Notes
to Condensed Consolidated Financial Statements (Unaudited)
June
30, 2019
NOTE
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
and Nature of Operations
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 drilling efficiencies
for the oil and natural gas drilling and completions industry. We are headquartered in Vernal, Utah with manufacturing operations
both there and in Abilene, Texas. We also have offices in Saudi Arabia. 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” or “Strider”). In addition, the Company is a manufacturer and refurbisher
of PDC (polycrystalline diamond compact) drill bits and other select products for a leading oil field services company. Our drill
tool fabrication facilities are state-of-the-art operations, where we manufacture both our solutions for the drilling industry,
as well as customers’ custom products.
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) Hard Rock Solutions, LLC (“HR” or “Hard Rock”).
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. 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).
We will remain an emerging growth company until the earliest of
(i) the end of the fiscal year in which the market value of our common stock that is held by
non-affiliates
exceeds
$700 million as of June 30, (ii) the end of the fiscal year in which we have total annual gross revenue of $1.07 billion or more
during such fiscal year, (iii) the date on which we issue more than $1.0 billion in
non-convertible
debt
in a three-year period or (iv) January 1, 2020.
Unaudited
Interim Financial Presentation
These
interim consolidated condensed financial statements for the three and six months ended June 30, 2019 and 2018, 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, 2019 are not
necessarily indicative of the results of operations expected for the year ended December 31, 2019. These interim consolidated
condensed financial statements should be read in conjunction with the audited restated consolidated financial statements
of the Company for the years ended December 31, 2018 and 2017 and the notes thereto, which were included in the Company’s
Annual Report on Form 10-K/A for the year ended December 31, 2018, 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.
Significant
Customers
For
the six months ended June 30, 2019, two customers represented 94% of our total revenue during the period. For the six months ended
June 30, 2018, two customers represented 95% of our total revenue during the period.
Significant
Vendors
The
Company had one vendor that represented 11% of our purchases for the six months ended June 30, 2019. This vendor had approximately
$158,000 in accounts payable at June 30, 2019 and purchases in the six months of 2019 from this vendor totaled approximately $479,000.
The Company had one vendor that represented 13% of our purchases for the six months ended June 30, 2018. This vendor had approximately
$97,000 in accounts payable at June 30, 2018 and purchases in the six months of 2018 from this vendor totaled approximately $486,000.
Recently
Issued Accounting Standards
Standards
Adopted
Effective
January 1, 2019, the Company adopted the accounting guidance in Accounting Standards Update (“ASU”) No. 2014-09, “
Revenue
from Contracts with Customers
.” This standard supersedes most of the existing revenue recognition requirements in U.S.
GAAP under Accounting Standards Codification (“ASC”) 605 and establishes a new revenue standard, ASC 606. This new
standard requires entities to recognize revenue at an amount that reflects the consideration to which such entities expect to
be entitled in exchange for transferring goods or services to a customer. The new standard also requires significantly expanded
disclosures regarding the qualitative and quantitative information of an entity’s nature, amount, timing, and uncertainty
of revenue and cash flows arising from contracts with customers. The Company adopted ASC 606 using the full retrospective method.
The adoption of this standard did not have a material impact on the Company’s consolidated financial statements. See Note
2 – Revenue.
Standards
Not Yet Adopted
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 is currently evaluating the impact the pronouncement will have on the consolidated
financial statements and related disclosure and will adopt this standard on January 1, 2020.
NOTE
2. REVENUE
Accounting
Policy
We
account for revenue in accordance with Topic 606, which we adopted on January 1, 2019, using the full retrospective method. The
adoption of Topic 606 did not have a material impact on the timing or amounts of revenue recognized in our unaudited condensed
consolidated financial statements and therefore did not have a material impact on our financial position, results of operations,
equity or cash flows as of the adoption date for the six months ended June 30, 2019. The Company did not record any adjustments
to opening retained earnings as of December 31, 2017 or for any periods previously presented. Furthermore, the impact of the adoption
of the new standard is immaterial to our revenue and gross profit on an ongoing basis.
Revenue
Recognition
Our
revenue is derived from short-term contracts. Revenue is recognized when we satisfy a performance obligation by transferring control
of the promised goods or services to our customers at a point in time, in an amount that reflects the consideration the Company
expects to be entitled to in exchange for those goods or services. We also assess our customer’s ability and intention to
pay, which is based on a variety of factors including our customer’s historical payment experience and financial condition.
Payment terms and conditions vary, although terms generally include a requirement of payment within 30 days.
