Item
1. Financial Statements
Superior
Drilling Products, Inc.
Condensed
Consolidated Balance Sheets
(Unaudited)
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,300,891
|
|
|
$
|
2,241,902
|
|
Accounts receivable,
net
|
|
|
2,875,130
|
|
|
|
1,038,664
|
|
Prepaid expenses
|
|
|
77,589
|
|
|
|
76,175
|
|
Inventories
|
|
|
1,285,738
|
|
|
|
1,167,692
|
|
Asset held for
sale
|
|
|
-
|
|
|
|
2,490,000
|
|
Other
current assets
|
|
|
163,733
|
|
|
|
13,598
|
|
Total current
assets
|
|
|
5,703,081
|
|
|
|
7,028,031
|
|
Property, plant
and equipment, net
|
|
|
8,630,237
|
|
|
|
9,068,359
|
|
Intangible assets,
net
|
|
|
7,356,111
|
|
|
|
8,579,444
|
|
Related party
note receivable
|
|
|
7,746,717
|
|
|
|
8,296,717
|
|
Other
noncurrent assets
|
|
|
15,954
|
|
|
|
15,954
|
|
Total
assets
|
|
$
|
29,452,100
|
|
|
$
|
32,988,505
|
|
LIABILITIES AND
SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
746,606
|
|
|
$
|
1,066,514
|
|
Accrued expenses
|
|
|
693,087
|
|
|
|
449,004
|
|
Capital lease
obligation
|
|
|
63,582
|
|
|
|
217,302
|
|
Related party
debt obligation
|
|
|
197,922
|
|
|
|
272,215
|
|
Current
portion of long-term debt, net of discounts
|
|
|
1,926,971
|
|
|
|
2,905,682
|
|
Total current
liabilities
|
|
|
3,628,168
|
|
|
|
4,910,717
|
|
Other long term liability
|
|
|
-
|
|
|
|
820,657
|
|
Long-term
debt, less current portion, net of discounts
|
|
|
11,583,939
|
|
|
|
13,288,701
|
|
Total liabilities
|
|
|
15,212,107
|
|
|
|
19,020,075
|
|
Commitments and
contingencies (Note 7)
|
|
|
|
|
|
|
|
|
Shareholders’
equity
|
|
|
|
|
|
|
|
|
Common stock - $0.001 par value;
100,000,000 shares authorized; 24,197,148 and 24,120,695 shares issued and outstanding, respectively
|
|
|
24,197
|
|
|
|
24,120
|
|
Additional paid-in-capital
|
|
|
38,646,092
|
|
|
|
38,295,428
|
|
Accumulated
deficit
|
|
|
(24,430,296
|
)
|
|
|
(24,351,118
|
)
|
Total
shareholders’ equity
|
|
|
14,239,993
|
|
|
|
13,968,430
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
29,452,100
|
|
|
$
|
32,988,505
|
|
The
accompanying notes are an integral part of these consolidated condensed financial statements.
Superior
Drilling Products, Inc.
Condensed
Consolidated Statements of Operations
(Unaudited)
|
|
For
the Three Months
|
|
|
For
the Six Months
|
|
|
|
Ended
June 30,
|
|
|
Ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
4,049,497
|
|
|
$
|
1,114,469
|
|
|
$
|
7,419,109
|
|
|
$
|
2,559,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating costs
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenue
|
|
|
1,491,383
|
|
|
|
1,331,985
|
|
|
|
2,672,116
|
|
|
|
2,352,597
|
|
Selling,
general and administrative expenses
|
|
|
1,237,335
|
|
|
|
1,538,824
|
|
|
|
2,734,852
|
|
|
|
2,829,427
|
|
Depreciation
and amortization expense
|
|
|
899,373
|
|
|
|
1,200,085
|
|
|
|
1,837,395
|
|
|
|
2,446,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating costs and expenses
|
|
|
3,628,091
|
|
|
|
4,070,894
|
|
|
|
7,244,363
|
|
|
|
7,628,991
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
421,406
|
|
|
|
(2,956,425
|
)
|
|
|
174,746
|
|
|
|
(5,069,896
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
(expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
82,509
|
|
|
|
77,952
|
|
|
|
164,368
|
|
|
|
156,319
|
|
Interest
expense
|
|
|
(215,103
|
)
|
|
|
(377,063
|
)
|
|
|
(474,128
|
)
|
|
|
(728,075
|
)
|
Other
income
|
|
|
-
|
|
|
|
52,225
|
|
|
|
43,669
|
|
|
|
108,951
|
|
Gain
on sale of assets
|
|
|
17,995
|
|
|
|
104,599
|
|
|
|
12,167
|
|
|
|
191,450
|
|
Total
other expense
|
|
|
(114,599
|
)
|
|
|
(142,287
|
)
|
|
|
(253,924
|
)
|
|
|
(271,355
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
306,807
|
|
|
$
|
(3,098,712
|
)
|
|
$
|
(79,178
|
)
|
|
$
|
(5,341,251
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income (loss) earnings per common share
|
|
$
|
0.01
|
|
|
$
|
(0.18
|
)
|
|
$
|
0.00
|
|
|
$
|
(0.31
|
)
|
Basic
weighted average common shares outstanding
|
|
|
24,197,148
|
|
|
|
17,464,443
|
|
|
|
24,196,726
|
|
|
|
17,462,024
|
|
Diluted income
(loss) per common share
|
|
$
|
0.01
|
|
|
$
|
(0.18
|
)
|
|
$
|
0.00
|
|
|
$
|
(0.31
|
)
|
Diluted
weighted average common shares outstanding
|
|
|
24,197,148
|
|
|
|
17,464,443
|
|
|
|
24,196,726
|
|
|
|
17,462,024
|
|
The
accompanying notes are an integral part of these consolidated condensed financial statements.
Superior
Drilling Products, Inc.
