4.3 million resulting from proceeds from the Merger and PIPE Financing, net of transaction costs, of $23.1 million, partially offset by a net decrease in amounts outstanding under the Credit Facility Agreement of $18.3 million, payments of deferred financing costs of $0.3 million and payments to holders of DTIH convertible preferred stock in connection with the Merger of $0.2 million.

Net cash used in financing activities for the nine months ended September 30, 2022 was $5.9 million resulting from a net decrease in amounts outstanding under the Credit Facility Agreement of $5.8 million.

Critical Accounting Policies and Estimates

The Interim Financial Statements included in this Report have been prepared in accordance with U.S. GAAP. The preparation of these Interim Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities. We also make estimates and assumptions that affect the reported amounts and related disclosures for the periods presented. Our estimates are based on our historical experience and other factors that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly. Additionally, changes in assumptions, estimates or assessments due to unforeseen events or other causes could have a material impact on our financial position or results of operations.

Our significant accounting policies are described in Note 1, Summary of significant accounting policies, to the Interim Financial Statements included elsewhere in this Report on Form 10-Q. We define our critical accounting policies as those under U.S. GAAP that require us to make subjective estimates and judgments about matters that are inherently uncertain and are likely to have a material impact on our financial condition and results of operations, as well as the specific manner in which we apply those principles.

There have been no material changes to our critical accounting policies and estimates as compared to those described in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in our Current Report on Form 8-K dated June 20, 2023, which was filed with the SEC on June 27, 2023.

Recently Issued and Adopted Accounting Standards

A discussion of recent accounting pronouncements is included in Note 1, Summary of significant accounting policies, to the Interim Financial Statements included elsewhere in this report.

JOBS Act Accounting Election

In April 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” may take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Therefore, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected to avail ourselves of this extended transition period and, as a result, we will not adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies. In addition, as an emerging growth company, we may take advantage of certain reduced disclosure and other requirements that are otherwise applicable generally to public companies. DTI will take advantage of these exemptions until such earlier time that it is no longer an emerging growth company. DTI would cease to be an emerging growth company on the date that is the earliest of (i) the last day of the fiscal year following the fifth anniversary of the date of the completion of this offering; (ii) the last day of the fiscal year in which its total annual gross revenue is equal to or more than $1.07 billion; (iii) the date on which it has issued more than $1.0 billion in nonconvertible debt during the previous three years; or (iv) the date on which it is deemed to be a large accelerated filer under the rules of the Securities and Exchange Commission.

Credit risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. We maintain cash and cash equivalents with major and reputable financial institutions. Deposits held with the financial institutions may exceed the amount of insurance provided by the Canadian Deposit Insurance Corporation and the Federal Deposit Insurance Corporation on such deposits but may be redeemed upon demand. We perform periodic evaluations of the relative credit standing of the financial institutions. With respect to accounts receivable, we monitor the credit quality of our customers as well as maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments.

Concentration risk

During the three and nine months ended September 30, 2023, 28% and 28%, respectively of our total revenue was earned from two customers. During the three and nine months ended September 30, 2022, 26% and 27%, respectively of our total revenue was earned from two customers. Amounts due from these customers included in accounts receivable at September 30, 2023 and December 31, 2022 were approximately $8.4 million and $8.6 million, respectively.

Foreign currency risk

Our customers are primarily located in the United States and Canada. Therefore, foreign exchange risk exposures arise from transactions denominated in currencies other than the United States dollar, which is our functional and reporting currency. To date, a majority of our sales have been denominated in United States and Canadian dollars. As we expand our presence in international markets, our results of operations and cash flows may increasingly be subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. To date, we have not entered into any hedging arrangements to minimize the impact of these fluctuations in the exchange rates. We will periodically reassess our approach to manage our risk relating to fluctuations in currency rates.

We do not believe that foreign currency risk had a material effect on our business, financial condition, or results of operations during the periods presented.

Inflation Risk

We expect we will continue to experience inflationary pressures on our cost structure for the foreseeable future. However, tightness in overseas freight and transit times have eased. Additionally, raw material and component costs are moderating due in part to a strengthening United States dollar and weakening steel demand. Nonetheless, we cannot be confident that transit times or input prices will return to the lower levels experienced in prior years. Continued inflation and looming concerns regarding a possible recession weigh on the outlook for oil demand which could in turn negatively impact demand for our goods and services.

Cybersecurity Risk

We have a suite of controls including technology hardware and software solutions, regular testing of the resiliency of our systems including penetration and disaster recovery testing as well as regular training sessions on cybersecurity risks and mitigation strategies. We have established an incident response plan and team to take steps it determines are appropriate to contain, mitigate and remediate a cybersecurity incident and to respond to the associated business, legal and reputational risks. There is no assurance that these efforts will fully mitigate cybersecurity risk and mitigation efforts are not an assurance that no cybersecurity incidents will occur.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures in effect as of September 30, 2023, the end of the period covered by this Report. As a result of management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of September 30, 2023, or as of the date of the filing of this Report.

Our disclosure controls and procedures were not effective as of September 30, 2023, or as of the date of filing of this Report, because all findings in connection with our preparation and the audit of our consolidated financial statements as of and for the year ended December 31, 2022 have not been fully remediated despite ongoing projects and improvements made in the current quarter. As a result, we were not able to rely upon the disclosure controls and procedures that were in place as of September 30, 2023, or as of the date of this filing, and we continue to have a material weakness in our internal control over financial reporting. This material weakness is described in more detail below.

Prior to the Business Combination, we had been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. In connection with our preparation and the audit of our consolidated financial statements as of and for the year ended December 31, 2022, we identified the following deficiencies in the design or operation of our internal controls to be a material weakness:

(1) Failure to promote effective internal control over financial reporting throughout the Company’s management structure;

(2) Failure to develop effective risk assessment controls to identify financial reporting risks and reacting to changes in the operating environment that could have a material effect on financial reporting;

(3) Ineffective monitoring activities to assess the operation of internal control over financial reporting; and

(4) Inadequate documentation and monitoring of information technology (“IT”) general controls and cybersecurity processes within the Company’s IT environment, including access controls and segregation of duties between key IT functions.

We are in the process of implementing a risk assessment process and measures designed to improve our internal control over financial reporting and remediate the control deficiencies that led to the material weakness, including (1) hiring more qualified staff and increasing resources with sufficient knowledge and experience to strengthen financial reporting, (2) implementing software and procedures to enhance our Company’s IT environment and (3) devoting proper time by senior management to perform comprehensive review of procedures to assess risks and enforce effective accountability. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. The elements of our remediation plan can only be accomplished over time, and we can offer no assurance that these initiatives will ultimately have the intended effects.

Changes in Internal Control over Financial Reporting

During the most recently completed fiscal quarter, there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our proxy statement/prospectus/consent solicitation statement filed with the SEC on May 12, 2023 (the “Proxy Statement”), describes important risk factors that could cause our business, financial condition, results of operations and growth prospects to differ materially from those indicated or suggested by forward-looking statements made in this Report or presented elsewhere by management from time to time. There have been no material changes in the risk factors that appear in the Proxy Statement. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business.