Notes
to Condensed Consolidated Financial Statements (Unaudited)
March
31, 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. Our headquarters and manufacturing operations are located in Vernal,
Utah. 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 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.
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. 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).
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 months ended March 31, 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 months ended March 31, 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 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 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 three months ended March 31, 2019, two customers represented 93% of our total revenue during the period. For the three months
ended March 31, 2018, two customers represented 97% of our total revenue during the period.
Significant
Vendors
The
Company had one vendor that represented 10% of our purchases for the three months ended March 31, 2019 This vendor had approximately
$248,000 in accounts payable at March 31, 2019 and purchases in the first quarter of 2019 from this vendor totaled approximately
$248,000. There were no vendors that represented more than 10% of our purchases for the first three months of March 31,2018.
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. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
Subsequent to the issuance of the consolidated
financial statements and following discussions with the Staff of the United States Securities and Exchange Commission (the “Staff”)
related to the Meier stock pledge and Meier Guaranties, the adequacy of the collateral, and the Company’s demonstrated intent
to enforce the Meier Guaranties, all as related to the loan made to Tronco Energy Corporation the (“Tronco Loan”),
the Company concluded that it had incorrectly accounted for the Tronco Loan. After a thorough review and interpretation of accounting
standards, the Company 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 GAAP that 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 demonstrate intent, by either enforcing 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
modifying the loan by extending the payment term, the Company determined the guarantees are not substantive and therefore should
not serve as the basis for concluding the loan is well secured and collateralized.
As a result, the Company fully reserved
the related party note receivable effective August 2017. 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.
Additionally, the Company determined that related party note receivable should have been classified as
an impaired loan upon the first modification in 2014. In 2018 and 2017, the Company received consideration on the related party
note receivable in the form of a non-cash payment given in lieu of making an annual restricted stock unit award to the Meiers.
This non-cash payment has been recorded as a reduction of the principal balance of the loan and not as income in accordance with
ASC 310-30-35-3.
To correct these errors on this Amendment, the Company has restated both the related party note receivable
and the interest income as detailed in the table below.
The effect of the restatements on the unaudited financial statements
for March 31, 2019 and 2018 are as follows:
|
|
|
For the Quarter Ended
March 31, 2019
|
|
|
|
|
As Reported
|
|
|
Restatement Adjustment
|
|
|
As Restated
|
|
|
Statement of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
5,036,346
|
|
|
$
|
-
|
|
|
$
|
5,036,346
|
|
|
Cost of revenue
|
|
|
2,043,028
|
|
|
|
-
|
|
|
|
2,043,028
|
|
|
Selling, general and administrative expenses
|
|
|
2,069,040
|
|
|
|
-
|
|
|
|
2,069,040
|
|
|
Depreciation and amortization expense
|
|
|
1,011,105
|
|
|
|
-
|
|
