Innovex International, Inc.: Form 10-Q for the period ended Sep 30, 2024

The following discussion and analysis of the results of operations, financial condition and liquidity position of Innovex for the three and nine months ended September 30, 2024 and 2023 should be read in conjunction with (i) the accompanying unaudited condensed consolidated financial statements and the related notes included in Part I, Item 1 of this Quarterly Report and (ii) the audited consolidated financial statements and related notes for the year ended December 31, 2023 included in our Form 8-K/A filed with the SEC on September 16, 2024. The following discussion and analysis contains forward-looking statements that are based on management’s current expectations, estimates and projections about Innovex’s business and operations, and involves risks and uncertainties. Actual results may differ materially from those currently anticipated and expressed in such forward-looking statements because of various factors, including those described in the sections titled “Cautionary Statement Regarding Forward- Looking Statements,” “Risk Factors” and elsewhere in this Quarterly Report, all of which are difficult to predict. Innovex does not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law. References in this section to “Innovex,” the “Company,” the “Combined Company,” “we,”“us” and “our” are to Innovex International, Inc.(formerly known as Dril-Quip, Inc.) and its consolidated subsidiaries after giving effect to the Merger and related transactions, unless the context otherwise requires or as otherwise indicated. Except as otherwise indicated, references herein to "Dril-Quip" are to Dril-Quip, Inc. prior to the completion of the Merger.

Overview

Innovex designs, manufactures, sells and rents mission critical engineered products to the global oil and natural gas industry. Our vision has been to create a global leader in well-centric products and technologies through organic, customer-linked innovations and disciplined acquisitions to drive leading returns for our investors. Our products are used across the life cycle of the well (during the construction, completion, production and intervention phases) and are typically utilized downhole and consumable in nature. Our products perform a critical well function, and we believe they are chosen due to their reliability and capacity to save our customers time and lower costs during the well lifecycle. We believe that our products have a significant impact on a well’s performance and economic profile relative to the price we charge, creating a “Big Impact, Small Ticket” value proposition. Many of our products can be used in a significant portion of our customers’ wells globally, with our most advanced products providing mission critical solutions for some of the most challenging and complex wells in the world. We have a track record of developing proprietary products to address our customers’ evolving needs, and we maintain an active pipeline of potential new products across various stages of development.

We are a global company, and for the nine months ended September 30, 2024, the US and Canadian onshore ("NAM") market made up approximately 63% of our revenue while the international and offshore ("International and Offshore") markets constituted 37%. Within the NAM market, we have a strong presence in the United States and a growing presence in Canada. The NAM market is core to us, and we maintain a robust sales and distribution infrastructure across the region. Our products have broad applicability in this market, particularly for horizontal or unconventional wells that have become prevalent methods of oil and natural gas development across the region. We are focused on significantly increasing our revenue from the International and Offshore markets, as these regions are typically subject to long-cycle investment horizons and exhibit relatively less cyclicality than the NAM market. The Middle East, and in particular Saudi Arabia, has been a key source of growth for Innovex and has become our largest International and Offshore market. We also operate across Latin America, Europe and the U.S. Gulf of Mexico, among other regions. To enhance our global reach, we have complemented our locations across these markets with a network of strategic distribution, sales and manufacturing partners.

We are an innovator and have a development process and culture focused on creating proprietary products for our customers. We seek to work with our customers to solve their operational challenges. We believe that these collaborations have been a source of growth as they have allowed us to develop new products with anchor customers that have served as an initial revenue base from which to scale. We have a unique culture that we view as having been critical to our success in the commercialization of new products. We define our culture as “No Barriers.” Our goal is to remove internal barriers that slow the pace of innovation and empower our employees to be responsive to our customers’ needs, while maintaining a focus on returns for the Company. As a result of our culture and our commitment to customer responsiveness, we believe that we are more agile and able to innovate faster than our larger competitors.

Our organic growth has been complemented by a disciplined and contrarian acquisition strategy. We view acquisitions as a core competency and have identified a rich opportunity set of acquisition targets that we believe are seeking to transact. We aim to execute a disciplined acquisition strategy for high-quality opportunities that meet our stringent investment criteria.

We have a broad customer base, ranging from the largest International Oil Companies, National Oil Companies, and exploration and production ("E&P") companies as well as multinational and regional oilfield service companies. Once a new product has been commercialized or acquired, our global sales and distribution infrastructure enables us to scale and drive customer adoption quickly.

Our business has produced strong returns on invested capital. Please see "—Non-GAAP Financial Measures” within this section for Return on Capital Employed, which is how we assess the effectiveness of our capital allocation over time. For the nine months ended September 30, 2024, our net income, income from operations and Adjusted EBITDA were equivalent to approximately 26%, 5% and 22% of revenue, respectively. Over the same period, capital expenditures accounted for only 1% of revenue, and we earned approximately $22.2 million in income from operations. For the nine months ended September 30, 2023, our net income, income from operations, and Adjusted EBITDA were equivalent to approximately 13%, 18% and 24% of revenue, respectively. Over the same period, capital expenditures accounted for only 3% of revenue, and we earned approximately $74.0 million in income from operations. We believe that our global sales and distribution network, as well as our manufacturing capacity and vendor network, position us well to drive revenue growth and margin expansion. Please see “—Non-GAAP Financial Measures” within this section for the definitions of Adjusted EBITDA, Adjusted EBITDA Margin, and Return on Capital Employed, as well as a reconciliation of Adjusted EBITDA, Adjusted EBITDA Margin, and Return on Capital Employed to our most directly comparable financial measures calculated and presented in accordance with GAAP.

We believe that we can create value for our stockholders across the industry cycle and view our “through-cycle playbook” as providing a plan for us to outperform in all market environments. We prioritize protecting the long-term health of the Company through investments in R&D and sustaining engineering in our existing portfolio in all market environments. We seek to maintain a conservative balance sheet to preserve operational and financial flexibility through the industry cycle.

Recent Developments

On March 18, 2024, the Company (formerly known as Dril-Quip, Inc.) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Innovex Downhole Solutions, Inc., a Delaware corporation (“Legacy Innovex”), Ironman Merger Sub, Inc., a Delaware corporation and wholly owned subsidiary of Dril-Quip, and DQ Merger Sub, LLC, a Delaware limited liability company and wholly owned subsidiary of the Company. Following the consummation of the transactions contemplated by the Merger Agreement (the “Merger”), Legacy Innovex became a wholly owned subsidiary of the Company, the name of the Company was changed to Innovex International, Inc., and its common stock remained listed on the New York Stock Exchange. The merger closed on September 6, 2024 and was accounted for using the acquisition method of accounting with Legacy Innovex being identified as the accounting acquirer. The consolidated financial statements of the Company reflect the financial position, results of operations and cash flows of only Legacy Innovex for all periods prior to the Merger and of the Combined Company (including activities of Dril-Quip) for all periods subsequent to the Merger.