Condensed
Consolidated Statements Of Cash Flows
(Unaudited)
|
|
For
the Six Months Ended
|
|
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Cash Flows From
Operating Activities
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(79,178
|
)
|
|
$
|
(5,341,251
|
)
|
Adjustments to reconcile net loss
to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization expense
|
|
|
1,837,395
|
|
|
|
2,446,967
|
|
Amortization
of debt discount
|
|
|
40,110
|
|
|
|
69,768
|
|
Share based compensation
expense
|
|
|
350,741
|
|
|
|
376,785
|
|
Write-off of
Strider asset
|
|
|
-
|
|
|
|
361,903
|
|
Gain on sale
of assets
|
|
|
(12,167
|
)
|
|
|
(191,450
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(1,836,466
|
)
|
|
|
1,387,203
|
|
Inventories
|
|
|
(118,046
|
)
|
|
|
(17,514
|
)
|
Prepaid expenses
and other noncurrent assets
|
|
|
(151,549
|
)
|
|
|
(86,281
|
)
|
Other assets
|
|
|
-
|
|
|
|
(12,537
|
)
|
Accounts payable
and accrued expenses
|
|
|
(328,992
|
)
|
|
|
134,691
|
|
Other
long term liabilities
|
|
|
(17,490
|
)
|
|
|
-
|
|
Net
Cash Used in Operating Activities
|
|
|
(315,642
|
)
|
|
|
(871,716
|
)
|
Cash Flows From
Investing Activities
|
|
|
|
|
|
|
|
|
Purchases of
property, plant and equipment
|
|
|
(141,137
|
)
|
|
|
(315,101
|
)
|
Proceeds
from sale of fixed assets
|
|
|
2,483,921
|
|
|
|
294,242
|
|
Net
Cash Provided by (Used in) Investing Activities
|
|
|
2,342,784
|
|
|
|
(20,859
|
)
|
Cash Flows From
Financing Activities
|
|
|
|
|
|
|
|
|
Principal payments
on debt
|
|
|
(2,740,140
|
)
|
|
|
(1,031,491
|
)
|
Principal payments
on related party debt
|
|
|
(74,293
|
)
|
|
|
(44,662
|
)
|
Principal payments
on capital lease obligations
|
|
|
(153,720
|
)
|
|
|
(133,403
|
)
|
Proceeds received
from debt borrowings
|
|
|
-
|
|
|
|
1,000,000
|
|
Proceeds from
sale of subsidiary
|
|
|
-
|
|
|
|
50,700
|
|
Proceeds from
payments on related party note receivable
|
|
|
-
|
|
|
|
22,534
|
|
Debt
issuance costs
|
|
|
-
|
|
|
|
(56,188
|
)
|
Net
Cash Used in Financing Activities
|
|
|
(2,968,153
|
)
|
|
|
(192,510
|
)
|
Net decrease in
Cash
|
|
|
(941,011
|
)
|
|
|
(1,085,085
|
)
|
Cash
at Beginning of Period
|
|
|
2,241,902
|
|
|
|
1,297,002
|
|
Cash
at End of Period
|
|
$
|
1,300,891
|
|
|
$
|
211,917
|
|
Supplemental information:
|
|
|
|
|
|
|
|
|
Cash paid for
Interest
|
|
$
|
460,842
|
|
|
$
|
689,409
|
|
Non-cash payment
of other long term liability by offsetting related party note receivable
|
|
$
|
550,000
|
|
|
$
|
-
|
|
Acquisition
of equipment by issuance of note payable
|
|
$
|
16,557
|
|
|
$
|
-
|
|
The
accompanying notes are an integral part of these consolidated condensed financial statements.
Superior
Drilling Products, Inc.
Notes
to Condensed Consolidated Financial Statements (Unaudited)
June
30, 2017
NOTE
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
and Nature of Operations
Superior
Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”)
is a drilling and completion tool technology company providing solutions for the oil and natural gas drilling industry. The Company,
designs, engineers, manufactures, sells, and repairs drilling and completion tools.
Our
subsidiaries include (a) Superior Drilling Solutions, LLC (previously known as Superior Drilling Products, LLC), a Utah limited
liability company (“SDS”), together with its wholly owned subsidiary Superior Design and Fabrication, LLC, a Utah
limited liability company (“SDF”), (b) Extreme Technologies, LLC, a Utah limited liability company (“ET”),
(c) Meier Properties Series, LLC, a Utah limited liability company (“MPS”), (d) Meier Leasing, LLC, a Utah limited
liability company (“ML”), and (e) HR.
Basis
of Presentation
The
Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted
in the United States of America (“GAAP”). The consolidated financial statements include the accounts of Superior Drilling
Products Inc. and all of its wholly-owned subsidiaries. All significant intercompany accounts have been eliminated in consolidation.
The Company does not have investments in any unconsolidated subsidiaries.
In
April 2012, the JOBS Act was enacted. Section 107 of the JOBS Act provides that an emerging growth company can utilize the
extended transition period provided in Section 7(a)(2)(B) of the Securities Act for implementing new or revised accounting
standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards
would otherwise apply to nonissuers. We have elected to delay such adoption of new or revised accounting standards, and as a result,
we may not implement new or revised accounting standards on the relevant dates on which adoption of such standards is required
for other issuer companies.
Subject
to certain conditions set forth in the JOBS Act, as an emerging growth company, we intend to rely on certain of these exemptions,
including without limitation, providing an auditor’s attestation report on our system of internal controls over financial
reporting pursuant to Section 404 and implementing any requirement that may be adopted regarding mandatory audit firm rotation
or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor
discussion and analysis). These exemptions will apply for a period of five years following the completion of our IPO although
if the market value of our common stock that is held by nonaffiliates exceeds $700 million as of any June 30 before that time,
we would cease to be an emerging growth company as of the following December 31.
Revenue
Recognition
We
are a drilling and completion tool technology company and we generate revenue from the refurbishment, manufacturing, repair, and
sale of drilling and completion tools. Our manufactured products are produced in a standard manufacturing operation, even when
produced to our customer’s specifications. We earn royalty commission revenue when our customer invoices their customer
for the use of our tools. The Company may act as an agent by billing and collecting its customers’ tool rental revenue.
When we are an agent for our customer, revenue is presented in the statement of operations on a net basis. At June 30, 2017, there
was approximately $300,000 of accounts receivable and approximately $326,000 of accounts payable related to transactions
we performed as an agent for our customer.