|
|
1,011,105
|
|
|
Total operating costs and expenses
|
|
|
5,123,173
|
|
|
|
-
|
|
|
|
5,123,173
|
|
|
Operating income (loss)
|
|
|
(86,827
|
)
|
|
|
-
|
|
|
|
(86,827
|
)
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
123,386
|
|
|
|
(104,453
|
)
|
|
|
18,933
|
|
|
Interest expense
|
|
|
(177,982
|
)
|
|
|
-
|
|
|
|
(177,982
|
)
|
|
Total other expense
|
|
|
(54,596
|
)
|
|
|
(104,453
|
)
|
|
|
(159,049
|
)
|
|
Net income (loss)
|
|
|
(141,423
|
)
|
|
|
(104,453
|
)
|
|
|
(245,876
|
)
|
|
Income tax expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Net income (loss)
|
|
|
(141,423
|
)
|
|
|
(104,453
|
)
|
|
|
(245,876
|
)
|
|
Earnings (loss) per common share - basic
|
|
$
|
(0.01
|
)
|
|
$
|
-
|
|
|
$
|
(0.01
|
)
|
|
Earnings (loss) per common share - diluted
|
|
$
|
(0.01
|
)
|
|
$
|
-
|
|
|
$
|
(0.01
|
)
|
|
Weighted average common shares outstanding - basic
|
|
|
25,018,098
|
|
|
|
-
|
|
|
|
25,018,098
|
|
|
Weighted average common shares outstanding - diluted
|
|
|
25,018,098
|
|
|
|
-
|
|
|
|
25,018,098
|
|
|
Balance Sheet:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
$
|
8,730,573
|
|
|
$
|
(104,453
|
)
|
|
$
|
8,626,120
|
|
|
Total assets
|
|
|
27,389,452
|
|
|
|
(7,471,665
|
)
|
|
|
19,917,787
|
|
|
Current liabilities
|
|
|
6,608,084
|
|
|
|
-
|
|
|
|
6,608,084
|
|
|
Total liabilities
|
|
|
12,571,592
|
|
|
|
-
|
|
|
|
12,571,592
|
|
|
Total shareholders’ equity
|
|
|
14,817,860
|
|
|
|
(7,471,665
|
)
|
|
|
7,346,195
|
|
|
Total liabilities and shareholders’ equity
|
|
|
27,389,452
|
|
|
|
(7,471,665
|
)
|
|
|
19,917,787
|
|
|
|
|
For the Quarter Ended March 31, 2018
|
|
|
|
|
As Reported
|
|
|
Restatement Adjustment
|
|
|
As Restated
|
|
|
Statement of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
4,600,293
|
|
|
$
|
-
|
|
|
$
|
4,600,293
|
|
|
Cost of revenue
|
|
|
1,798,944
|
|
|
|
-
|
|
|
|
1,798,944
|
|
|
Selling, general and administrative expenses
|
|
|
1,697,663
|
|
|
|
-
|
|
|
|
1,697,663
|
|
|
Depreciation and amortization expense
|
|
|
936,027
|
|
|
|
-
|
|
|
|
936,027
|
|
|
Total operating costs and expenses
|
|
|
4,432,634
|
|
|
|
-
|
|
|
|
4,432,634
|
|
|
Operating income (loss)
|
|
|
167,659
|
|
|
|
-
|
|
|
|
167,659
|
|
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
92,428
|
|
|
|
(86,287
|
)
|
|
|
6,141
|
|
|
Interest expense
|
|
|
(191,553
|
)
|
|
|
-
|
|
|
|
(191,553
|
)
|
|
Total other expense
|
|
|
(99,125
|
)
|
|
|
(86,287
|
)
|
|
|
(185,412
|
)
|
|
Net income (loss)
|
|
|
68,534
|
|
|
|
(86,287
|
)
|
|
|
(17,753
|
)
|
|
Income tax expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Net income (loss)
|
|
|
68,534
|
|
|
|
(86,287
|
)
|
|
|
(17,753
|
)
|
|
Earnings (loss) per common share - basic
|
|
$
|
0.00
|
|
|
$
|
-
|
|
|
$
|
(0.00
|
)
|
|
Earnings (loss) per common share - diluted
|
|
$
|
0.00
|
|
|
$
|
-
|
|
|
$
|
(0.00
|
)
|
|
Weighted average common shares outstanding - basic
|
|
|
24,535,155
|
|
|
|
-
|
|
|
|
24,535,155
|
|
|
Weighted average common shares outstanding - diluted
|
|
|
25,140,646
|
|
|
|
-
|
|
|
|
24,535,155
|
|
|
Balance Sheet:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
$
|
6,728,071
|
|
|
$
|
(86,287
|
)
|
|
$
|
6,641,784
|
|
|
Total assets
|
|
|
28,210,450
|
|
|
|
(7,453,499
|
)
|
|
|
20,756,951
|
|
|
Current liabilities
|
|
|
9,055,574
|
|
|
|
-
|
|
|
|
9,055,574
|
|
|
Total liabilities
|
|
|
13,702,323
|
|
|
|
-
|
|
|
|
13,702,323
|
|
|
Total shareholders' equity
|
|
|
14,508,127
|
|
|
|
(7,453,499
|
)
|
|
|
7,054,628
|
|
|
Total liabilities and shareholders' equity
|
|
|
28,210,450
|
|
|
|
(7,453,499
|
)
|
|
|
20,756,951
|
|
NOTE
3. 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 three months ended March 31, 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 three months ended March 31, 2019. For the three months ended March 31, 2018, 100% of our revenue was from the United States.
