Notes
to Condensed Consolidated Financial Statements (Unaudited)
March
31, 2021
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 production efficiencies for the
oil and natural gas drilling 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.
Unaudited
Interim Financial Presentation
These
interim consolidated condensed financial statements for the three months ended March 31, 2021 and 2020, 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, 2021 are not necessarily indicative of the results of operations expected
for the year ending December 31, 2021. 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, 2020 and 2019 and the notes thereto,
which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, 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.
Concentrations
of Credit Risk
The
Company has two significant customers that represented 85% and 84% of our revenue for the three months ended March 31, 2021 and 2020,
respectively. These customers had approximately $846,000 and $2,120,000 in accounts receivable at March 31, 2021 and 2020, respectively.
The
Company had two vendors that represented 22% of our purchases for the quarter ended March 31, 2021. These vendors had
approximately $221,000 in accounts payable at March 31, 2021 and purchases in the first quarter of 2021 from these vendors
totaled approximately $239,000. The Company had two vendors that represented 26% of our purchases for the three months
ended March 31, 2020. The vendors had approximately $454,000 in accounts payable at March 31, 2020 and purchases in the first
quarter of 2020 from these vendors totaled approximately $524,000.
Impact
of COVID-19
The
COVID-19 pandemic has impacted and may further impact the Company’s operations, and the operations of the Company’s suppliers
and vendors, as a result of quarantines, facility closures, and travel and logistics restrictions. The extent to which the COVID-19 pandemic
will continue to impact the Company’s business, financial condition and results of operations will depend on future developments,
which are highly uncertain and depend on, among other things, the duration, spread, severity, and impact of the COVID-19 pandemic and
the success and speed of vaccination efforts both in the United States and globally, the effects of the COVID-19 pandemic on the Company’s
customers, suppliers, and vendors and the remedial actions and stimulus measures adopted by local and federal governments, and to what
extent normal economic and operating conditions can resume. Therefore, the Company cannot reasonably estimate future impacts of the COVID-19
pandemic at this time.
Uncertain Tax Matters
The
Company believes it has appropriately accrued for the expected outcome of uncertain tax matters and believes such liabilities
represent a reasonable provision for taxes ultimately expected to be paid; however, these liabilities may need to be adjusted
as new information becomes known and as tax examinations continue to progress, or as settlements or litigations occur.
Recent
Accounting Pronouncements
There
are no recently issued accounting pronouncements that we have not yet adopted that we believe will have a material effect on our financial
statements.
NOTE
2. LIQUIDITY
We
believe that our cash generated from operations and our borrowing capacity under our current credit facility will be sufficient
to fund our operations for the next 12 months. To enhance liquidity, our operational and financial strategies include managing our operating
costs, accelerating collections of international receivables, and reducing working capital requirements and restructuring our debt. If
we are unable to do this, we may not be able to, among other things, (i) maintain our revised general and administrative spending levels;
(ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital requirements. COVID-19
has also led to a significant disruption in the equity and debt capital markets, which could hinder our ability to raise new capital
or obtain financing on acceptable terms. We cannot provide any assurance that financing will be available to us in the future on acceptable
terms, if at all.
In
2020, the Company filed a Form S-3 Shelf Registration that will allow the Company to offer and sell, from time to time, up to $20,000,000
of securities. We believe maintaining an active Shelf Registration provides additional financial flexibility to access the capital
markets. However, there is no assurance that such financings could be consummated on acceptable terms or at all.
Also
in 2020, the Company received notification from the NYSE American to the Company indicating that, as a result of the Company’s
stockholders’ equity of $4.7 million as of September 30, 2020, and reported losses for each of the last five fiscal years, the
Company was not in compliance with the stockholders’ equity standards for continued listing on the NYSE American. On January
28, 2021, the Company received notice that the NYSE American had accepted the Company’s plan that was submitted on December 18,
2020, to regain compliance with the continued listing standards of the NYSE American. The Company has been granted a plan period through
May 18, 2022 to regain compliance.
NYSE
American Regulations staff will review the Company periodically for compliance with the initiatives outlined in the plan. If the Company
is not in compliance with the continued listing standards by May 18, 2022 or if the Company does not make progress consistent with the
plan during the plan period, NYSE Regulation staff may initiate delisting proceedings as appropriate.
NOTE
3. REVENUE
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
86% of our revenue is from North America and approximately 14% is from the Middle East for the three months ended March 31, 2021. For
the three months ended March 31, 2020, approximately 85% of our revenue was from North America and approximately 15% was from the Middle
East.
Revenue
disaggregated by revenue source are as follows:
|
|
Three months ended March 31,
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
Tool Revenue:
|
|
|
|
|
|
|
|
|
Tool and product sales
|
|
$
|
495,000
|
|
|
$
|
990,734
|
|
Tool rental
|
|
|
336,453
|
|
|
|
777,253
|
|
Other related revenue
|
|
|
832,310
|
|
|
|
1,844,931
|
|
Total Tool Revenue
|
|
|
1,663,763
|
|
|
|
3,612,918
|
|
|
|
|
|
|
|
|
|
|
Contract Services
|
|
|
760,890
|
|
|
|
1,744,845
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
2,424,653
|
|
|
$
|
5,357,763
|
|
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 Topic 606.