Pursuant to the Merger Agreement, as of the effective time of the Merger, each outstanding share of common stock, par value $0.01 per share, of Legacy Innovex was converted into the right to receive 2.0125 shares of common stock, par value $0.01 per share, of the Company (the “Company Common Stock”). The number of shares of Company Common Stock received by the Legacy Innovex stockholders was equal to 32,183,966. On September 9, 2024, the first trading day following the closing of the Merger, the Company Common Stock began trading on the New York Stock Exchange under the new ticker symbol “INVX.”

Market Factors and Trends

Our business is driven by the number of oil and natural gas wells drilled worldwide, which, in turn, is tied to the level of global spending of the oil and natural gas E&P industry. Rystad Energy expects, based on their current forecast of $85 per barrel for Brent crude oil in 2025, global E&P capital spending, excluding Russia and China, to increase 12% from approximately $239 billion in 2023 to approximately $268 billion in 2026. Rystad Energy also estimates that the annual number of global wells drilled, excluding Russia and China, will increase 1% from approximately 34,000 in 2023 to approximately 34,300 in 2026, which we expect will lead to modest additional revenue opportunities for our business. As a result, the average E&P capex spending per well is expected to increase, a trend that would increase the TAM of our business, all else held equal. The pace of development activity is driven by expected well profitability and returns, which, in turn, are influenced by several factors, including current global oil and natural gas supply and demand balances, current and expected future prices for oil and natural gas and the perceived stability and sustainability of these commodity prices over time.

The oil and natural gas industry has historically been characterized by volatility in commodity prices and in the level of drilling and production activity, which are driven by a variety of market forces. After a decline due to the COVID-19 pandemic, the global demand for oil and natural gas recovered to near pre-COVID levels by the fourth quarter of 2021. As a result, demand for our products and services improved, resulting in increased revenue for us. It is estimated that total hydrocarbon demand will increase modestly over the medium-term.

We believe that the outlook for oil and natural gas development activity and prices remains positive. Multiple years of under investment in oil and natural gas development has left the industry with a limited amount of spare production capacity. Additionally, public E&P operators have adopted a more conservative approach to capital spending in response to stockholders’ desire for increased return of capital. We believe that these factors have laid a foundation to support oil and natural gas prices and will lead to a sustained spending cycle and increased activity levels by our customers in the near and medium-term.

Description of Certain Components of Financial Data

Revenues

We generate our revenue from three primary sources: sales of products and other associated revenues with product sales, such as freight; rentals of tools that are used to deploy our products or to provide a critical well function; and services that are typically connected to the well-site deployment of our engineered products. We have global operations, with sales generated within both our NAM market operations and our International and Offshore markets.

The Company accounts for more complex, customer specific projects that have relatively longer manufacturing time frames on an over-time basis. For the three months ended September 30, 2024, there were 6 projects representing approximately 0.2% of the Company’s total revenues and approximately 0.2% of its product revenues that were accounted for using over-time accounting, compared to zero projects for the three months ended September 30, 2023. For the nine months ended September 30, 2024, there were 6 projects representing approximately 0.1% of the Company’s total revenues and approximately 0.1% of its product revenues that were accounted for using over-time accounting, compared to zero projects for the nine months ended September 30, 2023. Revenues accounted for in this manner are generally recognized based upon a calculation of the percentage complete, which is used to determine the revenue earned and the appropriate portion of total estimated cost of revenues to be recognized. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments, proportionate to the percentage complete, are reflected in the period when such estimates are revised. Losses, if any, are recorded in full in the period they become known. Amounts received from customers in excess of revenues recognized are classified as a current liability.

Cost of revenues

Our cost of revenues consists of expenses relating to the manufacture and procurement of our products in addition to the costs of our support services. Cost of revenues related to manufacturing and procurement of our products includes the cost of components sourced from third-party suppliers and direct and indirect costs to manufacture and supply products, including labor, materials, machine time, lease expense related to our manufacturing facilities, freight and other variable manufacturing costs, such as shrinkage, obsolescence variances and revaluation or scrap related to our existing inventory. Our support services costs include personnel expenses for our field service organization, lease expense related to our operations facilities, threading charges, vehicle expenses and freight.

Selling, general and administrative expense

Selling, general and administrative expense consists of costs such as sales and marketing, engineering and R&D expenses, general corporate overhead, compensation expense, IT expenses, safety and environmental expenses, insurance costs, legal expenses and other related administrative functions.

Gain/loss on sale of assets

Gain/loss on sale of assets represents profit recognized on the sale of property and equipment, net.

Depreciation and amortization

Depreciation and amortization expense consists of depreciation related to our tangible assets, including investments in property and equipment, and amortization of intangible assets, including identified intangible assets related to acquisition purchase price accounting.

Impairment of long-lived assets

Impairment of long-lived assets consists of the write down of the carrying value of our long-lived assets to fair value when, as part of our periodic impairment evaluation performed in accordance with Accounting Standards Codification 360 Property, Plant, and Equipment, we determine that the carrying value of the asset or asset group is not recoverable and exceeds its fair value.

Acquisition Costs

Acquisition costs consist of legal, accounting, advisory fees, and other integration costs incurred in connection with the acquisition and integration of a business.

Interest expense

Interest expense, net primarily consists of interest expense associated with the Term Loan and the Credit Facility (each as defined herein).

Other income/expense, net

Other income/expense, net consists of foreign exchange transaction gains or losses resulting from a change in exchange rates between the functional currency and the currency in which a foreign currency transaction is denominated and other non-operating items.

Equity method earnings

Equity method earnings consist of our proportional share of the earnings of our equity method investee, Downhole Well Solutions, LLC ("DWS"), acquired on May 1, 2023 along with the associated amortization of our proportional share of the step up in fair value of the intangible assets acquired.

Income tax expense

We are subject to income taxes in both the United States and foreign jurisdictions in which we operate. Differences between our effective tax rate and the U.S. federal statutory tax rate are primarily due to state taxes, foreign jurisdiction rate differences, permanent differences between book and tax income and changes in the valuation allowance.