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 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:
|
|
|
Three months ended March 31,
|
|
|
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Tool Revenue:
|
|
|
|
|
|
|
|
|
|
Tool and product sales
|
|
$
|
1,507,160
|
|
|
$
|
1,892,000
|
|
|
Tool rental
|
|
|
245,602
|
|
|
|
99,818
|
|
|
Other related revenue
|
|
|
1,691,147
|
|
|
|
1,533,042
|
|
|
Total Tool Revenue
|
|
|
3,443,909
|
|
|
|
3,524,860
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract Services
|
|
|
1,592,437
|
|
|
|
1,075,433
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
5,036,346
|
|
|
$
|
4,600,293
|
|
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
4. INVENTORIES
Inventories
are comprised of the following:
|
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
|
Raw
material
|
|
$
|
1,038,210
|
|
|
$
|
738,330
|
|
|
Work
in progress
|
|
|
145,408
|
|
|
|
217,158
|
|
|
Finished
goods
|
|
|
48,135
|
|
|
|
48,135
|
|
|
|
|
$
|
1,231,753
|
|
|
$
|
1,003,623
|
|
NOTE
5. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
|
Buildings
|
|
|
4,847,778
|
|
|
|
4,847,778
|
|
|
Building
improvements
|
|
|
755,039
|
|
|
|
755,039
|
|
|
Machinery
and equipment
|
|
|
9,137,705
|
|
|
|
8,816,880
|
|
|
Office
equipment, fixtures and software
|
|
|
518,806
|
|
|
|
518,806
|
|
|
Transportation
assets
|
|
|
811,378
|
|
|
|
811,378
|
|
|
|
|
|
16,951,122
|
|
|
|
16,630,297
|
|
|
Accumulated
depreciation
|
|
|
(8,785,786
|
)
|
|
|
(8,404,288
|
)
|
|
|
|
$
|
8,165,336
|
|
|
$
|
8,226,009
|
|
Depreciation
expense related to property, plant and equipment for the three months ended March 31, 2019 and 2018 was $399,438 and $324,360,
respectively. The increase in machinery and equipment was mostly the result of building a tool inventory for the Middle East operations.
NOTE
6. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
|
March
31, 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
|
|
|
(11,825,556
|
)
|
|
|
(11,213,889
|
)
|
|
|
|
$
|
3,074,444
|
|
|
$
|
3,686,111
|
|
Amortization
expense related to intangible assets was $611,667 for the three months ended March 31, 2019 and 2018.
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 March 31, 2019, the Company reviewed the net balance of the intangible assets and determined no impairment was needed.
NOTE
7. 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
8. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
|
March
31, 2019
|
|
|
December
31, 2018
|
|
|
Real
estate loans
|
|
$
|
3,169,227
|
|
|
$
|
4,255,152
|
|
|
Hard
Rock Note
|
|
|
5,250,000
|
|
|
|
6,000,000
|
|
|
Credit
Agreement
|
|
|
1,438,884
|
|
|
|
-
|
|
|
Machinery
loans
|
|
|
187,840
|
|
|
|
327,879
|
|
|
Transportation
loans
|
|
|
275,514
|
|
|
|
292,722
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
Current
portion
|
|
|
(4,357,957
|
)
|
|
|
(4,578,759
|
)
|
|
Long-term
debt, net
|
|
$
|
5,963,508
|
|
|
$
|
6,296,994
|
|
Real
Estate Loans
On
February 1, 2019, we signed a loan agreement for $3,129,861 refinancing our commercial bank loan which 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. The remaining principal due is $4,500,000.
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 March 31, 2019,
$698,031 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 March 31, 2019, may not exceed $2,712,645, 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 March 31, 2019, we
had approximately $18,000 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 March 31, 2019, approximately $698,000 of the
Revolving Loan was outstanding. Also at March 31, 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 March 31, 2019, the interest rate was 7.5%. 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.