Unaudited
Interim Financial Presentation
These
interim consolidated condensed financial statements for the three and six months ended June 30, 2017 and 2016, and the related
footnote disclosures included herein, are unaudited. However, in the opinion of management, these unaudited interim financial
statements have been prepared on the same basis as the audited financial statements, and reflect all adjustments necessary to
fairly state the results for such periods. The results of operations for the three and six months ended June 30, 2017 are not
necessarily indicative of the results of operations expected for the year ended December 31, 2017. These interim consolidated
condensed financial statements should be read in conjunction with the audited consolidated financial statements of the Company
for the years ended December 31, 2016 and 2015 and the notes thereto, which were included in the Company’s Annual Report
on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (the “SEC”).
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant
items subject to estimates and assumptions include the carrying amount and useful lives of property and equipment and intangible
assets, impairment assessments, share-based compensation expense, and valuation allowances for accounts receivable, inventories,
and deferred tax assets.
Accounting
Standards
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09,
Revenue from Contracts with Customers
(“ASU 2014-09”), which requires an entity to recognize the
amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09
will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In August 2015, the FASB issued
ASU No. 2015-14,
Revenue from Contracts with Customers
(“ASU 2015-14”)
,
which deferred the effective
date of ASU 2014-09 for all entities by one year.
The
Company will adopt this guidance on January 1, 2019.
ASU
2015-14 permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition
method nor has the effect of the standard on ongoing financial reporting been determined.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases
,” which introduces the recognition of lease assets
and lease liabilities by lessees for all leases which are not short-term in nature. The new standard requires a modified retrospective
transition for capital or operating leases existing at or entered into after the beginning of the earliest comparative period
presented in the financial statements. The Company will adopt this guidance on January 1, 2019. The Company is currently evaluating
the impact the pronouncement will have on the consolidated financial statements and related disclosure.
NOTE
2. INVENTORIES
Inventories
is comprised of the following:
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
Raw
material
|
|
$
|
1,043,037
|
|
|
$
|
952,419
|
|
Work
in progress
|
|
|
134,363
|
|
|
|
90,017
|
|
Finished
goods
|
|
|
108,338
|
|
|
|
125,256
|
|
|
|
$
|
1,285,738
|
|
|
|
$
1,167,692
|
|
NOTE
3. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
Buildings
|
|
|
4,847,778
|
|
|
|
4,847,778
|
|
Leasehold
improvements
|
|
|
717,232
|
|
|
|
717,232
|
|
Machinery
and equipment
|
|
|
5,172,202
|
|
|
|
5,060,281
|
|
Machinery
under capital lease
|
|
|
2,322,340
|
|
|
|
2,322,340
|
|
Furniture
and fixtures
|
|
|
507,554
|
|
|
|
507,554
|
|
Transportation
assets
|
|
|
811,381
|
|
|
|
882,163
|
|
|
|
|
15,258,903
|
|
|
|
15,217,764
|
|
Accumulated
depreciation
|
|
|
(6,628,666
|
)
|
|
|
(6,149,405
|
)
|
|
|
$
|
8,630,237
|
|
|
$
|
9,068,359
|
|
Depreciation
expense related to property, plant and equipment for the three and six months ended June 30, 2017 was $287,706 and $614,062, respectively,
and for the three and six months ended June 30, 2016 was $588,418 and $1,223,634, respectively.
NOTE
4. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
June 30,
2017
|
|
|
December 31,
2016
|
|
Developed
technology
|
|
$
|
7,000,000
|
|
|
$
|
7,000,000
|
|
Customer contracts
|
|
|
6,400,000
|
|
|
|
6,400,000
|
|
Trademarks
|
|
|
1,500,000
|
|
|
|
1,500,000
|
|
|
|
|
14,900,000
|
|
|
|
14,900,000
|
|
Accumulated
amortization
|
|
|
(7,543,889
|
)
|
|
|
(6,320,556
|
)
|
|
|
$
|
7,356,111
|
|
|
$
|
8,579,444
|
|
Amortization
expense related to intangible assets for the three and six months ended June 30, 2017 and June 30, 2016 was $611,667 and $1,223,333,
respectively.
Annually,
and more often as necessary, we will perform an evaluation of our intangible assets for indications of impairment. If indications
exist, we will perform an evaluation of the fair value of the intangible assets and, if necessary, record an impairment charge.
As of June 30, 2017, the Company reviewed the net balance of the intangible assets and determined no impairment was needed.
NOTE
5. RELATED PARTY NOTE RECEIVABLE
In
January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy
Corporation (“Tronco”), a party related to us through common control, in order to take over the legal position as
Tronco’s senior secured lender. That agreement provided that, upon our full repayment of the Tronco loan from the proceeds
of the Offering, the lender would assign to us all of its rights under the Tronco loan, including all of the collateral documents.
On May 30, 2014, we closed our purchase of the Tronco loan for a total payoff of $8.3 million, including principal, interest,
and early termination fees. As a result of that purchase, we became Tronco’s senior secured lender, and as a result are
entitled to receive all proceeds from sales of the Tronco-owned collateral, as discussed below.
In
2015, the Board of Directors agreed to extend the terms of the Tronco loan to interest only payments due on December 31, 2015
and 2016, with a balloon payment of all unpaid interest and principal due in full maturity on December 31, 2017. The related party
note receivable is classified as long term in accordance with management’s estimate of realizability. The interest rate
on the note is 4.25%. We earned interest of $81,650 and $163,733 for the three and six months ended June
30, 2017, respectively, and interest of $77,567 and $155,137 for the three and six months ended June 30, 2016, respectively.
On
March 28, 2017, the Company and Tronco finalized an agreement with a third party and pursuant to this agreement, the third party
acquired all of the Ohio assets of Tronco for $550,000. As Tronco’s senior secured lender, we agreed to release our lien
and security interest on these assets in accordance with the agreement. The Company agreed to a non-cash receipt of the $550,000
from Tronco by reducing our bonus accrual liabilities, which was earned by the Meiers in 2014 but not paid, and was recorded in
other long-term liability. As a result of this agreement, we reduced both the other long-term liability and the Tronco related
party note receivable during the first quarter of 2017.
On
August 8, 2017, the Board of Directors agreed to extend the terms of the Tronco loan to interest only payments due December 31,
2017, 2018, 2019, 2020, and 2021, with a balloon payment of all unpaid interest and principal due upon full maturity on December
31, 2022.