Factors Affecting the Comparability of Our Results of Operations

Our historical financial condition and results of operations for the periods presented may not be comparable, either from period to period or going forward, due to recent and future acquisitions. One way in which we have grown, and will continue to grow, our operations and financial results is through strategic acquisitions. In August 2022, Legacy Innovex acquired Pride Energy Services, LLC ("Pride"), a company that complemented our well production and intervention product group. In May 2023, Legacy Innovex acquired 20% of DWS, a company that manufactures and rents engineered downhole tools designed to improve the performance of directional and horizontal drilling operations. Finally, in March 2024, Legacy Innovex entered into the Merger Agreement with Dril-Quip and the Merger was consummated on September 6, 2024. As a general matter, following an acquisition, our results of operations are affected by the results of the newly acquired business or operations, the purchase accounting for the acquisition, any debt incurred in connection with the acquisition and expenditures made to integrate the newly acquired business or operations. As a result of our acquisitions and the consolidation of our operating subsidiaries’ into the Company's financial results, the periods presented in our historical financial statements may not be comparable to one another and our future results of operations and financial results may differ.

Results of Operations

The following table presents summary consolidated operating results for the periods presented:

(in thousands)

Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023

Revenues. Our NAM market revenue for the three months ended September 30, 2024 was $98.3 million, an increase of $6.0 million from $92.3 million for the three months ended September 30, 2023, primarily driven by an increase in market share and incremental business operations due to the Merger. This was offset by a reduction in drilling activity in North America due to a decline in the North America land rig count during the comparative period. Our International and Offshore market revenue for the three months ended September 30, 2024, was $53.5 million, an increase of $6.7 million from $46.8 million for the three months ended September 30, 2023, primarily driven by increased business operations due to the Merger.

Cost of Revenues, Exclusive of Depreciation and Amortization. Total cost of revenues for the three months ended September 30, 2024 was $99.1 million, an increase of $9.9 million from $89.2 million for three months ended September 30, 2023. The increase was primarily attributable to a $6.3 million increase in personnel expense due to increased activity levels due to the Merger. The remaining difference is attributable to increased product costs, as a result of increased sales.

Selling, General and Administrative Expenses. Selling, general and administrative expense for the three months ended September 30, 2024 was $38.0 million, an increase of $18.8 million from $19.2 million for the three months ended September 30, 2023. The increase is primarily attributable to a $10.4 million increase in stock-based compensation expenses mostly related to vested stock awards as a result of the closing of the Merger, $3.6 million increase in salaries and wages caused by an increased headcount after the Merger, and $1.9 million increase in other personnel expenses driven by increased payroll tax expenses due to the Merger. The remaining change is increased business insurance expenses along with increases in other miscellaneous selling, general and administrative expenses.

(Gain)/loss on sale of assets. (Gain)/loss on sale of assets for the three months ended September 30, 2024 and 2023 was $(0.2) million and $(0.1) million, respectively. The change during the two periods was due to normal variations in property and equipment sales activity.

Depreciation and Amortization. Total depreciation and amortization expense for the three months ended September 30, 2024 was $7.8 million, an increase of $2.0 million from $5.8 million for the three months ended September 30, 2023. The increase in depreciation and amortization was primarily due to additional depreciation for assets acquired related to the Merger.

Long-lived asset impairments. There was no long-lived asset impairment expense for the three months ended September 30, 2024, compared to $0.3 million for the three months ended September 30, 2023. The impairment expense in 2023 was related to a building lease in Texas. Management performed an impairment analysis in the current quarter, noting no indicators of impairment of existing long-lived assets.

Acquisition Costs. Acquisition Costs for the three months ended September 30, 2024 was $20.3 million, an increase of $19.5 million from $0.8 million for the three months ended September 30, 2023. The increase in acquisition costs was due to the costs incurred in connection with the Merger.

Interest Expense, Net. Total interest expense, net for the three months ended September 30, 2024 was $0.7 million, a decrease of $0.8 million from $1.5 million for the three months ended September 30, 2023. The decrease was primarily due to higher average debt balances outstanding during 2023 due to the acquisition of Pride in August of 2022, the acquisition of a 20% interest in DWS in May of 2023, and the overall continued paydown of our debt through the generation of operational cash flows throughout 2023 and for the nine months ended September 30, 2024.

Other (Income) Expense, Net. Total other (income) expense, net for the three months ended September 30, 2024 was $(0.3) million, a decrease of $0.4 million from $0.1 million for the three months ended September 30, 2023, with the change primarily being due to the net change in our foreign currency exchange gains (losses).

Equity Method Earnings. Equity method earnings consist of the net earnings of our equity method investee, DWS, acquired on May 1, 2023, along with the amortization of our proportional ownership interest in the step up of the fair value of the intangible assets acquired. Total Equity method earnings, excluding the amortization of the step up in fair value, for the three months ended September 30, 2024 and 2023 were $1.4 million and $1.4 million, respectively. The amortization of the step up in the fair value of the intangible assets acquired for the three months ended September 30, 2024 and 2023 were $0.4 million and $0.6 million, respectively.

Gain on Bargain Purchase. Gain on bargain purchase for the three months ended September 30, 2024 and 2023 was $92.7 million and zero, respectively. The gain on bargain purchase in the third quarter of 2024 was related to the Merger.

Income Tax Expense. Our operations are subject to U.S. federal income tax at an entity level, as well as various state income and franchise taxes. In addition, our operations located in international jurisdictions are subject to local country income taxes. Income tax expense for the three months ended September 30, 2024 was $(2.6) million, a decrease of $10.5 million from $7.9 million for the three months ended September 30, 2023. The decrease was primarily driven by changes in mix of income before income taxes by geography and tax jurisdiction, discrete items recorded in the quarter, and other non-deductible expenses. For the three months ended September 30, 2024, income before income taxes was $80.0 million, representing an increase of $56.8 million from $23.2 million for the three months ended September 30, 2023 primarily due to the effect of the Gain on Bargain Purchase discussed above, which is treated as a permanent discrete adjustment for purposes of calculating income tax expense.

Net Income. Net income for the three months ended September 30, 2024 was $82.6 million, an increase of $67.2 million from net income of $15.4 million for the three months ended September 30, 2023, as a result of the factors discussed above.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

Revenues. Our NAM market revenue for the nine months ended September 30, 2024 was $258.3 million, a decrease of $22.5 million from $280.8 million for the nine months ended September 30, 2023, primarily attributable to a reduction in drilling activity in North America due to a decline in the North America Land Rig Count during the comparative periods. This reduction was partially offset by an increase in market share and incremental business due to the Merger. Our International and Offshore market revenue for the nine months ended September 30, 2024 was $151.8 million, an increase of $10.2 million from $141.6 million for the nine months ended September 30, 2023, primarily attributable to incremental business as a result of the Merger.