NOTE 9. TOTAL EQUITY
A
summary of changes in total equity for the three months ended March 31, 2019 and 2018 is presented below:
|
|
|
Common
Stock
|
|
|
Additional
Paid-in
|
|
|
Restated
Accumulated
|
|
|
Restated
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
|
|
|
-
|
|
|
|
-
|
|
|
|
181,852
|
|
|
|
-
|
|
|
|
181,852
|
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(245,876
|
)
|
|
|
(245,876
|
)
|
|
Balance - March
31, 2019
|
|
|
25,018,098
|
|
|
$
|
25,018
|
|
|
$
|
39,622,463
|
|
|
$
|
(32,301,286
|
)
|
|
$
|
7,346,195
|
|
|
|
|
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
|
|
|
-
|
|
|
|
-
|
|
|
|
137,017
|
|
|
|
-
|
|
|
|
137,017
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(17,753)
|
|
|
|
(17,753
|
)
|
|
Balance - March
31, 2018
|
|
|
24,535,155
|
|
|
$
|
24,535
|
|
|
$
|
39,044,881
|
|
|
$
|
(32,014,788
|
)
|
|
$
|
7,054,628
|
|
NOTE
10. 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
11. SUBSEQUENT EVENTS
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.
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 sale 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.
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 March 31, 2019, and our results of operations for
the three months ended March 31, 2019 and 2018. 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, 2018 and 2017, which were included in the Company’s Annual Report on Form 10-K
for the year ended December 31, 2018, 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).
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
$700.0 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.
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
operations, financial results, business plans, cash flow and cash requirements;
|
|
|
|
|
|
|
●
|
scheduled,
budgeted and other future capital expenditures;
|
|
|
|
|
|
|
●
|
working
capital requirements;
|
|
|
|
|
|
|
●
|
the
availability of expected sources of liquidity;
|
|
|
|
|
|
|
●
|
cost, risks, and uncertainties associated with
the Company’s recent restatement of its prior financial statements, and including any pending future claims or proceedings
relating to such matters;
|
|
|
|
|
|
|
●
|
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
|
|
|
|
|
|
|
●
|
environmentally
related penalties, capital expenditures, remedial actions and proceedings;
|
|
|
|
|
|
|
●
|
effects
of potential legal proceedings;
|
|
|
|
|
|
|
●
|
changes
in customers’ future product and service requirements that may not be cost effective or within the Company’s capabilities;
and
|
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, 2018 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;
|
|
|
|
|
|
|
●
|
our
reliance on significant customers;
|
|
|
|
|
|
|
●
|
consolidation
within our customers’ industries;
|
|
|
|
|
|
|
●
|
competitive
products and pricing pressures;
|
|
|
|
|
|
|
●
|
our
ability to develop and commercialize new and/or innovative drilling and completion tool technologies;
|
|
|
|
|
|
|
●
|
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 and other cybersecurity risks;
|
|
|
|
|
|
|
●
|
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.
Executive
Summary
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. Our headquarters and manufacturing operations are located in Vernal,
Utah. 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 for a leading oil
field services company. We operate a state-of-the-art drill tool fabrication facility, where we manufacture our own solutions
for the drilling industry, as well as customers’ custom products.
We
innovate, design, engineer, manufacture, sell, and repair drilling and completion tools in the United States, Canada, and the
Middle East.
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.
|
Our
strategy for growth is to leverage our expertise in drill tool technology and precision machining in order to broaden our product
offerings and solutions for the oil and gas industry. We believe through our patented technologies, as well as technologies under
development, that we can offer the industry the solutions it demands to improve drilling efficiencies and reduce production costs.
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. He was also co-inventor of the patented Drill-N-Ream® well bore conditioning
tool (“Drill-N-Ream tool” or “DNR”). We made a major strategic shift in 2016 to focus on our core competencies
of innovation in manufacturing technologies, creation of solutions for the upstream oil and gas industry, drilling tool fleet
maintenance and repair and the development engineering and manufacture of new tools and technologies.