W
e
have the direct legal right to enforce the collateral and guaranty agreements entered into in connection with the Tronco loan
and to collect Tronco’ s collateral sales proceeds, in order to recover the loan purchase amount. The Tronco loan continues
to be secured by the first position liens on all of Tronco assets, as well as by the guarantees of Troy and Annette Meier (the
“Meier Guaranties”), which are directly payable to and legally enforceable by us. In addition, the Meiers have provided
us with stock pledges in which they pledge all of their shares of our common stock held by their family entities (the “Meier
Stock Pledge”), as collateral for the Meiers guaranties until full repayment of Tronco loan. The pledged shares, which are
subject to insider timing requirements and volume limitations under Rule 144 of the Securities Act and required periodic black-out
periods, are being held in third-party escrow until full repayment of the Tronco loan. The Company holds 8,267,860 shares and
530,725 restricted stock units as collateral for the Tronco note as of June 30, 2017.
NOTE
6. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
June
30,
2017
|
|
|
December 31,
2016
|
|
Real
estate loans
|
|
$
|
4,642,880
|
|
|
$
|
7,264,036
|
|
Hard Rock Note, net
of discount
|
|
|
7,884,705
|
|
|
|
7,846,497
|
|
Machinery loans
|
|
|
600,721
|
|
|
|
684,921
|
|
Transportation
loans
|
|
|
382,604
|
|
|
|
398,929
|
|
|
|
|
13,510,910
|
|
|
|
16,194,383
|
|
Current
portion of long-term debt
|
|
|
(1,926,971
|
)
|
|
|
(2,905,682
|
)
|
Long-term
debt, less current portion
|
|
$
|
11,583,939
|
|
|
$
|
13,288,701
|
|
Real
Estate Loans
Our
manufacturing facility is financed by a commercial bank loan requiring monthly payments of approximately $39,000, including principal
and interest at 5.25%. A lump sum principal payment of approximately $4.2 million is due at the maturity date of this loan on
August 15, 2018.
On
February 9, 2017, the Company sold real estate to Superior Auto Body (“SAB”), a related party, for the net proceeds
of $2.5 million. The cash received from the sale was used to pay down the $2.5 million loan balance on the property. As part of
the sale, the Company released 547,000 shares of the Meiers common stock from the collateral for the Tronco note (see Note 5 –
Related Party Note Receivable).
Hard
Rock Note
In
2014, the Company purchased all of the interests of Hard Rock Solutions, LLC (“Hard Rock”). Consideration consisted
of $12.5 million paid in cash at closing and a $12.5 million seller’s note (the “Hard Rock Note”). The Hard
Rock Note and subsequent amendments are secured by all of the patents, patents pending, other patent rights, and trademarks transferred
in the closing of the Hard Rock acquisition. At issuance, the fair value of the Hard Rock Note was determined to
be $11,144,000, which is less than the face value due to a below-market interest rate. The resulting discount of $1,356,000 will
be amortized to interest expense using the effective interest method, totaling approximately $19,104 and $38,207
for the three and six months ended June 30, 2017, respectively.
On
August 10, 2016, certain of our subsidiaries entered into an amended and restated note with the seller in our acquisition of Hard
Rock. As amended and restated, the Hard Rock Note accrues interest at 5.75% per annum and matures and is fully payable on January
15, 2020. Under the current terms of the Hard Rock Note, we are required to make the following payments: accrued interest only
on each of January 15, March 15, May 15 and July 15, 2017; $500,000 in principal plus accrued interest on each of January 15,
March 15, May 15 and July 15, 2018, and $1,000,000 in principal plus accrued interest on each of January 15, March 15, May 15
and July 15, 2019. The remaining balance of principal of $2,000,000 and accrued interest on the Hard Rock Note are due on January
15, 2020. During 2017, we have made the accrued interest payments related to the note on January 15, 2017, March 15, 2017, May
15, 2017, and July 15, 2017 of $129,808, $74,356, $76,877, and $76,877, respectively.
NOTE
7. COMMITMENTS AND CONTINGENCIES
We
are subject to litigation that arises from time to time in the ordinary course of our business activities. We are not currently
involved in any litigation which management believes could have a material effect on our financial position or results of operations,
except as follows:
Del
Rio Suit
In
October 2013, Del-Rio Resources, Inc. (“Del-Rio”) filed suit, on its own behalf and derivatively on behalf of Philco
Exploration, LLC (“Philco”), against the following co-defendants (a) Tronco Ohio, LLC and Tronco, (b) the lender on
the Tronco loan, ACF Property Management, Inc. (p.k.a. Fortuna Asset Management, LLC,) (“ACF”), (c) Troy and Annette
Meier personally, and several of their family trusts, (d) Meier Family Holding Company, LLC and Meier Management Company, LLC,
and (e) SDS and MPS in the Eighth Judicial District Court, Uintah County, Utah Cause #130800125 (the “Suit”). On
May 11, 2017, pursuant to a mediation proceeding, all of the plaintiffs and remaining defendants in the Suit executed a Settlement
Agreement whereby each of the parties have released all of their claims against the other parties to the Suit without liability
effective as of March 22, 2017. Such release includes the Company’s two subsidiaries that were a party to the Suit, SDS
and MPS, as well as Troy and Annette Meier personally and all of their family trusts named as defendants in the Suit. As a result
of the execution of the Settlement Agreement, a Stipulated Motion for Dismissal with Prejudice was filed with the Court which
includes a form of Order of Dismissal with Prejudice (the “Court Order”). On May 15, 2017, the Court Order was executed
by the judge and the Suit was formally dismissed with prejudice.
NOTE
8. RELATED PARTY TRANSACTIONS
In
2014, the Company issued notes payable to related parties in the amount of $2 million. The notes bear interest at 7.5% and were
scheduled to mature on January 2, 2017. The Company made principal payments of $50,000 in January 2017 and $24,000
in May 2017. Based on an informal agreement, the Company will continue to reduce the balance on the note in 2017 against the
interest due to the Company on the Tronco related party note receivable (see Note 5 – Related Party Note Receivable) instead
of repaying the note.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Introduction
The
following discussion and analysis was prepared to supplement information contained in the accompanying financial statements and
is intended to provide certain details regarding our financial condition as of June 30, 2017, and our results of operations
for the three and six months ended June 30, 2017 and 2016. It should be read in conjunction with the unaudited financial
statements and notes thereto contained in this Quarterly Report on Form 10-Q (this “Quarterly Report”) as well as
our audited financial statements for the years ended December 31, 2016 and 2015, which were included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2016, which was filed with the Securities and Exchange Commission (the “SEC”).