Cost of Revenues, Exclusive of Depreciation and Amortization. Total cost of revenues for the nine months ended September 30, 2024 was $262.4 million, a decrease of $13.0 million from $275.4 million for the nine months ended September 30, 2023.The decrease was primarily attributable to $6.2 million decrease in product cost of goods sold, a $2.1 million decrease in freight expenses, and a $2.4 million decrease in cost of supplies and general manufacturing expenses, as a result of decreased procurement and manufacture of supplies and products due to the decrease in revenues. The remaining difference is attributable to increases in manufacturing absorption costs, change in inventory reserves, and other miscellaneous costs.

Selling, General and Administrative Expenses. Selling, general and administrative expense for the nine months ended September 30, 2024 was $77.9 million, an increase of $23.8 million from $54.1 million for the nine months ended September 30, 2023. The increase was primarily attributable to a $10.3 million increase in stock-based compensation expenses mostly related to vested stock awards as a result of the closing of the Merger, $4.6 million increase in salaries and wages caused by increased headcounts due to the Merger, $2.0 million increase in payroll tax expenses due to the Merger and a $1.9 million increase in other personnel expenses in preparation for Legacy Innovex's transition to becoming a public company, along with an increase of $1.2 million in attorneys and professional fees in connection with Legacy Innovex's Form S-1 filings in connection with its then-planned initial public offering ("IPO"). The increase is also partly due to an increase in business insurance expense of $1.5 million, along with other changes in Selling, general and administrative expenses resulting in an increase of $1.0 million, these increases in cost being due to inflationary pressures and cost increases due to the growth in our business.

(Gain)/loss on sale of assets. (Gain)/loss on sale of assets for the nine months ended September 30, 2024 and 2023 was $(0.5) million and $0.1 million, respectively. The change during the two periods was due normal variations in property and equipment sales activity.

Depreciation and Amortization. Total depreciation and amortization expense for the nine months ended September 30, 2024 was $19.2 million, an increase of $2.6 million from $16.6 million for the nine months ended September 30, 2023. The increase in depreciation and amortization was primarily due to additional depreciation for assets acquired related to the Merger, along with a $1.2 million increase in amortization for right of use finance leases due to an increase in our leases that are classified as finance leases during the comparative periods.

Long-lived asset impairments. Total long-lived asset impairment expense for the nine months ended September 30, 2024 was $3.5 million. Total long-lived asset impairment expense for the nine months ended September 30, 2023 was $0.3 million. The increase in long-lived asset impairment expense was due to a significant decrease in the market price of a right of use asset related to a building lease and a company owned building, which ultimately resulted in an impairment expense of $3.5 million for the combined assets.

Acquisition Costs. Acquisition Costs for the nine months ended September 30, 2024 and 2023 was $25.5 million, an increase of $23.5 million from $2.0 million for the nine months ended September 30, 2023. The increase in acquisition costs was primarily due to the costs incurred in connection with the Merger.

Interest Expense, Net. Total interest expense, net for the nine months ended September 30, 2024 was $2.1 million, a decrease of $2.6 million from $4.7 million for the nine months ended September 30, 2023. The decrease was primarily due to higher average debt balances outstanding during 2023 due to the acquisition of Pride in August of 2022, the acquisition of a 20% interest in DWS in May of 2023, and the overall continual paydown of our debt through the generation of operational cash flows throughout 2023 and for the nine months ended September 30, 2024.

Other (Income) Expense, Net. Total other (income) expense, net for the nine months ended September 30, 2024 was $(0.4) million, an increase of $0.3 million from $(0.1) million for the nine months ended September 30, 2023, with the change primarily being due to the net change in our foreign currency exchange gains (losses).

Equity Method Earnings. Equity method earnings consist of the net earnings of our equity method investee, DWS, acquired on May 1, 2023, along with the amortization of our proportional ownership interest in the step up of the fair value of the intangible assets acquired. Total equity method earnings, excluding the amortization of the step up in fair value, for the nine months ended September 30, 2024 and 2023 was $3.3 million and $2.1 million, respectively. The amortization of the step up in the fair value of the intangible assets acquired for the nine months ended September 30, 2024 and 2023 were $1.1 million and $0.6 million, respectively.

Gain on Bargain Purchase. Gain on bargain purchase for the nine months ended September 30, 2024 and 2023 was $92.7 million and zero, respectively. The gain on bargain purchase in the third quarter of 2024 was related to the Merger.

Income Tax Expense. Our operations are subject to U.S. federal income tax at an entity level, as well as various state income and franchise taxes. In addition, our operations located in international jurisdictions are subject to local country income taxes. Income tax expense for the nine months ended September 30, 2024 was $6.9 million, a decrease of $8.5 million from $15.4 million for the nine months ended September 30, 2023. The decrease was primarily driven by changes in mix of income before income taxes by geography and tax jurisdiction, discrete items recorded in the quarter, and other non-deductible expenses. For the nine months ended September 30, 2024, income before income taxes was $115.4 million, an increase of $44.5 million from $70.9 million for the nine months ended September 30, 2023 primarily due to the effect of the Gain on Bargain Purchase discussed above, which is treated as a permanent discrete adjustment for purposes of calculating income tax expense.

Net Income. Net income for the nine months ended September 30, 2024 was $108.5 million, an increase of $53.0 million, or 95%, from net income of $55.5 million for the nine months ended September 30, 2023, as a result of the factors discussed above.

Liquidity and Capital Resources

Our primary sources of liquidity are our existing cash, cash provided by operating activities, and borrowings under the Credit Facility. As of September 30, 2024, we had cash and restricted cash of $99.9 million and availability under the Revolver (as defined herein) of $90.8 million. Our total indebtedness was $23.0 million as of September 30, 2024.

Our principal liquidity needs have been, and are expected to continue to be, working capital, capital expenditures, debt service and potential mergers and acquisitions. Historically capital expenditures have been relatively modest, with working capital being the predominant use of cash for the Company during periods of growth. We continuously evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including, among other things, prevailing economic conditions, market conditions in the oil and natural gas industry, customers’ forecasts, demand volatility and company initiatives.