For
the past 24 years, we have manufactured and refurbished PDC drill bits exclusively for Baker Hughes’s oilfield operations
in the Rocky Mountain, California and Alaska regions, as well as other areas as needed to support their internal operations. Effective
April 1, 2018, we entered into a new Vendor Agreement (the “Agreement”) with Baker Hughes Oilfield Operations LLC
(“Baker Hughes”), replacing our former Vendor Agreement, which expired on March 31, 2018. Under the agreement, we
will now serve an expanded market throughout the U.S., receive a base minimum volume in drill bit refurbishment and continue to
provide our drill bit refurbishment services exclusively for Baker Hughes. The agreement has a four-year term with minimum repair
levels and allows for modifications in the event of market deterioration. Either party has the right to cancel the agreement with
6-months’ notice.
We
have been expanding our offerings and broadening our customer base and the end-users of our technologies by demonstrating our
engineering, design and manufacturing expertise of down-hole drilling tools. In addition to the patented Drill-N-Ream tool, our
products include the patented Strider™ Drill String Oscillation System (“Strider technology”), the V-Stream
Advanced Conditioning System and the Dedicated Reamer Stinger. We have under design and development a suite of other horizontal
drill string tools, each of which addresses a different technical challenge presented by today’s horizontal drilling designs.
In addition, we work with our customers to develop new products and enhancements to existing products in order to improve efficiency
and safety and solve complex drilling tool problems.
In
May 2016, the Company entered into an agreement with Drilling Tools International (“DTI”), under which DTI had a requirement
to purchase our Drill-N-Ream tool for their rental tool business and achieve market share requirements in order to maintain exclusive
marketing rights for the Drill-N-Ream. This agreement began the shift of our business model from a rental tool company to a manufacturer
that designs, builds and sells tools. DTI has exclusive rights to market the Drill-N-Ream in the U.S. and Canada, both onshore
and offshore. It must achieve defined market share goals with our tool that started in June 2017 and increase through the end
of 2020. We receive revenue from DTI for tool sales, tool repairs and a royalty fee based on the tools usage.
Also
in 2016, the Company entered into a non-exclusive agreement with Baker Hughes to supply them with the Strider technology
and related services. Tool shipments under the agreement are expected to begin in late 2019. 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.
In
December 2017, the Company entered into an agreement with Weatherford U.S., L.P. (“Weatherford”) to launch a joint
market development program to introduce our Drill-N-Ream tool in the Middle East. Under the development agreement, Weatherford
and SDPI will demonstrate the Drill-N-Ream’s capabilities with large Middle East operators in Saudi Arabia, Kuwait and Oman.
The program ended January 31, 2019 and the companies are currently discussing next steps. SDPI and Weatherford each employ a local
resident Product Champion to execute the pilot test program of 20 Drill-N-Ream tools.
In
November 2018, we entered into a joint market development agreement with Odfjell Drilling. Similar to the Weatherford agreement,
this program will further the introduction of our Drill-N-Ream tool to large Middle East operators in Kuwait. The program ended
April 30, 2019 and the companies are currently discussing next steps.
Industry
Trends and Market Factors
Our
business is highly dependent upon the vibrancy of the oil and gas drilling operations primarily in the U.S. Oil and gas prices
have historically been volatile. The total U.S. rig count as reported by Baker Hughes at the end of the first quarter of 2019
was 1,006 rigs, an increase of 13 from the first quarter of 2018 total of 993 rigs. Production of oil in
the U.S. has increased to record levels of roughly 11.7 million barrels per day, which makes the U.S. the number one oil producing
country in the world. Oil production in the U.S. has grown at a faster rate than the increased rig count because of better rig
technology and higher rates of productivity per rig. With the increase in market activity, we have seen an increase in demand
for our products and services. As we expand into international markets,
we will become more subject to changes in the industry in the countries in which we operate, such as Saudi Arabia, Kuwait and
Oman. 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.
Although
the Company has seen demand for its oil and gas related products and services in the United States and Canada impacted by these
industry conditions, we continue to aggressively market our drilling products. The oil and gas industry is increasingly using
directional (e.g., horizontal) drilling in their exploration and production activities because of significantly 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. In addition,
current and expected oil and natural gas prices combined with more technically challenging horizontal drilling has driven the
demand for new technologies. We believe the value of our Drill-N-Ream tool has proven to provide significant operational efficiencies
and costs savings for horizontal drilling activity and, combined with our low market penetration, provide us sales opportunities
in soft as well as robust markets. Early results of our Strider technology has also delivered a similar outcome.