Unless
the context requires otherwise, references to the “Company” or to “we,” “us,” or “our”
and other similar terms are to Superior Drilling Products, Inc. and all of its subsidiaries.
Jumpstart
Our Business Startups Act of 2012
In
April 2012, the JOBS Act was enacted. Section 107 of the JOBS Act provides that an emerging growth company can utilize the
extended transition period provided in Section 7(a)(2)(B) of the Securities Act for implementing new or revised accounting
standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards
would otherwise apply to nonissuers. We have elected to delay such adoption of new or revised accounting standards, and as a result,
we may not implement new or revised accounting standards on the relevant dates on which adoption of such standards is required
for other issuer companies.
Subject
to certain conditions set forth in the JOBS Act, as an emerging growth company, we intend to rely on certain of these exemptions,
including without limitation, providing an auditor’s attestation report on our system of internal controls over financial
reporting pursuant to Section 404 and implementing any requirement that may be adopted regarding mandatory audit firm rotation
or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor
discussion and analysis). These exemptions will apply for a period of five years following the completion of our IPO, which occurred
in May 2014, although if the market value of our common stock that is held by nonaffiliates exceeds $700 million as of any June
30 before that time, we would cease to be an emerging growth company as of the following December 31.
Forward
- Looking Statements
This
Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within
the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document
that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control
of the Company. You can identify the Company’s forward-looking statements by the words “anticipate,” “estimate,”
“expect,” “may,” “project,” “believe” and similar expressions, or by the Company’s
discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements
are reasonable, no assurances can be given that these expectations will prove to be correct. These forward-looking statements
include the following types of information and statements as they relate to the Company:
|
●
|
future
operating results and cash flow;
|
|
|
|
|
●
|
scheduled,
budgeted and other future capital expenditures;
|
|
|
|
|
●
|
working
capital requirements;
|
|
|
|
|
●
|
the
availability of expected sources of liquidity;
|
|
|
|
|
●
|
the
transition of our business to primarily selling tools;
|
|
|
|
|
●
|
the
introduction into the market of the Company’s future products;
|
|
|
|
|
●
|
the
market for the Company’s existing and future products;
|
|
|
|
|
●
|
the
Company’s ability to develop new applications for its technologies;
|
|
|
|
|
●
|
the
exploration, development and production activities of the Company’s customers;
|
|
|
|
|
●
|
compliance
with present and future environmental regulations and costs associated with
|
|
|
|
|
●
|
future
operations, financial results, business plans and cash needs
|
|
|
|
|
●
|
environmentally
related penalties, capital expenditures, remedial actions and proceedings;
|
|
|
|
|
●
|
effects
of pending legal proceedings;
|
|
|
|
|
●
|
changes
in customers’ future product and service requirements that may not be cost effective or within the Company’s capabilities;
and
|
|
|
|
|
●
|
future
operations, financial results, business plans and cash needs
|
These
statements are based on assumptions and analyses in consideration of the Company’s experience and perception of historical
trends, current conditions, expected future developments and other factors the Company believes were appropriate in the circumstances
when the statements were made. Forward-looking statements by their nature involve substantial risks and uncertainties that could
significantly impact expected results, and actual future results could differ materially from those described in such statements.
While
it is not possible to identify all factors, the Company continues to face many risks and uncertainties. Among the factors that
could cause actual future results to differ materially are the risks and uncertainties discussed under “Item 1A. Risk Factors”
in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 and the following:
|
●
|
the
volatility of oil and natural gas prices;
|
|
|
|
|
●
|
the
cyclical nature of the oil and gas industry;
|
|
|
|
|
●
|
availability
of financing, flexibility in restructuring existing debt and access to capital markets;
|
|
|
|
|
●
|
consolidation
within our customers’ industries;
|
|
|
|
|
●
|
competitive
products and pricing pressures;
|
|
|
|
|
●
|
our
reliance on significant customers;
|
|
|
|
|
●
|
our
limited operating history;
|
|
|
|
|
●
|
fluctuations
in our operating results;
|
|
|
|
|
●
|
our
dependence on key personnel;
|
|
|
|
|
●
|
costs
of raw materials;
|
|
|
|
|
●
|
our
dependence on third party suppliers;
|
|
|
|
|
●
|
unforeseen
risks in our manufacturing processes;
|
|
|
|
|
●
|
the
need for skilled workers;
|
|
|
|
|
●
|
our
ability to successfully manage our growth strategy;
|
|
|
|
|
●
|
unanticipated
risks associated with, and our ability to integrate, acquisitions;
|
|
|
|
|
●
|
current
and potential governmental regulatory actions in the United States and regulatory actions and political unrest in other countries;
|
|
|
|
|
●
|
terrorist
threats or acts, war and civil disturbances;
|
|
|
|
|
●
|
our
ability to protect our intellectual property;
|
|
|
|
|
●
|
impact
of environmental matters, including future environmental regulations;
|
|
|
|
|
●
|
implementing
and complying with safety policies;
|
|
|
|
|
●
|
breaches
of security in our information systems;
|
|
|
|
|
●
|
related
party transactions with our founders; and
|
|
|
|
|
●
|
risks
associated with our common stock
|
Many
of such factors are beyond the Company’s ability to control or predict. Any of the factors, or a combination of these factors,
could materially affect the Company’s future results of operations and the ultimate accuracy of the forward-looking statements.
Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such
statements or present or prior earnings levels. Every forward-looking statement speaks only as of the date of the particular statement,
and the Company undertakes no obligation to publicly update or revise any forward-looking statement.
Overview
Superior
Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”)
is an innovative drilling and completion tool technology company providing cost saving solutions that drive production efficiencies
for the oil and natural gas drilling industry. The Company innovates, designs, engineers, manufactures, sells, and repairs drilling
and completion tools. Our drilling solutions include the patented Drill-N-Ream® well bore conditioning tool (“Drill-N-Ream
tool”) and the patented Strider™ Drill String Oscillation System technology (“Strider technology”). In
addition, the Company is a manufacturer and refurbisher of PDC (polycrystalline diamond compact) drill bits for a leading oil
field services company. We operate a state-of-the-art drill tool fabrication facility, where we manufacture solutions for the
drilling industry, as well as customers’ custom products. The Company’s strategy for growth is to leverage its expertise
in innovative drill tool technology and precision machining in order to broaden its product offerings and solutions for
the oil and gas industry.
