Item
4.02. Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review.
On
July 25, 2019, Moss Adams LLP (“Moss Adams”), as the independent registered public accounting firm of Superior Drilling
Products, Inc. (the “Company”), informed management of the Company that Moss Adams reached the conclusion that its
2017 and 2018 audit opinions on the financial statements of the Company should no longer be relied upon and such financial statements
should be restated due to the identified errors described below in accounting related to the Tronco Loan (as defined below).
On
July 26, 2019, the Board of Directors (the “Board”) of the Company, after consultation with management of the Company,
determined that the Company will restate its interim condensed consolidated financial statements for the quarterly and year-to-date
periods ended September 30, 2017, December 31, 2017, March 31, 2018, June 30, 2018, September 30, 2018, December 31, 2018 and
March 31, 2019, and for the years ended December 31, 2017 and December 31, 2018 (collectively, the “Non-Reliance Periods”).
Accordingly, investors should no longer rely upon the Company’s previously released consolidated financial statements for
the Non-Reliance Periods. In addition, investors should no longer rely upon earnings releases for these periods and other communications
relating to these consolidated financial statements to the extent related to or affected by the Tronco Loan.
This restatement
follows discussions with the Staff of the United States Securities and Exchange Commission (the “Staff”) and Moss
Adams regarding Staff comments relating to the Meier stock pledge and Meier Guaranties, the adequacy of the collateral, and the
Company’s demonstrated intent to enforce the Meier Guarantees, all as related to the loan made to Tronco Energy Corporation
the (“Tronco Loan”). After a thorough review and interpretation of accounting standards that a typical bank would
use for the definition of an impaired loan and the accounting of such, the Company, in consultation with Moss Adams, concluded
that it was necessary to revise its financial statements to reflect the write-down of the loan. The Meier Guaranties were determined
not to be substantive based on the application of FASB ASC 310-10-25-22 through ASC 310-10-25-25, which relates to accounting
for an arrangement as a loan or an investment in real estate within the acquisition, development and construction arrangements
of the FASB Accounting Standards and states that the substance of a personal guarantee depends on the ability of the guarantor
to perform, the practicality of enforcing the guarantee, and the demonstrated intent to enforce the guarantee. Since the Company
did not have contemporaneous documentation supporting demonstration of intent, to either enforce the redemption of collateral
or the guarantees by the borrowers to repay the loan when the related party note receivable was due and payable on December 31,
2017 and instead modified the loan by extending the payment term, the Company and Moss Adams have determined the guarantees,
with the application of the above referenced FASB accounting standards, are not substantive and therefore should not serve as
the basis for concluding the loan is well secured and collateralized. The Company is also evaluating the impact on previously
recognized interest income.
As
a result of these discussions, the Company will fully reserve the related party note receivable effective August 2017. The Company
will pursue full repayment of the note and continues to hold the 8,267,860 shares of the Company’s common stock as
collateral. The Company will record a recovery of the loan upon receiving repayment of the note.
The
errors will be corrected in restated financial statements included in an amendment to the Annual Report on Form 10-K for the year
ended December 31, 2018 and the Quarterly Report on Form 10-Q for the quarter ended March 31, 2019 (the “Amended Form
10-K and Form 10-Q”). The Company is diligently pursuing completion of the restatement and intends to file the Amended
Form 10-K and Form 10-Q as soon as reasonably practicable. The Company will file the restated financials in advance of
filing the Company’s Quarterly Report on Form 10-Q for the three months ended June 30, 2019.
The
Company has evaluated the restatement with respect to internal control over financial reporting and disclosure controls and procedures
and will report a material weakness in internal control over financial reporting. As such, the Company has concluded that its
disclosure controls and procedures and internal control over financial reporting for the Non-Reliance Periods were not effective
as of the end of the Non-Reliance Periods, as well as in subsequent periods until such material weakness is remediated.
Determination
of the impact of the error described above, including the impact on the previously recognized interest income, is subject
to continued analysis by management and the Company’s independent registered public accounting firm and could change based
on further review and analysis of the Non-Reliance Periods. The Company, when restating the previously filed consolidated financial
statements, may also correct other previously identified errors that were determined to be immaterial.
The
Board and management of the Company have discussed the matters disclosed in this Item 4.02 with Moss Adams and Moss Adams
was provided a copy of the above disclosures and has furnished the Company with a letter addressed to the Securities and
Exchange Commission stating whether it agrees with the above statements. A letter from Moss Adams is attached hereto as
Exhibit 7.1.
Forward-Looking
Statements
This
report contains forward-looking statements, and any statements other than statements of historical fact could be deemed to be
forward-looking statements. These forward-looking statements include, among other things, statements regarding the Company’s
intent to restate its prior consolidated financial statements for the Non-Reliance Periods, the estimated impact of adjustments
to the financial statements for the Non-Reliance Periods, the anticipated timing for filing the Amended Form 10-K and Form
10-Q and related matters. These statements are subject to risks and uncertainties, including the risk that the process of
preparing the restated consolidated financial statements or other subsequent events would require the Company to make additional
adjustments to its financial statements and the time and effort required to complete the restatement of its consolidated financial
statements and file the Amended Form 10-K and Form 10-Q, and actual results may differ materially from these statements.
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.
The Company undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after
the date hereof.