Revenue
generally does not include right of return or other significant post-delivery obligations. Revenue is recognized net of any taxes
collected from customers, which are subsequently remitted to governmental authorities. We elected to treat shipping and handling
costs as a fulfillment cost instead of as a separate performance obligation. We recognize the cost for shipping and handling when
incurred as an expense in cost of sales.
Performance
Obligations
A
performance obligation is a promise in a contract to transfer a distinct good or service to the customer under Topic 606. A contract’s
transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance
obligation is satisfied. The majority of our contracts with customers contain a single performance obligation to provide agreed-upon
products or services. For contracts with multiple performance obligations, we allocate revenue to each performance obligation
based on its relative standalone selling price. In accordance with Topic 606, we do not assess whether promised goods or services
are performance obligations if they are immaterial in the context of the contract with the customer.
All
of our contracts are less than one year in duration. We do not disclose the value of unsatisfied performance obligations for (i)
contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount
to which we have the right to invoice for services performed.
Disaggregation
of Revenue
Approximately
96% of our revenue is from the United States and approximately 4% is from the Middle East for the six months ended June 30, 2019.
For the six months ended June 30, 2018, approximately 97% of our revenue was from the United States and approximately 3% was from
the Middle East.
Tool
Revenue
Tool
and Product Sales
: Revenue for tool and product sales is recognized upon shipment of tools or products to the customer. Shipping
and handling costs related to tool and product sales are recorded gross as a component of both the sales price and cost of the
product sold.
Tool
Rental
: Tool rental revenue is recognized upon completion of the customer’s job for which the tool was rented. While
the duration of the rents vary by job and number of runs, these rents are generally less than one month. The rental agreements
are typically based on the price per run or footage drilled and do not have any minimum rental payments or term.
Other
Related Revenue:
We receive revenue from the repair of tools upon delivery of the repaired tool to the customer. We earn royalty
commission revenue when our customer invoices their customer for the use of our tools.
Contract
Services
Drill
Bit Manufacturing and Refurbishment
: We recognize revenue for our PDC drill bit services upon transfer of control, which we
determined to be the shipping point. Shipping and handling costs related to refurbishing services are paid directly by the customer
at the time of shipment. By contract, we can only refurbish and manufacture oil or gas drill bits for Baker Hughes, but we are
not contractually prohibited from manufacturing drill bits for the mining industry.
Revenue
disaggregated by revenue source are as follows:
|
|
Six
months ended June 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Tool Revenue:
|
|
|
|
|
|
|
|
|
Tool
and product sales
|
|
$
|
2,303,489
|
|
|
$
|
4,168,958
|
|
Tool rental
|
|
|
449,648
|
|
|
|
329,235
|
|
Other
related revenue
|
|
|
3,264,285
|
|
|
|
3,102,696
|
|
Total Tool Revenue
|
|
|
6,017,422
|
|
|
|
7,600,889
|
|
|
|
|
|
|
|
|
|
|
Contract Services
|
|
|
3,562,366
|
|
|
|
2,398,327
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
9,579,788
|
|
|
$
|
9,999,216
|
|
Contract
Costs
We
do not incur any material costs of obtaining contracts.
Contract
Balances
Under
our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional.
Accordingly, our contracts do not give rise to contract assets or liabilities under ASC 606.
NOTE
3. INVENTORIES
Inventories
are comprised of the following:
|
|
June
30, 2019
|
|
|
December
31, 2018
|
|
Raw
material
|
|
$
|
979,451
|
|
|
$
|
738,330
|
|
Work in progress
|
|
|
134,918
|
|
|
|
217,158
|
|
Finished
goods
|
|
|
48,135
|
|
|
|
48,135
|
|
|
|
$
|
1,162,504
|
|
|
$
|
1,003,623
|
|
NOTE
4. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
June 30, 2019
|
|
|
December 31, 2018
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
Buildings
|
|
|
4,771,635
|
|
|
|
4,847,778
|
|
Building improvements
|
|
|
755,039
|
|
|
|
755,039
|
|
Machinery and equipment
|
|
|
9,405,020
|
|
|
|
8,816,880
|
|
Office equipment, fixtures and software
|
|
|
525,250
|
|
|
|
518,806
|
|
Transportation assets
|
|
|
654,054
|
|
|
|
811,378
|
|
Construction in progress
|
|
|
338,573
|
|
|
|
-
|
|
|
|
|
17,329,987
|
|
|
|
16,630,297
|
|
Accumulated depreciation
|
|
|
(9,157,073
|
)
|
|
|
(8,404,288
|
)
|
|
|
$
|
8,172,914
|
|
|
$
|
8,226,009
|
|
The
Company has decided to sell the Company airplane and respective hangar, and we expect a sale to be completed in the next
12 months. Accordingly, these assets are reported as assets held for sale on our balance sheet as of June 30, 2019 at their carrying
value, which is lower than the expected fair value less costs to sell.