We
currently have three basic operations:
|
●
|
Our
PDC drill bit and other tool refurbishing and manufacturing service,
|
|
|
|
|
●
|
Our
emerging technologies business that manufactures the Drill-N-Ream tool, our innovative drill string enhancement tool, the
Strider technology and other tools, and
|
|
|
|
|
●
|
Our
new product development business that conducts our research and development, and designs our horizontal drill string enhancement
tools, other down-hole drilling technologies, and drilling tool manufacturing technologies.
|
From
our headquarters in Vernal, Utah, we operate a technologically-advanced PDC drill bit refurbishing facility, as well as a state-of-the-art,
high-tech drilling and completion tool engineering design and manufacturing operation. We manufacture our drill string enhancement
tools, including the patented Drill- N-Ream tool and the patented Strider technology, and conduct our new product research and
development from this facility.
Our
co-founder, Troy Meier, developed the first commercially-viable process for refurbishing PDC drill bits after a successful 13-year
career with a predecessor of Baker Hughes Inc. For the past 21 years, we have exclusively provided our PDC drill bit refurbishing
services for the Rocky Mountain, California and Alaska regions of Baker Hughes’s oilfield operations. In addition, we have
expanded our offerings and our customer base by demonstrating our engineering, design and manufacturing expertise to develop
our own down-hole drilling tools. We continuously work with our customers to develop new products and enhancements to existing
products, improve efficiency and safety, and solve complex drilling tool problems.
We
employ a senior work force with specialized training and extensive experience related to drill bit refurbishing and tooling manufacturing.
They produce our products and services using a suite of highly technical, purpose-built equipment, much of which we design and
manufacture for our proprietary use. Our manufacturing equipment and products use advanced technologies that enable us to increase
efficiency, enhance product integrity, improve efficiency and safety, and solve complex drilling tool problems.
Oil
and Gas Drilling Industry
Overview
Drilling
and completion of oil and gas wells are upstream operations in the oil & gas industry served by the oilfield services
group within the energy industry. The drilling industry is often segmented into the North American market and the International
market. These markets share common exposure to the same macro environment, but also exhibit unique factors that drive the dynamics
of each market.
Oilfield
services companies drill the wells for hydrocarbon exploration and production (“E&P”) companies. Demand for onshore
drilling is a function of the willingness of E&P companies to make operating and capital expenditures to explore for, develop
and produce hydrocarbons. When oil or natural gas prices increase, E&P companies generally increase their capital expenditures,
resulting in greater revenue and profits for both drillers and equipment manufacturers. Likewise, significant decreases in the
prices of those commodities may lead E&P companies to reduce their capital expenditures, which decreases the demand for drilling
equipment.
Trends
in the Industry
Recent
Rig Count Improvement and Stabilization; Industry Volatility.
Our business is highly dependent upon the vibrancy of
the oil and gas drilling operations in the U.S. Worldwide military, political and economic events have contributed to oil and
natural gas price volatility and are likely to continue to do so in the future. Very soon after the completion of our initial
public offering in late May 2014 and through early 2016, oil prices dramatically declined in the United States and as a result,
the number of operating drill rigs was measurably reduced. The NYMEX-WTI oil price was as low as $26.19 in February 2016, while
the NYMEX-Henry Hub natural gas price was as low as $1.49 per MMBtu in March 2016. The Baker Hughes weekly rotary rig count decreased
over 70% from the high of 1,931 on September 13, 2014 to a historic low of 404 as of May 27, 2016.
During
the downturn in 2015 and 2016, our business with Baker Hughes decreased measurablyas a result of the decline in drilling activity.
This severely impacted both pricing and volume for drill bit refurbishment. We are contracted with Baker Hughes to serve the Rocky
Mountain region that includes the Bakken shale formation in North Dakota. This region is higher cost production and as such, the
drill rig count reduction was more dramatic than the overall U.S rig count decline. During the second half of calendar year 2016
and the first half of 2017, the U.S. rig count began to increase from the historic low in May 2016 to 954 as of August 4, 2017.
With this increase in market activity, we have seen an increase in demand for our product and services, however we have not seen
an increase in pricing. The rate of growth in rig count has stabilized in July 2017 and is expected to not increase at the same
rate as it has over the last twelve months.
Advent
of horizontal drilling requires new technologies
. We believe the value of our Drill-N- Ream tool and Strider technology combined
with our low market penetration provide us sales opportunities in soft as well as robust markets.
The
oil and gas industry is increasingly using directional (e.g., horizontal) drilling in their exploration and production activities
because of measurably improved recovery rates that can be achieved with these methods. With the rise of this type of drilling,
traditional drill string tools used for vertical drilling do not necessarily provide the best performance or are not well suited
for directional drilling.
We
believe that our Drill-N-Ream tool and Strider technology have proven to provide significant operational efficiencies and costs
savings for horizontal drilling activity. In addition, we are developing additional technologies to take advantage of the oil
and gas industry’s significant shift to horizontal/directional drilling and its resulting need for new drill string tools
and technology.
We
expect that with our extensive knowledge and experience in the oilfield industry, we can identify additional challenges with directional
drilling, and then design and develop tools that will help our customers with their drilling challenges. Further development of
additional drill string components, such as our Drill-N-Ream and Strider technology, will become increasingly important to our
business as we continue to grow through both organic expansion and strategic acquisitions.
GE
Oil & Gas to merge with Baker Hughes
. In October 2016, GE Oil and Gas and Baker Hughes announced an agreement to combine
their businesses. Currently, Baker Hughes is our sole customer for our bit refurbishment business and we do not know how this
merger may impact our business. Despite this, we intend to continue developing our long-time relationship with Baker Hughes. In
January 2016, the Company entered into an agreement with Baker Hughes to supply the Strider technology with our Open Hole Strider
tool and related services to Baker Hughes. Tool shipments associated with the agreement are expected to begin in early 2018.