How
We Generate our Revenue
We
are a drilling and completion tool technology company and we generate revenue from the refurbishment, manufacture, repair,
rental and sale of drill string tools. Our manufactured products are produced in a standard manufacturing operation, even
when produced to our customer’s specifications. We also earn royalty fees under certain arrangements for the tools we sell.
In May 2016, the Company entered into an agreement with DTI to be our exclusive distributor of the Drill-N-Ream tool in the United
States and Canada. This agreement began the change of direction of our business from renting tools to selling tools.
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 shipment of the drill bit. Shipping
and handling costs related to refurbishing services are paid directly by Baker Hughes 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.
Costs
of Conducting Our Business
The
principal elements of cost of revenue for manufacture, repair, rental and sale of tools (“product”)
are the direct and indirect costs to manufacture, repair and supply the product, including labor, materials, utilities, equipment
repair, lease expense related to our facilities, supplies and freight.
Selling,
general and administrative expense is comprised of costs such as new business development, technical product support,
research and development costs, compensation expense for general corporate operations including accounting, human resources,
risk management, information technology expenses, safety and environmental expenses, legal and professional fees and other
related administrative functions.
Other
income (expense), net is comprised primarily of interest expense associated with outstanding borrowings net of interest income
or gains (losses) of disposed assets.
CONSOLIDATED
RESULTS OF OPERATIONS
Three
Months Ended March 31, 2019 Compared with the Three Months Ended March 31, 2018
The
following table represents summary consolidated operating results for the periods indicated:
|
|
|
Three-Months
Ended March 31,
|
|
|
(in
thousands)
|
|
2019 (Restated)
|
|
|
2018
|
|
|
Tool
revenue
|
|
|
3,444
|
|
|
|
68
|
%
|
|
|
3,525
|
|
|
|
77
|
%
|
|
Contract
services
|
|
|
1,592
|
|
|
|
32
|
%
|
|
|
1,075
|
|
|
|
23
|
%
|
|
Revenue
|
|
$
|
5,036
|
|
|
|
100
|
%
|
|
$
|
4,600
|
|
|
|
100
|
%
|
|
Operating
costs and expenses
|
|
|
5,123
|
|
|
|
102
|
%
|
|
|
4,433
|
|
|
|
96
|
%
|
|
Income
(loss) from operations
|
|
|
(87
|
)
|
|
|
(2
|
)%
|
|
|
167
|
|
|
|
4
|
%
|
|
Other
expense
|
|
|
(159
|
)
|
|
|
(3
|
)
%
|
|
|
99
|
|
|
|
2
|
%
|
|
Net
income (loss)
|
|
$
|
(246
|
)
|
|
|
(5
|
)%
|
|
$
|
68
|
|
|
|
2
|
%
|
Material
changes of certain items in our statements of operations included in our financial statements for the comparative periods are
discussed below. Comparisons are to the prior-year period unless stated otherwise.
Revenue
.
Our revenue increased approximately $436,000, or 9%, driven by higher contract services revenue which more than offset the slight
decline of tool revenue.
Tool
revenue was $3,444,000, down 2% or $81,000, from the prior-year period. The decline was mostly the result of tool rental and sales
revenue declining $239,000, or 2%, to approximately $1,753,000 primarily due to lower tool sales in U.S., offset by increases
in tool rental revenue in the Middle East. Other related tool revenue increased $158,000, or 10%, to $1,691,000, reflecting the
high level of activity of DNR. Other related tool revenue includes royalty fees, maintenance and repair of tools.
Contract
services revenue increased approximately $517,000, or 48%, to $1,592,000. The increase was due to the result of an increase
in drill refurbishment activity reflecting the level of activity in the U.S. oil & gas drilling industry.