We have certain obligations related to debt maturities, finance leases and operating leases. As of September 30, 2024, we have $18.0 million of minimum non-cancelable lease obligations for the twelve months following September 30, 2024, comprised of $6.2 million of finance lease maturities and $11.8 million of operating lease obligations. We have an additional $55.7 million of minimum non-cancelable lease obligations for the periods after September 30, 2025, comprised of $5.5 million of finance lease maturities and $50.2 million of non-cancelable operating lease obligations. As of September 30, 2024, interest rates on our lease obligations range from 2.08% -12%. In addition, as of September 30, 2024, we have $5.0 million of debt maturities over the next twelve months comprised of $5.0 million of required amortization payments on our Term Loan (as defined herein). For the periods after September 30, 2025, for our Term Loan, we have an additional $7.7 million of debt maturities representing the remaining balance on our Term loan. Any outstanding balances under our Revolver would become due and payable during 2026. For the nine months ended September 30, 2024 and 2023, the Company’s effective interest rate on the term loan was approximately 8.85% and 7.33%, respectively, and the effective interest rate on the revolving line of credit was approximately 10.46% and 8.48%, respectively. See “Note 9—Debt” to our consolidated financial statements included in Part I, Item 1 of this Quarterly Report for additional information.

We believe that our existing cash on hand, cash generated from operations and available capacity under the Revolver will be sufficient to meet our liquidity needs in the short-and long-term. Our ability to satisfy our liquidity requirements depends on our future operating performance, which is affected by prevailing economic conditions, market conditions in the oil and natural gas industry, availability and cost of raw materials. and other factors, many of which are beyond our control.

Cash Flows

The following table summarizes our cash flows for the periods indicated:

(in thousands)

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

Net cash provided by operating activities was $57.1 million and $54.5 million for the nine months ended September 30, 2024 and 2023, respectively. The $2.6 million increase in cash provided by operations for the comparative periods was due to the following:

• an increase in net income of $53.1 million;
• changes in non-cash adjustments to net income from the comparative period as a result of a $10.3 million increase in stock compensation expense, primarily due to the accelerated vesting of equity based awards, an $11.2 million increase in deferred taxes due to timing differences, offset by a $92.7 million gain on bargain purchase as a result of the Merger, which was a non-cash equity based transaction, along with other non-cash (gains) losses of $6.5 million; and
• changes in operating assets and liabilities, net of assets acquired as part of the Merger, totaling $14.2 million, primarily due to changes in trade receivable balances from the comparative period of $31.5 million due to increased cash collections on outstanding receivables for the nine months ended September 30, 2024, partially offset by increases in cash used to acquire inventory for the nine months ended September 30, 2024 of $16.2 million from the comparative period due to

inventory procurement activity in anticipation of expected increases in product sales and to allow us to take advantage of vendor pricing incentives.

Net cash provided by (used in) investing activities was $150.4 million and $(31.6) million for the nine months ended September 30, 2024 and 2023, respectively. The $182.0 million increase in cash generated by investing activities was primarily due to $154.3 million of cash acquired from the Merger, $8.3 million decrease in capital expenditures and $18.4 million decrease due to the investment in DWS during the third quarter of 2023.

Net cash used in financing activities was $(114.2) million and $(23.0) million for the nine months ended September 30, 2024 and 2023, respectively. The $91.2 million increase in cash used in financing activities was primarily due to the payment of $75.0 million in dividends, the payment of $10.2 million of taxes related to net share settlement of equity awards during the third quarter of 2024, and an increase of $7.4 million in net repayments on the Revolver due to cash generated from positive operating cash flows.

Credit Agreement

Legacy Innovex, Tercel Oilfield Products USA L.L.C., Top-Co Inc. and Pride (collectively, the “Original Borrowers”) entered into the Second Amended and Restated Revolving Credit, Term Loan, Guaranty and Security Agreement in June 2022 (as amended in November 2022, April 2023, December 2023, and June 2024, the “Credit Agreement”), with PNC Bank, National Association, as agent, and the lenders party thereto. On September 6, 2024, the Company and TIW Corporation (collectively and together with the Original Borrowers, the "Borrowers") joined the Credit Agreement as borrowers thereunder. The Credit Agreement provides for (i) a term loan tranche in a principal amount of the lesser of $25.0 million and a certain amount determined based, in part, on appraised values of certain assets of Legacy Innovex and certain of its subsidiaries (the “Term Loan”) and (ii) a revolving credit facility of up to $110.0 million with a $5.0 million sublimit for letters of credit and a $11.0 million swing loan (collectively, the “Revolver” and, together with the Term Loan, the “Credit Facility”).

The Credit Facility matures on June 10, 2026. The Term Loan is amortized in an amount equal to $1.25 million each quarter. Amounts borrowed under the Credit Facility are subject to an interest rate per annum equal to, at the Company’s option, either (a) an alternate base rate determined as the highest of (i) the base commercial lending rate of PNC Bank, National Association, (ii) the overnight federal funds rate (subject to a 0% floor) plus 0.5% and (iii) Daily Simple SOFR (as defined in the Credit Agreement) plus 1% (such base rate to be subject to a 0% floor) or (b) the forward-looking term rate based on the secured overnight financing rate (“SOFR”) for the applicable interest period two business days before such interest period divided by a number equal to 1.00 minus any SOFR reserve percentage (such term rate to be subject to a 0% floor), plus, in each case of clauses (a) and (b) above, an applicable margin of 0.75% for swing loans and alternate base rate revolving loans, 1.75% for term SOFR revolving loans, 1.00% for alternate base rate term loans and 2.00% for term SOFR term loans. Interest is payable monthly for alternate base rate loans and at the end of the applicable interest period for term SOFR loans (or quarterly if the applicable interest period is longer than three months).

In addition to paying interest on outstanding borrowings under the Credit Facility, the Company is required to pay a quarterly commitment fee to the lenders under the Credit Agreement equal to 0.25% per annum on the amount by which $110.0 million exceeds the daily unpaid balance of the Revolver plus any swing loans plus any undrawn amount of outstanding letters of credit under the Credit Agreement on any day.

The Credit Facility is secured by liens on substantially all of the assets of the Borrowers and certain future subsidiaries of Innovex and guarantees from certain future subsidiaries of Innovex. The Credit Facility requires the Borrowers to make mandatory prepayments on the outstanding amount of (i) the Term Loan in an amount equal to 25% of excess cash flow for each fiscal year, (ii) the Credit Facility if Borrowers issue debt other than certain permitted debt or, subject to certain exceptions, sell assets and (iii) the Term Loan and/or the Revolver if the Borrowers issue equity interests the proceeds of which are not used for certain purposes.