The agreement has no set expiration date or minimum shipment requirement. It will remain in force until it is canceled by either
us or Baker Hughes, as stipulated in the agreement. The Company’s current agreement with Baker Hughes regarding drill bit
refurbishment expires in October 2017. The Company plans to review the agreement with its customer to determine its future
opportunity.
RESULTS
OF OPERATIONS
The
following table represents our condensed consolidated statement of operations for the periods indicated:
|
|
Three-Months
Ended June 30,
|
|
|
Six-Months
Ended June 30,
|
|
(in
thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Revenue
|
|
$
|
4,049
|
|
|
|
100
|
%
|
|
$
|
1,114
|
|
|
|
100
|
%
|
|
$
|
7,419
|
|
|
|
100
|
%
|
|
$
|
2,559
|
|
|
|
100
|
%
|
Operating costs and expenses
|
|
|
3,628
|
|
|
|
90
|
%
|
|
|
4,071
|
|
|
|
365
|
%
|
|
|
7,244
|
|
|
|
98
|
%
|
|
|
7,629
|
|
|
|
298
|
%
|
Income (loss) from continuing
operations
|
|
|
421
|
|
|
|
(10
|
)%
|
|
|
(2,956
|
)
|
|
|
(265
|
)%
|
|
|
175
|
|
|
|
|
2%
|
|
|
(5,070
|
)
|
|
|
(198
|
)%
|
Other expense
|
|
|
(115
|
)
|
|
|
(3
|
)%
|
|
|
(142
|
)
|
|
|
(43
|
)%
|
|
|
(254
|
)
|
|
|
(3
|
)%
|
|
|
(271
|
)
|
|
|
(11
|
)%
|
Net income (loss)
|
|
$
|
307
|
|
|
|
8
|
8%
|
|
$
|
(3,099
|
)
|
|
|
(278
|
)%
|
|
$
|
(79)
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|
|
|
(1
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)%
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|
$
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(209
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)
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|
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(209
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)%
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Material
changes of certain items in our statements of operations included in our financial statements for the comparative periods are
discussed below.
During
2016, the Company changed its revenue model from primarily renting tools to primarily selling tools. In May 2016, the Company
entered into a distribution agreement with Drilling Tools International, Inc., (“DTI”), under which they purchase
our Drill-N-Ream tool for their rental tool business. As part of this agreement, DTI also hired much of our field sales team and
the related vehicles associated with our previous rental tool business in the second half of 2016. In order to maintain exclusivity
of the Drill-N-Ream Tool in the U.S. and Canada, the agreement required DTI to achieve 10% market share, defined as 10% of the
average horizontal rig count in the 30 days prior to June 30, 2017. As a result of DTI’s successful efforts to achieve this
10% market share, our sales grew measurably when compared with the prior-year period.
For
the three months ended June 30, 2017, as compared with the three months ended June 30, 2016
Revenue
.
Our revenue increased approximately $2,935,000, during the three months ended June 30, 2017 compared with the same period in 2016.
Tool revenue for second quarter of 2017 was $2,486,000 which was comprised of approximately $1,609,000 of tool rental and sales
revenue and approximately $877,000 of other related revenue. Other related revenue includes royalty fees, maintenance and repair
of tools and agency fees. Tool revenue for second quarter of 2016 was approximately $850,000 and other related revenue was approximately
$42,000 for the same period. Tool revenue in the second quarter of 2016 was comprised of rental tool revenue and tool sales. Tool
revenue for the second quarter 2017 grew as a result of the increase in U.S. drilling activity from 2016 to 2017, and the Company’s
shift in business model in May 2016 from a rental tool business to a tool sales business. Contract services revenue increased
600% to approximately $1,564,000 for the three months ended June 30, 2017 compared with approximately $223,000 for the
same period in 2016 as a result of the increase in drilling activity in the first half of 2017 and the Company receiving overflow
drill bit refurbishment work from outside its contracted territory.
Operating
Costs and Expenses
. Total operating costs and expenses decreased approximately $443,000 during the three months ended
June 30, 2017 compared with the same period in 2016.
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Cost of revenue
increased approximately $160,000 in the second quarter of 2017 compared with the prior-year period due to an increase in volume.
As a percentage of revenue, cost of sales was 37%, compared with 120% in the prior year period.
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Selling,
general and administrative expenses decreased approximately $301,000 for the three months ended June 30, 2017 compared with
the same period in 2016. The decrease was due to a reduction in professional fees and research and development expense.
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Depreciation and
amortization expense decreased approximately $301,000 primarily as a result of the Drill-N-Ream tool being reclassified
from property, plant, and equipment to inventory in accordance with the Company’s shift from a rental tool business
to a tool sales business, for the three months ended June 30, 2017 compared with the same period in 2016.
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Other
Income (Expenses)
. Other income and expense primarily consists of rent income, interest income, interest expense and loss
on disposition of assets.
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Other Income.
There was no other income in the second quarter of 2017 due to the sale of SAB facilities in February 2017. As
result of the sale, we will no longer receive this rental income.
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Interest Income.
For the three months ended June 30, 2017 and 2016 interest income was approximately $82,000 and $78,000, respectively,
and relates to interest received from the Tronco related party note receivable.
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Interest Expense.
The interest expense for the three months ended June 30, 2017 and 2016 was approximately $215,000 and $377,000, respectively.
The decline in interest expense was due primarily to principal payments associated with the Hard Rock Note.
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For
the six months ended June 30, 2017 as compared with the six months ended June 30, 2016
Revenue
.
Our revenue increased approximately $4,860,000, during the six months ended June 30, 2017 compared with the same period in 2016.
Tool revenue for the six months ended June 30, 2017 was approximately $4,756,000 which was comprised of approximately $3,245,000
of tool rental and sales revenue and approximately $1,511,000 of other related revenue. Other related revenue includes royalty
fees, maintenance and repair of tools and agency fees. Tool revenue for the six months ended June 30, 2016 was approximately $1,751,000
and other related revenue was approximately $95,000 for the same period. Tool revenue for the first six months of 2016 was comprised
of rental tool revenue and tool sales. Tool revenue for the six months of 2017 grew as a result of the increase in U.S. drilling
activity from 2016 to 2017, and the Company’s shift in business model in May 2016 from a rental tool business to a tool
sales business. Contract services revenue increased 273% to approximately $2,663,000 for the six months ended June 30, 2017 compared
with approximately $713,000 for the same period in 2016 as a result of the increase in drilling activity in for the first half
of 2017.