Depreciation
expense related to property, plant and equipment for the three and six months ended June 30, 2019 was $425,410 and $824,849, respectively
and for the three and six months ended June 30, 2018 was $330,016 and $654,377, respectively.
NOTE
5. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
June
30, 2019
|
|
|
December
31, 2018
|
|
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
|
|
|
(12,330,555
|
)
|
|
|
(11,213,889
|
)
|
|
|
$
|
2,569,445
|
|
|
$
|
3,686,111
|
|
Amortization
expense related to intangible assets for the three and six months ended June 30, 2019 was $505,000 and $1,116,666, respectively
and for the three and six months ended June 30, 2018 was $611,667 and $1,223,334, 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, 2019, the Company reviewed the net balance of the intangible assets and determined no impairment was needed.
NOTE
6. 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. Effective August 2017, the Company fully reserved the related party note receivable of
$6,979,043, which reduced the related party note receivable balance to $0. The Company 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 or interest in other income. Interest only is due December 31, 2019, 2020 and 2021, with a balloon payment of all unpaid
interest and principal due upon maturity on December 31, 2022. The interest rate on the note is 5.75.%.
NOTE
7. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
June
30, 2019
|
|
|
December
31, 2018
|
|
Real estate loans
|
|
$
|
3,101,250
|
|
|
$
|
4,255,152
|
|
Hard Rock Note
|
|
|
4,500,000
|
|
|
|
6,000,000
|
|
Credit Agreement
|
|
|
1,557,990
|
|
|
|
-
|
|
Machinery loans
|
|
|
434,000
|
|
|
|
327,879
|
|
Transportation loans
|
|
|
325,386
|
|
|
|
292,722
|
|
Less:
|
|
|
|
|
|
|
|
|
Current portion
|
|
|
(4,820,299
|
)
|
|
|
(4,578,759
|
)
|
Long-term debt,
net
|
|
$
|
5,098,327
|
|
|
$
|
6,296,994
|
|
Real
Estate Loans
On
February 1, 2019, we signed a loan agreement for $3,129,861 refinancing our commercial bank loan that is secured by our Vernal,
Utah Campus. We paid $1,000,000 towards the previous loan that was scheduled to mature on February 15, 2019, upon refinancing.
The loan requires monthly payments of approximately $43,000, including principal and interest at 7.25%, and is secured by the
land and buildings at our Vernal, Utah Campus. A balloon payment of approximately $2,500,000 is due upon maturity on February
15, 2021.
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
to Hard Rock.
Under
the current terms of Hard Rock Note, we are required to pay principal payments of $750,000 (plus accrued interest) on each January
5, April 5, July 5 and October 5 in 2019 and 2020. In January 2019, the Company made a principal payment of $750,000 and an interest
payment of $183,411. In April 2019, the Company made a principal payment of $750,000 and an interest payment of $88,639. In July
2019, the Company made a principal payment of $750,000 and an interest payment of $81,339. The remaining principal due is $3,750,000.
Credit
Agreement
In
February 2019, the Company entered into a Loan and Security Agreement (the “Credit Agreement”) with Austin Financial
Services, Inc. (“AFS”). The Credit Agreement provides a $4.3 million credit facility, which includes a $0.8 million
term loan (the “Term Loan”) and a $3.5 million revolver (the “Revolving Loan”). As of June 30, 2019, $871,914
was outstanding on the Revolving Loan.
Amounts outstanding under the revolver at any time
may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem
appropriate if it determines that there has been a material adverse effect; less a dilution reserve as determined by AFS in its
sole good faith discretion, plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion
may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c)
the borrowing base reserve as may be determined from time to time by AFS.
Amounts outstanding on the Revolving Loan as
of June 30, 2019, may not exceed $2,727,667, which is based on a calculation applying 85% of accounts receivable and 50% of inventory.
A collateral management fee is payable monthly on the used portion of the Revolving Loan and Term Loan. If our borrowings are
less than $1,000,000 then we pay interest as if we had borrowed $1,000,000. At June 30, 2019, we had approximately $17,000 of
accrued interest.