NOTE
4. INVENTORIES
Inventories
are comprised of the following:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
Raw material
|
|
$
|
734,215
|
|
|
$
|
733,734
|
|
Work in progress
|
|
|
99,261
|
|
|
|
50,631
|
|
Finished goods
|
|
|
162,607
|
|
|
|
235,643
|
|
|
|
$
|
996,083
|
|
|
$
|
1,020,008
|
|
NOTE
5. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
Buildings
|
|
|
4,764,441
|
|
|
|
4,764,441
|
|
Building improvements
|
|
|
755,039
|
|
|
|
755,039
|
|
Machinery and equipment
|
|
|
11,373,601
|
|
|
|
11,298,642
|
|
Office equipment, fixtures and software
|
|
|
628,358
|
|
|
|
628,358
|
|
Transportation assets
|
|
|
265,760
|
|
|
|
265,760
|
|
|
|
|
18,667,615
|
|
|
|
18,592,656
|
|
Accumulated depreciation
|
|
|
(11,455,967
|
)
|
|
|
(11,057,558
|
)
|
|
|
$
|
7,211,648
|
|
|
$
|
7,535,098
|
|
In
2019, the Company decided to sell the Company airplane and related hangar and reported the assets as assets held for sale on our balance
sheet at their carrying value, which is lower than the expected fair value less costs to sell. The Company sold the airplane for a gain
of approximately $142,000 in February 2020 and the Company sold the hangar for a gain of $10,000 in March 2021.
Depreciation
expense related to property, plant and equipment for the three months ended March 31, 2021 and 2020 was $398,408 and $469,098,
respectively. The increase in machinery and equipment was mostly the result of the Company’s increased rental tool fleet
for the Middle East operations.
NOTE
6. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
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
|
|
|
(14,372,222
|
)
|
|
|
(14,080,556
|
)
|
|
|
$
|
527,778
|
|
|
$
|
819,444
|
|
Amortization
expense related to intangible assets was $291,666 for the three months ended March 31, 2021 and 2020.
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. Tronco is an entity owned by Troy and Annette Meier. 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 if and when consideration or payments of the loan are made in the future. On July 7, 2020,
the Company entered into an amended and restated loan agreement and note with Tronco changing the payment terms on the note. As
amended, the interest rate on the note is fixed at 2% per annum. Interest only is due December 31, 2021, with a balloon payment
of all unpaid interest and principal due upon maturity on December 31, 2022.
NOTE
8. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
Hard Rock Note
|
|
$
|
1,500,000
|
|
|
$
|
1,500,000
|
|
Credit Agreement
|
|
|
1,002,749
|
|
|
|
825,366
|
|
Machinery loans
|
|
|
440,716
|
|
|
|
466,448
|
|
Transportation loans
|
|
|
49,305
|
|
|
|
56,572
|
|
|
|
|
2,992,770
|
|
|
|
2,848,386
|
|
Less:
|
|
|
|
|
|
|
|
|
Current portion
|
|
|
(1,651,283
|
)
|
|
|
(1,397,337
|
)
|
Long-term debt, net
|
|
$
|
1,341,487
|
|
|
$
|
1,451,049
|
|
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.
The
Hard Rock Note has a remaining balance of $1,500,000 as of March 31, 2021, accrues interest at 8.00% per annum and is due in full by
October 5, 2022. Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued interest
on January 5, April 5, July 5 and October 5 in 2021 and 2022; plus $750,000 in principal on July 5, 2021 with the remaining balance of
principal and accrued interest on the Hard Rock Note due on October 5, 2022. In January and April 2021, the Company made interest payments
of $30,247 and $29,589, respectively.
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 $4,500,000 credit facility, which includes a $1,000,000 term loan (the “Term
Loan”) and a $3,500,000 revolver (the “Revolving Loan”). As of March 31, 2021, we had $583,330 outstanding on the Term
Loan and $454,925 outstanding on the Revolving Loan. Amounts outstanding under the Revolving Loan 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, 2021, may not exceed $456,428, 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. Even if our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000.
At March 31, 2021, we had approximately $10,000 of accrued interest.