Operating
Costs and Expenses
. Total operating costs and expenses decreased approximately $385,000 during the six months ended June 30,
2017 compared with the same period in 2016.
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Cost
of revenue increased approximately $320,000 for the six months ended June 30, 2017 compared with the prior-year period due
to an increase in volume. As a percentage of revenue, cost of sales was 36% compared with 92% in the prior year period.
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Selling,
general and administrative expenses decreased approximately $95,000 for the six months ended June 30, 2017 compared with the
same period in 2016. The decrease was due to restructuring the sales and marketing departments.
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Depreciation
and amortization expense decreased approximately $610,000 primarily as a result of the Drill-N-Ream tool being reclassified
from property, plant, and equipment to inventory in accordance with the Company’s shift from a rental tool business
to a tool sales business, for the six months ended June 30, 2017 compared with the same period in 2016.
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Other
Income (Expenses)
. Other income and expense primarily consists of rent income, interest
income, interest expense and loss on disposition of assets.
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Other
Income.
For the six months ended June 30, 2017 and 2016, other income was approximately $44,000 and $109,000, respectively.
The decrease was the result of the sale of the SAB facilities in February 2017. As result of the sale, we will no longer receive
this rental income. For the six months ended June 30, 2016, we received $108,951 rental from two real property leases, our
SAB facilities and our Vernal campus.
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Interest
Income.
For the six months ended June 30, 2017 and 2016, interest income was approximately $164,000 and $156,000, respectively,
and relates to interest received from the Tronco related party note receivable.
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Interest
Expense.
The interest expense for the six months ended June 30, 2017 and 2016 was approximately $474,000 and $728,000,
respectively. The decline in interest expense was due primarily to principal payments associated with the Hard Rock Note.
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Liquidity
At
June 30, 2017, we had working capital of approximately $2.1 million. Our principal uses of cash are operating expenses, working
capital requirements, capital expenditures and debt service payments. In February 2017, the Company received approximately $2,483,000
related to the sale of the SAB facilities, and we used the proceeds to repay the mortgage related to the SAB property of approximately
$2,500,000. Our operational and financial strategies include lowering our operating costs and capital spending to match revenue
trends, managing our working capital and managing our debt to enhance liquidity. We will continue to work to grow revenue and
review additional cost containment measures with the plan to continue to be cash flow positive in the second half of 2017.
If we are unable to do this, we may not be able to, among other things, (i) maintain our current general and administrative spending
levels; (ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital
requirements. We cannot provide any assurance that financing will be available to us in the future on acceptable terms.
Public
Offering: On September 30, 2016, we priced a follow-on public offering of common stock at $1.00 per share. The transaction closed
on October 5, 2016. Net of underwriting expenses of $452,500, stock offering expenses of $256,419, net proceeds were approximately
$5.0 million. The Company used the proceeds to repay its $1 million bridge financing entered into the summer of 2016, Federal
National Commercial Credit (“FNCC”) indebtedness of $868,000 and pay the remaining $500,000 plus accrued interest
on the Hard Rock Note. We have used the remaining $2.6 million from the offering to service on going debt obligations, which include
real property leases and equipment loans, as well as for general corporate purposes, including growth working capital. The Bridge
Financing Agreement and the FNCC lending agreement were both terminated upon the repayment on October 5, 2016.
Hard
Rock Note: On August 10, 2016, certain of our subsidiaries entered into an amended and restated note with the seller in our acquisition
of Hard Rock Solutions, LLC (as so amended and restated, the “Hard Rock Note”). As amended and restated, the Hard
Rock Note accrues interest at 5.75% per annum and matures on January 15, 2020. Under the current terms of the Hard Rock Note,
we are required to make the following payments: accrued interest only on each of January 15, March 15, May 15 and July 15, 2017;
$500,000 in principal plus accrued interest on each of January 15, March 15, May 15 and July 15, 2018, and $1,000,000 in principal
plus accrued interest on each of January 15, March 15, May 15 and July 15, 2019. The remaining principal balance of $2,000,000
and accrued interest on the Hard Rock Note are due on January 15, 2020. During 2017, we have made the accrued interest payments
related to the note on January 15, 2017, March 15, 2017, May 15, 2017 and July 15, 2017 of $129,808, $74,356, $76,877
and $76,877, respectively.
Cash
Flow
Operating
Cash Flows
For
the six months ended June 30, 2017, net cash used by our operating activities was approximately $316,000. The Company had approximately
$79,000 of net loss, approximately $1,836,000 increase in accounts receivable, a decrease in accounts payable and accrued
expenses of approximately $329,000 and a decrease in depreciation and amortization expense of approximately $610,000.
Investing
Cash Flows
For
the six months ended June 30, 2017, net cash provided by our investing activities was approximately $2,343,000. The Company received
approximately $2,483,000 related to the sale of the SAB facilities. The Company used approximately $141,000 in investing
activities for property, plant and equipment purchases.
Financing
Cash Flows
For
the six months ended June 30, 2017, net cash used in our financing activities was approximately $2,968,000 primarily attributable
to a $2,500,000 loan repayment related to the SAB property that was sold in February 2017.
Critical
Accounting Policies
The
discussion of our financial condition and results of operations is based upon our consolidated condensed financial statements,
which have been prepared in accordance with U.S. GAAP. During the preparation of our financial statements, we are required to
make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related
disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below. We base our estimates
on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results
of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily
apparent from other sources. While we believe that the estimates and assumptions used in the preparation of our consolidated condensed
financial statements are appropriate, actual results may differ from these estimates under different assumptions or conditions,
and the impact of such differences may be material to our consolidated condensed financial statements. Our estimates and assumptions
are evaluated periodically and adjusted when necessary. The more significant estimates affecting amounts reported in our consolidated
condensed financial statements include, but are not limited to: revenue recognition, stock based compensation, determining the
allowance for doubtful accounts, valuation of inventories, recoverability of long-lived assets, useful lives used in calculating
depreciation and amortization, and valuation of intangible assets.