The
Credit Agreement contains various restrictive covenants that, among other things, limit or restrict the ability of the borrowers
to incur additional indebtedness; incur additional liens; make dividends and other restricted payments; make investments; engage
in mergers, acquisitions and dispositions; make optional prepayments of other indebtedness; engage in transactions with affiliates;
and enter into restrictive agreements. The Credit Agreement does not include any financial covenants. If an event of default occurs,
the lenders are entitled to accelerate the advances made thereunder and exercise rights against the collateral. Borrowing under
the Revolving Loan is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration
clause. At June 30, 2019, $871,914 of the Revolving Loan was outstanding. Also at June 30, 2019, we were in compliance with the
covenants in the Credit Agreement.
The
interest rate for the Term Loan and the Revolving Loan is prime plus 2%. At June 30, 2019, the interest rate was 11.1%, which includes a 3.6% management fee rate.
The obligations of the borrowers under the agreement are secured by a security interest in substantially all of the tangible and
intangible assets of the borrowers, other than any assets owned by the borrowers that constitute real property (and fixtures affixed
to such real property), certain excluded equipment, intellectual property, or aircraft. The Credit Agreement matures on February
20, 2023, subject to early termination pursuant to the terms of the agreement or extension as may be agreed by the parties.
Equipment
Loans
In June 2019, the Company entered into two financing agreement to purchase equipment. The Company made
a down payment of $291,578 and recorded a current liability of $272,000 that is due to the financing company. The Company
is obligated to pay 1% a month on the outstanding balance. The financing loans will be finalized once the equipment is delivered
later in the year. In August 2019, the Company decided not to purchase one piece of equipment and we will refund the down
payment to the financing company. We don’t anticipate any penalties from canceling the equipment order or financing
agreement.
NOTE
8. TOTAL EQUITY
A
summary of changes in total equity for the six months ended June 30, 2019 and 2018 is presented below:
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total
Shareholders
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Capital
|
|
|
Deficit
|
|
|
Equity
|
|
Balance - December 31, 2018
|
|
|
25,018,098
|
|
|
$
|
25,018
|
|
|
$
|
39,440,611
|
|
|
$
|
(32,055,410
|
)
|
|
$
|
7,410,219
|
|
Stock-based compensation expense
|
|
|
16,649
|
|
|
|
17
|
|
|
|
317,949
|
|
|
|
-
|
|
|
|
317,966
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(643,300
|
)
|
|
|
(643,300
|
)
|
Balance – June 30, 2019
|
|
|
25,034,747
|
|
|
$
|
25,035
|
|
|
$
|
39,758,560
|
|
|
$
|
(32,698,710
|
)
|
|
$
|
7,084,885
|
|
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total
Shareholders
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Capital
|
|
|
Deficit
|
|
|
Equity
|
|
Balance - December 31, 2017
|
|
|
24,535,155
|
|
|
$
|
24,535
|
|
|
$
|
38,907,864
|
|
|
$
|
(31,997,035
|
)
|
|
$
|
6,935,364
|
|
Stock-based compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
240,344
|
|
|
|
-
|
|
|
|
240,344
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
895,207
|
|
|
|
895,207
|
|
Balance – June 30, 2018
|
|
|
24,535,155
|
|
|
$
|
24,535
|
|
|
$
|
39,148,208
|
|
|
$
|
(31,101,828
|
)
|
|
$
|
8,070,915
|
|
NOTE
9. COMMITMENTS AND CONTINGENCIES
We are subject to litigation that arises from
time to time in the ordinary course of our business activities. In February 2019, the Company filed a patent infringement lawsuit
in the United States District Court for the Western District of Louisiana Lafayette Division asserting Stabil Drill Specialties,
LLC (“Stabil Drill”) infringed on our patent that covers the Company’s well bore conditioning tool, the Drill-N-Ream.
Stabil Drill has not yet responded to the lawsuit. As of the date of this quarterly report,
the lawsuit is in initial stages. We cannot predict the outcome of this matter, but our legal costs could have a material effect
on our financial position or results of operations in future periods. We are not currently involved in any other litigation which
management believes could have a material effect on our financial position or results of operations.
NOTE
10. SUBSEQUENT EVENTS
On July 30, 2019, the Board of Directors granted 125,000 restricted stock units to Chris Cashion, Chief Financial
Officer, and 78,125 restricted stock units to each of the three independent members of the Board of Directors. These restricted
stock units will vest over three years. In addition, the Board of Directors approved grants of restricted stock units to Troy and
Annette Meier with an approximate value of $587,500. The Board and the Meiers decided in lieu of making such awards, the dollar
value of such awards would be used to pay $327,238 on the Tronco Note and the remaining $260,262 will be remitted for taxes on
the Meiers behalf.
In
August 2019, the Company accepted an offer to sell its airplane hangar. This asset was held for sale as of June 30, 2019. The
Company expects to finalize the sale in the third quarter of 2019 for a $6,000 loss.