The
Credit Agreement contains various restrictive covenants that, among other things, limit or restrict the ability of the Company
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, 2021,
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, 2021, the interest rate for the Term Loan was 8.85%,
which includes a 3.6% management fee rate. The effective interest rate for the Revolving Loan for the quarter ending March 31, 2021 was
9.56%. The obligations of the Company under the Credit Agreement are secured by a security interest in substantially all of the tangible
and intangible assets of the Company, other than any assets owned by the Company 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. FINANCING OBLIGATION
On
December 7, 2020, the Company entered into a sale agreement (the “Sale Agreement”). Pursuant to the terms of the Sale Agreement,
the Company sold land and property related to the Company’s headquarters and manufacturing facility in Vernal, Utah (the “Property”)
for a purchase price of $4,448,500. Concurrent with the sale of the Property, the Company entered into a fifteen-year lease agreement
(the “Lease Agreement”), whereby the Company will lease back the Property at an annual rate of $311,395 with payments made
monthly, subject to annual rent increases of 1.5%. Under the Lease Agreement, the Company has an option to extend the term of the lease
and to repurchase the Property. Due to this repurchase option, the Company was unable to account for the transfer as a sale under ASC
Topic 842, Leases, and as such, the transaction is accounted for as a financing transaction.
The
Company received cash of $1,622,106, retired real estate debt of $2,638,773 and recorded a financing obligation liability of $4,260,879
related to the transaction. There was no gain recorded since sale accounting was precluded. The financing obligation has an implied interest
rate of 6.0%. At the conclusion of the fifteen-year lease period, the financing obligation residual will be $2,160,242, which will correspond
to the carrying value of the property. The Company paid $25,950 of principal in 2020 that was prorated for the month of December.
The
financing obligation is summarized below:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
Finance obligations for sale-leaseback transactions
|
|
$
|
4,220,883
|
|
|
$
|
4,239,952
|
|
Current principal portion of finance obligation
|
|
|
(59,420
|
)
|
|
|
(61,691
|
)
|
Non-current portion of finance obligation
|
|
$
|
4,161,463
|
|
|
$
|
4,178,261
|
|
NOTE
10. TOTAL EQUITY
A
summary of changes in total equity for the three months ended March 31, 2021 and 2020 is presented below:
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total
Shareholders’
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Capital
|
|
|
Deficit
|
|
|
Equity
|
|
Balance - December 31, 2020
|
|
|
25,762,342
|
|
|
$
|
25,762
|
|
|
$
|
40,619,620
|
|
|
$
|
(36,421,707
|
)
|
|
$
|
4,223,675
|
|
Stock-based compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
167,472
|
|
|
|
-
|
|
|
|
167,472
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,101,793
|
)
|
|
|
(1,101,793
|
)
|
Balance - March 31, 2021
|
|
|
25,762,342
|
|
|
$
|
25,762
|
|
|
$
|
40,787,092
|
|
|
$
|
(37,523,500
|
)
|
|
$
|
3,289,354
|
|
|
|
Common Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total
Shareholders
|
|
|
|
Shares
|
|
|
Par Value
|
|
|
Capital
|
|
|
Deficit
|
|
|
Equity
|
|
Balance - December 31, 2019
|
|
|
25,418,126
|
|
|
$
|
25,418
|
|
|
$
|
40,069,391
|
|
|
$
|
(32,991,833
|
)
|
|
$
|
7,102,976
|
|
Stock-based compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
106,996
|
|
|
|
-
|
|
|
|
106,996
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
198,046
|
|
|
|
198,046
|
|
Balance - March 31, 2020
|
|
|
25,418,126
|
|
|
$
|
25,418
|
|
|
$
|
40,176,387
|
|
|
$
|
(32,793,787
|
)
|
|
$
|
7,408,018
|
|
NOTE
11. GEOGRAPHICAL OPERATIONS INFORMATION
The
following summarizes revenue by geographic location:
|
|
Three months ended March 31, 2021
|
|
|
Three months ended March 31, 2020
|
|
Revenue:
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
2,092,200
|
|
|
$
|
4,580,510
|
|
Middle East
|
|
|
332,453
|
|
|
|
777,253
|
|
|
|
$
|
2,424,653
|
|
|
$
|
5,357,763
|
|
The
following summarizes net property, plant and equipment by geographic location:
|
|
March 31, 2021
|
|
|
December 31, 2020
|
|
Property, plant and equipment, net:
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
5,975,625
|
|
|
$
|
6,008,431
|
|
Middle East
|
|
|
1,236,023
|
|
|
|
1,526,667
|
|
|
|
$
|
7,211,648
|
|
|
$
|
7,535,098
|
|
NOTE
12. 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. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District
of Texas, Houston Division. Additionally, on May 20, 2019, Extreme Technologies, LLC sued Short Bit & Tool Co. and Lot William Short,
Jr. (“Defendants”) in the Northern District of Texas - Dallas Division. Extreme sued for patent infringement based on the
same patents discussed in the Stabil Drill litigation. On December 23, 2019, the Court stayed Extreme’s patent infringement claim
against Defendants pending resolution of the Southern District of Texas Stabil Drill case. The court ordered the Company to serve discovery
requests upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit product inspection. Stabil Drill
filed a motion for summary judgement and the Company responded and cross-moved for patent infringement. The parties are awaiting the
judge’s decision. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company, filed for bankruptcy, which
may result in a delay in the resolution of this litigation. Superior Energy Services announced on February 2, 2021 that it successfully
completed its financial restructuring and emerged from Chapter 11 bankruptcy. 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.