Operating
Costs and Expenses
. Total operating costs and expenses increased approximately $690,000 for the 2019 three-month period.
|
|
●
|
Cost
of revenue increased approximately $244,000 due to an increase in volume. As a percentage of revenue, cost of sales was
41% for the three months ended March 31, 2019, and 39% for the three months ended March 31, 2018. Cost of revenue
as a percent of sales increased due to international start-up costs, which was offset by the volume of bit refurbishment.
|
|
|
|
|
|
|
●
|
Selling,
general and administrative expenses increased approximately $371,000 to $2,069,000 and was 41% of revenue
compared with 37% in the prior-year period. The increase was primarily due to an increase in professional fees, stock compensation
expense, and accrued bonus expense. Payment of bonuses is subject to the Company’s annual financial performance
goals.
|
Other
Income (Expenses)
. Other income and expense primarily consists of interest income, interest expense and loss
on disposition of assets.
|
|
●
|
Interest
Income.
For the three months ended March 31, 2019 and 2018 interest income was approximately $19,000 and $6,000,
respectively.
|
|
|
|
|
|
|
●
|
Interest
Expense.
Interest expense for the three months ended March 31, 2019 and 2018 was approximately $178,000 and $192,000,
respectively. The decline in interest expense was due primarily to the reduction in the balance outstanding on the Hard Rock
Note.
|
Liquidity
and Capital Resources
At
March 31, 2019, we had working capital of approximately $2,000,000. Our principal uses of cash are operating expenses,
working capital requirements, capital expenditures and debt service payments. Our operational and financial strategies include
lowering our operating costs and capital spending to match revenue trends, managing our working capital and debt to enhance liquidity.
We will continue to work to grow revenue and manage costs to be cash flow positive in 2019. 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.
As
amended and restated effective November 21, 2018, the Hard Rock Note has a remaining balance of $5.25 million as of
March 31, 2019, accrues interest at 7.25% per annum and matures and is fully payable on October 5, 2020. 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. We made all the January 5, 2019 and the April 5, 2019 payment.
In
February 2019, we refinanced our commercial bank loan which is secured by our Vernal, Utah campus. The loan requires monthly
payments of approximately $43,000, including principal and interest at 7.25%, and a balloon payment of $2,500,000 is due upon
maturity on February 15, 2021.
Also
in February 2019, we entered into a $4.3 million Credit Agreement comprised of a $0.8 million Term Loan and a $3.5 million Revolving
Loan. As of March 31, 2019, we had $800,000 outstanding on the Term Loan and $698,031 outstanding on the Revolving Loan. The interest
rate is prime plus 2% for both loans. The Credit Agreement matures on February 20, 2023.
Cash
Flows
Three
Months Ended March 31, 2019 Compared with the Three Months Ended March 31, 2018
Net
cash provided by operating activities was $976,355 and $520,848 for the three months ended March 31, 2019 and 2018, respectively.
The primary reason for the improvement was the change in working capital requirements.
Net
cash used in investing activities was $338,765 and $94,780 for the three months ended March 31, 2019 and 2018, respectively, and
related to property, plant and equipment purchases mostly for tools to support the expansion in the Middle East.
Net
cash used in financing activities was $555,891 and $625,905 for the three months ended March 31, 2019 and 2018, respectively.
Higher principal payments on debt were offset by proceeds of debt borrowings.
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, revenue, 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.
Item
4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
Our management, with the participation
of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures
(as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report.
Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls
and procedures were not effective as of March 31, 2019 due to a material weakness.
A material
weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a possibility
that a material misstatement in our interim financial statements will not be prevented or detected on a timely basis. A material
weakness in internal control was discovered related to a related party note receivable and the application of complex accounting
guidance.
During the course of our assessment, management identified that the Company
has a lack of appropriate accounting expertise within its accounting department,
specifically around evaluating the related party note receivable for
recoverability
. Management believes the lack of accounting expertise
to appropriately apply GAAP for complex and non-routine transactions amounts to a material weakness in its internal control over
financial reporting.
As a result, at March 31, 2019 and on the date of this Report, our internal
control over financial reporting is not effective.
Changes
in Internal Controls over Financial Reporting
None
Internal
Controls and Procedures
This
quarterly report does not include a report of management’s assessment regarding internal control over financial reporting
or an attestation report of the Company’ s registered public accounting firm due to a transaction period established by
the rules of the Securities and Exchange Commission for newly public companies. Under these rules, we will not be required to
include an attestation report for so for as long as we are an “emerging growth company” pursuant to the provisions
of the JOBS Act or a “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act.