The Credit Agreement contains restrictive covenants that may limit our ability to, among other things, incur additional indebtedness, guarantee obligations, incur liens, make investments, loans or capital expenditures, sell or dispose of assets, enter into mergers or consolidations, enter into transactions with affiliates, or make or declare dividends. The Credit Agreement also requires the Borrowers to maintain as of the last day of each fiscal quarter, a total leverage ratio of not more than 2.50 to 1.00 for the four-quarter period then ending as long as the Term Loan is outstanding. In addition, the Credit Facility contains a springing covenant that requires the Borrowers to maintain, as of the last day of each fiscal quarter, a fixed charge coverage ratio of not less than 1.10 to 1.00 for the four quarter period then ending if (i) an event of default occurs and is continuing or (ii) the lesser of (x) the undrawn availability of the Revolver and (y) a certain amount determined based, in part, on appraised values of certain assets of Innovex and certain of its subsidiaries, is less than 20% of $110.0 million plus any increases to the maximum principal amount of the Revolver in accordance with the terms of the Credit Agreement. As of September 30, 2024, we were in compliance with all covenants under the Credit Facility.

If an event of default exists under the Credit Agreement, the lenders will be able to accelerate the maturity of the Credit Facility and exercise other rights and remedies. An event of default includes, among other things, the nonpayment of principal, interest, fees or other amounts, the failure of any representation or warranty to be correct when made or deemed made in all material respects, the failure to perform or observe covenants in the Credit Agreement or other loan documents, subject, in limited circumstances, to certain grace periods, a cross-default to certain other indebtedness if the effect of such default is to cause, or permit the holders of such indebtedness to cause, the acceleration of such indebtedness, the occurrence of bankruptcy or insolvency events, the rendering of material monetary judgments, the invalidity of any guaranty, security agreement or pledge agreement and the occurrence of a Change of Control (as defined in the Credit Agreement).

As of September 30, 2024 and September 30, 2023, we had $12.7 million and $19.0 million, respectively, of borrowings outstanding under the Term Loan, and no borrowings, and $31.3 million, respectively, of borrowings under the Revolver.

The consummation of the transactions contemplated by the Merger Agreement constituted a Change of Control (as defined in the Credit Agreement). In June 2024, Legacy Innovex entered into the Fourth Amendment to the Second A&R Credit Agreement, which permitted the change in control event and payment of the cash dividend contemplated by the Merger Agreement.

Non-GAAP Financial Measures

Adjusted EBITDA and Adjusted EBITDA Margin

We define Adjusted EBITDA (a non-GAAP measure) as net income before interest expense, income tax expense, depreciation and amortization, (gain)/loss on sale of assets and other expense, net, further adjusted to exclude certain items which we believe are not reflective of our ongoing performance or which are non-cash in nature. Management uses Adjusted EBITDA to assess the profitability of our business operations and to compare our operating performance to our competitors without regard to the impact of financing methods and capital structure and excluding costs that management believes do not reflect our ongoing operating performance, and for this reason we believe this measure will provide useful information to investors. We track Adjusted EBITDA on an absolute dollar basis and as a percentage of revenue, which we refer to as Adjusted EBITDA Margin.

The following table presents a reconciliation of the GAAP financial measure of net income (loss) and net income (loss) as a percentage of revenue to Adjusted EBITDA and Adjusted EBITDA Margin, respectively, for each of the periods indicated:

(in thousands)

(1) Primarily represents foreign currency exchange gain/loss, gain/loss on lease terminations, and other non-operating items.

(2) For the nine months ended September 30, 2024, Acquisition Costs consisted of legal, accounting, advisory fees, and other integration costs associated with the Merger. For the nine months ended September 30, 2023, Acquisition Costs consisted of legal, accounting, advisory fees, associated with the acquisition of our ownership interest in DWS along with other integration related expenses. These Acquisition Costs are one-time in nature and represent expenses that we do not view as normal operating expenses necessary to operate our business.

(3) Reflects the elimination of our percentage of interest expense, depreciation, amortization and other non-recurring expenses included within Equity method earnings relating to our unconsolidated investment in DWS.

(4) Reflects legal, consulting and accounting fees and expenses related to IPO preparation.

Return on Capital Employed

We utilize Return on Capital Employed ("ROCE") (a non-GAAP measure) to assess the effectiveness of our capital allocation over time and to compare our capital efficiency to our competitors, and for this reason we believe this measure will provide useful information to investors. We define ROCE as Income from Operations, before acquisition costs and after tax (resulting in Adjusted Income from Operations, after tax) divided by average capital employed. Capital employed is defined as the combined values of debt and stockholders’ equity.

The following table presents a reconciliation of the GAAP financial measure of Income from Operations to Adjusted Income from Operations, after tax to ROCE for each of the periods indicated:

(in thousands)

Free Cash Flow

We also utilize Free Cash Flow (a non-GAAP measure) to evaluate the cash generated by our operations and results of operations. We define Free Cash Flow as net cash provided by operating activities less capital expenditures, as presented in our condensed consolidated statements of cash flows. Management believes Free Cash Flow is useful because it demonstrates the cash that was available in the period that was in excess of our needs to fund our capital expenditures. Free Cash Flow does not represent our residual cash flow available for discretionary expenditures, as we have non-discretionary expenditures, including, but not limited to, principal payments required under the terms of our Credit Facility, which are not deducted in calculating Free Cash Flow.

The following table presents a reconciliation of the GAAP financial measure of net cash provided by (used in) operating activities to Free Cash Flow for each of the periods indicated:

(in thousands)

Off-Balance Sheet Arrangements

Currently, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements or capital resources.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations is derived from the review of our consolidated financial statements prepared in accordance with GAAP, which includes our interpretation of accounting guidance and application through accounting policies. The preparation of financial statements requires the use of judgments and estimates. Our critical accounting estimates are described below to provide a better understanding of how we develop our assumptions and judgments about future events and related estimates and how they can impact our financial statements. A critical accounting estimate is one that requires our most difficult, subjective or complex judgments and assessments and is fundamental to our results of operations.

We base our estimates on historical experience and on various other assumptions we believe to be reasonable according to the current facts and circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We believe the following are the critical accounting estimates used in the preparation of our consolidated financial statements, as well as the significant estimates and judgments affecting the application of these policies. This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in Part I. Item 1 of this Quarterly Report and with Legacy Innovex's financial statements and related notes thereto for the year ended December 31, 2023 included in our Current Report on Form 8-K/A filed with the Securities and Exchange Commission on September 16, 2024.

Income Taxes

Deferred taxes are recorded using the asset and liability method, whereby tax assets and liabilities are determined based on the differences between the carrying amount and tax basis of assets and liabilities using enacted tax laws and rates expected to apply to taxable income in the year in which the differences are expected to reverse. We regularly evaluate the valuation allowances established for deferred tax assets for which future realization is uncertain. In assessing the realizability of deferred tax assets, we consider both positive and negative evidence, including scheduled reversals of deferred tax assets and liabilities, projected future taxable income, tax planning strategies and results of recent operations. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, a valuation allowance is recorded. As of September 30, 2024, the valuation allowance for deferred tax assets was $65.1 million. The Company recognizes a tax benefit in our financial statements for an uncertain tax position only if management’s assessment is that the position is “more likely than not” (i.e., a likelihood greater than 50 percent) to be allowed by the tax jurisdiction based solely on the technical merits of the position.

The term “tax position” in the accounting standards for income taxes refers to a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. Our financial statements could be materially affected if: (i) our actual results differ significantly from our forecast estimates; (ii) there are future changes in enacted tax laws with retroactive application; or (iii) tax authorities do not agree with our application of the tax law to our circumstances and the matter is not ultimately resolved in our favor.

Business Combinations and Goodwill

We recognize and measure the assets acquired and liabilities assumed in a business combination based on their estimated fair values at the acquisition date. Goodwill represents the excess of purchase price paid by the Company over the fair market value of the net assets acquired. A bargain purchase occurs when the fair market value of net assets acquired is higher than the purchase price paid. Certain assumptions and estimates are employed in evaluating the fair value of assets acquired and liabilities assumed. These estimates may be affected by factors such as changing market conditions, technological advances in the oil and natural gas industry or changes in regulations governing that industry. The most significant assumptions requiring judgment involve identifying and estimating the fair value of inventory, fixed assets and intangible assets. To finalize purchase accounting for significant acquisitions, we utilize the services of independent valuation specialists to assist in the determination of the fair value of acquired assets.

Impairments

We evaluate our property and equipment and identifiable intangible assets for impairment whenever changes in circumstances indicate that the carrying amount of an asset group may not be recoverable or if there are potential indicators of impairment. We also perform an annual impairment analysis of goodwill as of December 31st, or whenever there is a triggering event that indicates an impairment loss may have been incurred. Estimating future net cash flows requires us to make judgments regarding long-term forecasts of future revenues and costs related to the assets subject to review. These forecasts are uncertain in that they require assumptions about our revenue growth, operating margins, capital expenditures, future market conditions and technological developments. In addition, if we are required to determine the fair value of our reporting units to test goodwill for impairment, we must apply estimates, assumptions, and judgment regarding revenue growth, operating margins, capital expenditures, future market conditions, weighted average costs of capital and terminal growth rate, and we must evaluate the metrics of a deemed set of comparable companies and market earnings multiples. Actual results may not align with these assumptions, and our expectations regarding future net cash flows may change such that a material impairment could result.

In the second quarter of 2024, Legacy Innovex identified a significant decrease in the fair value of an operating lease right of use asset related to a building lease for which the carrying value is held in Right of use assets - operating, and a company owned building for which the carrying value is held in Property and equipment, net. In the second quarter of 2024, Legacy Innovex received third-party quoted market prices for both assets; based on this market information Legacy Innovex determined that the carrying value of both assets was not recoverable and exceeded their fair values. Legacy Innovex then measured the impairment losses by comparing the carrying values with the current third-party quoted market prices resulting in a total impairment of $3.0 million and $0.5 million for the operating lease right of use asset and the company owned building, respectively.

We believe that the estimates and assumptions used in our impairment assessments are reasonable. However, if market conditions change dramatically, the impact on our forecasts and projections may be significant which could result in future impairments for our reportable units with long-term assets including goodwill.

Recent Accounting Pronouncements

Refer to Note 2. Summary of Significant Accounting Policies to our unaudited condensed consolidated financial statements for a discussion of the recent accounting pronouncements issued by the Financial Accounting Standards Board.

Commodity Price Risk

The market for our products and services is indirectly exposed to fluctuations in the prices of oil and natural gas to the extent such fluctuations impact drilling and completion activity levels and thus impact the activity levels of our customers in the exploration and production industries. Additionally, because we do not sell our products under long-term contracts, we believe that we are particularly exposed to short-term fluctuations in the prices of oil and natural gas. We do not currently intend to hedge our indirect exposure to commodity price risk.

Interest Rate Risk

We are primarily exposed to interest rate risk through the Revolver and Term Loan. As of September 30, 2024, we had $12.7 million in variable rate debt outstanding, consisting of $12.7 million under the Term Loan and no outstanding debt under the Revolver which bear interest at an adjusted SOFR rate plus an applicable margin or at the alternate base rate plus an applicable margin. We do not currently intend to hedge our exposure to interest rate risk.

Credit Risk

Our customers are primarily E&P operators. This concentration of counterparties operating in a single industry may increase our overall exposure to credit risk in that the counterparties may be similarly affected by changes in economic, regulatory or other conditions. We manage credit risk by analyzing the counterparties’ financial condition prior to accepting new customers and prior to adjusting existing credit limits.

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 Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the fiscal quarter ended September 30, 2024. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2024, our disclosure controls and procedures were not effective because of the material weaknesses identified in our internal control.

We previously identified two material weaknesses for Legacy Innovex due to deficiencies identified in the operating effectiveness of controls over financial reporting wherein we did not design and maintain effective controls related to the accounting for income taxes at a sufficient level of precision or rigor and failed to employ personnel with adequate expertise to identify and evaluate complex income tax accounting matters. In addition, Dril-Quip identified a material weakness wherein we did not design and maintain effective controls over the financial statement classification of inventory write-downs related to restructurings.

Our management has implemented remediation steps to improve our internal control over financial reporting. Specifically, for the material weaknesses for Legacy Innovex, which relates to the accounting for income taxes at a sufficient level of precision, we have (i) designed and implemented new controls for the preparation and review of the income tax provision, related to income tax assets and liabilities and the corresponding valuation allowance, and the income tax disclosures in our consolidated financial statements to ensure the mathematical accuracy and completeness of information underlying the income tax provision and that conclusions are sufficient to timely identify potential misstatements, and (ii) employed personnel with adequate expertise to identify and evaluate complex income tax accounting matters. For the material weakness for Dril-Quip, which relates to the financial statement classification of inventory write-downs related to restructurings, we plan to (i) perform an evaluation of the design and implementation of certain internal controls impacted by the material weakness; and (ii) enhance the design of those identified controls.

Changes in Internal Control over Financial Reporting

Except as described above, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, has determined that there were no changes in the Company’s control over financial reporting that have materially affected, or are reasonably likely to materially affect, these internal controls over financial reporting during the period covered by this quarterly report.

With the closing of the Merger on September 6, 2024, there was a change in management and a process was initiated to integrate Legacy Innovex and Dril-Quip. We expect these changes to have a significant impact on internal control over financial reporting going forward. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business post-Merger, but cannot assure you that such actions will be sufficient to provide us with effective internal control over financial reporting.

In addition to the risk factors set forth below, you should carefully consider the factors discussed in "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2023, as amended by Form 10-K/A filed with the SEC on July 8, 2024 and Form 10-K/A (Amendment No. 2) filed with the SEC on August 1, 2024, our Quarterly Report on Form 10-Q for the period ended March 31, 2024, filed with the SEC on July 8, 2024, and under the headings "Risk Factors—Risks Relating to the Combined Company" and "Risk Factors—Risks Relating to Innovex" in the Form S-4. The risks described below and in those documents are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Legacy Innovex has identified material weaknesses in Legacy Innovex's internal control over financial reporting which, if not corrected, could affect the reliability of our financial statements and have other adverse consequences. Additional material weaknesses in internal controls over financial reporting may be identified, which may not be remedied in a timely manner.

Legacy Innovex identified material weaknesses in its internal control over financial reporting during the year ended December 31, 2023. A “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

Legacy Innovex did not design and maintain effective controls related to the accounting for income taxes at a sufficient level of precision or rigor to prepare, review and reconcile the income tax provision, related income tax assets and liabilities and corresponding valuation allowance and the income tax disclosures in Legacy Innovex’s consolidated financial statements. In addition, Legacy Innovex did not design and maintain effective controls related to the review of the accounting for income taxes as a result of its failure to employ personnel with adequate expertise to identify and evaluate complex income tax accounting matters. These findings resulted in material weaknesses in Legacy Innovex’s internal control over financial reporting during the year ended December 31, 2023. The material weaknesses described above resulted in audit adjustments to deferred tax assets and liabilities, the income tax valuation allowance and related disclosures as of and for the year ended December 31, 2023.

Legacy Innovex has taken steps towards remediating these material weaknesses primarily by designing and implementing additional internal controls, including those related to (i) the preparation and review of the income tax provision, related income tax assets and liabilities and corresponding valuation allowance, and the income tax disclosures in Legacy Innovex’s consolidated financial statements to ensure the mathematical accuracy and completeness of information underlying the income tax provision conclusions are sufficient to timely identify potential misstatements, and (ii) the employment of personnel with adequate expertise to identify and evaluate complex income tax accounting matters. Although Legacy Innovex has been in the process of remedial action to address the internal control deficiencies that led to the material weaknesses, Legacy Innovex was not able to fully remediate these deficiencies in 2023 and is unable to assure that the measures it has taken to date and it expects to take in the future will be sufficient to remediate the material weaknesses it identified or avoid the identification of additional material weaknesses in the future.

Effective internal controls are necessary for us to provide reliable financial reports, prevent fraud and operate successfully. Legacy Innovex cannot assure that it has identified all, or that it will not in the future have additional, material weaknesses. If the material weaknesses are not remediated, any future material weaknesses related to financial reporting are identified or there are difficulties in implementing or improving internal controls or a failure to develop and maintain effective internal control over financial reporting, then our reputation and operating results could be harmed, we could fail to meet its reporting obligations or it may have a restatement of its financial statements. Ineffective internal control over financial reporting could also cause investors to lose confidence in our reported financial information, which would harm our business and likely have a negative effect on the trading price of our shares of common stock.

Our indebtedness and liquidity needs could restrict its operations and make us more vulnerable to adverse economic conditions.

Our existing and future indebtedness, whether incurred in connection with acquisitions, operations or otherwise, and limited access to liquidity may adversely affect our operations and limit its growth, and we may have difficulty making debt service payments on such indebtedness as payments become due. Our level of indebtedness may affect its operations in several ways, including the following:

• increasing our vulnerability to general adverse economic and industry conditions;
• the covenants that are contained in the agreements governing our indebtedness could limit its ability to borrow funds, dispose of assets, pay dividends and make certain investments;
• our debt covenants could also affect its flexibility in planning for, and reacting to, changes in the economy and in its industry;
• any failure to comply with the financial or other debt covenants, including covenants that impose requirements to maintain certain financial ratios, could result in an event of default, which could result in some or all of our indebtedness becoming immediately due and payable;
• our level of debt could impair its ability to obtain additional financing, or obtain additional financing on favorable terms, in the future for working capital, capital expenditures, acquisitions or other general corporate purposes; and
• our business may not generate sufficient cash flow from operations to enable us to meet its obligations under our indebtedness.

Restrictions in our debt agreements and any future financing agreements may limit our ability to finance future operations, meet capital needs or capitalize on potential acquisitions and other business opportunities.

The operating and financial restrictions and covenants in existing and future debt agreements could restrict our ability to finance future operations, meet capital needs or expand or pursue its business activities. For example, our debt agreements restrict or limit our ability to:

• grant liens;
• incur additional indebtedness;
• engage in a merger, consolidation or dissolution;
• enter into transactions with affiliates;
• sell or otherwise dispose of assets, businesses and operations;
• substantially change the nature of our business; and
• make acquisitions, capital expenditures or other investments and make dividends or repurchase our stock.

Furthermore, our debt agreements contain certain other operating and financial covenants, including the obligation to satisfy a certain fixed charge coverage ratio and a leverage ratio. Our ability to comply with the covenants and restrictions contained in our debt agreements may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. If we violate any of the restrictions, covenants, ratios or tests in our debt agreements, all or a significant portion of our indebtedness may become immediately due and payable, and our lenders’ commitment to make further loans to us may terminate. We might not have, or be able to obtain, sufficient funds to make these accelerated payments. Our Credit Facility is secured by liens on substantially all of our assets and certain of our future subsidiaries and guarantees from certain of our future subsidiaries, and any acceleration of our debt obligations could result in a foreclosure on the collateral securing such debt. Our debt agreements also require us to make mandatory prepayments in certain circumstances, including a requirement to make a prepayment of the term loans with a certain percentage of our excess cash flow each year. This excess cash flow payment, and other future required prepayments, will reduce our cash available for investment in our business. Any subsequent replacement of our debt agreements or any new indebtedness could have similar or greater restrictions. Please see “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Agreement.”

An increase in interest rates would increase the cost of servicing our indebtedness and could reduce its profitability, decrease its liquidity and impact its solvency.

A number of our existing debt agreements provide for, and our future debt agreements may provide for, debt incurred thereunder to bear interest at variable rates. As a result, increases in interest rates could increase the cost of servicing such indebtedness and materially reduce our profitability and cash flows.