ITEM
1. BUSINESS
Our
Company
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.
We
were incorporated on December 10, 2013 under the name SD Company, Inc. in order to facilitate (a) the reorganization of the entities
that are now our consolidated subsidiaries and (b) the subsequent acquisition of Hard Rock Solutions, LLC (“HR”).
We changed our name from SD Company Inc. to Superior Drilling Products, Inc. on May 22, 2014 in conjunction with closing of that
reorganization and our initial public offering, which occurred on May 23, 2014 (“Offering” or “IPO”).
Our corporate headquarters and manufacturing operations are located in Vernal, Utah. Our common stock trades on the NYSE MKT exchange
under the ticker symbol “SDPI”.
Our
subsidiaries include (a) Superior Drilling Solutions, LLC (previously known as Superior Drilling Products, LLC), a Utah limited
liability company (“SDS”), together with its wholly owned subsidiary Superior Design and Fabrication, LLC, a Utah
limited liability company (“SDF”), (b) Extreme Technologies, LLC, a Utah limited liability company (“ET”),
(c) Meier Properties Series, LLC, a Utah limited liability company (“MPS”), (d) Meier Leasing, LLC, a Utah limited
liability company (“ML”), and (e) HR.
We
innovate, design, engineer, manufacture, sell, and repair drilling and completion tools in the United States, Canada, and the
Middle East region.
We
currently have three basic operations:
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Our
PDC drill bit and other tool refurbishing and manufacturing service,
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Our
emerging technologies business that manufactures the Drill-N-Ream tool, our innovative drill string enhancement tool, the
Strider technology and other tools, and
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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.
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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 25 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 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 processes.
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 problems.
In
May 2016, the Company entered into an agreement with Drilling Tools International (“DTI”), under which DTI purchases
our Drill-N-Ream tool for their rental tool business. We receive revenue from DTI for tool sales, tool repairs and a royalty fee
based on the tools usage. Pursuant to the agreement, DTI must achieve certain market share requirements in order to maintain exclusive
marketing rights for the Drill-N-Ream in the U.S. and Canada, both onshore and offshore. DTI has not achieved the defined market
share goals and, therefore, does not currently have exclusive rights to market the Drill-N-Ream. The Company can work with other
customers to expand the market reach of the Drill-N-Ream and plans to do so.
Also,
in 2016, the Company entered into a non-exclusive agreement with Baker Hughes to supply them with the Strider technology and related
services. 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.
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 would 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 now operating under a new equipment rental agreement that
was executed on June 15, 2019 for a one year term. The new equipment rental agreement established Drill-N-Ream pricing in Kuwait.
Any work performed outside of Kuwait is not in the scope of the new rental agreement, and pricing will be established for that
work on a proposal basis.
In
November 2018, we entered into a joint market development agreement with Odfjell Drilling and a Back-to-Back subcontract
agreement. Similar to the Weatherford agreement, this program was intended to further the introduction of our
Drill-N-Ream tool to large Middle East operators in Kuwait. The program ended October 31, 2019, however an amendment to
the Back-to-Back subcontract agreement was executed in October 2019 for a one year term. This Amendment amended and
established new terms for pricing, equipment operations and equipment maintenance.
The
Company is also now providing the Drill-N-Ream tool to National Energy Services Reunited Corp. (“NESR”) in Kuwait
under a pricing and operating agreement executed on June 24, 2019 with a one year term.
Our
Products
Drill-N-Ream
Tool. The Drill-N-Ream tool is a dual-section wellbore conditioning tool which is located approximately 150 feet behind the
bottom hole assembly (BHA). The Drill-N-Ream smooths and slightly enlarges the well drift in all sections of horizontal wells,
in both oil and water-based mud. The Drill-N-Ream tool is available in multiple sizes and can be custom manufactured to
accommodate most drill hole sizes. Concurrently as the well bore is being drilled, the Drill-N-Ream tool conditions the well bore.
It reduces tortuosity resulting from the geo-steering drill bit, and the overcorrections and formation interactions that occur
during directional drilling. With the well bore conditioned by the Drill-N-Ream, the drill string is then able to move through
the conditioned well bore with less friction and stress. In effect, the Drill-N-Ream accelerates drilling speed and extends the
horizontal distance of the well bore by:
(a)
Smoothing out ledges and doglegs left by the bit, which allows the drill string to move through a conditioned well bore with less
friction and stress,
(b)
Reducing tool joint damages and trip time (i.e. the time required to remove and reinsert the drill string),
(c)
Enhancing the power available to drive the drill bit assembly,
(d)
Extending the horizontal distance that can be drilled during a run,
(e)
Improving the running of casing in the completed well much easier, and
(f)
Tripping out of the hole on elevators, rotation not required.
The
number of “trips” required by the operator, or the number of times the drill string has to be removed and reinserted,
is reduced as a result of the Drill-N-Ream. Each time a drilling operator has to trip the drill string and replace a bit or other
drill string component, it costs the operator substantial time and money, so we believe anything that allows each run to extend
further without additional tripping is of great value to our customers. Traditional methods for conditioning the well bore entails
removing the drill string and running a dedicated reamer through the well bore, typically in two separate runs. The Drill-N-Ream
tool eliminates the need for dedicated reamer runs, and therefore reduces the cost of drilling a horizontal well.
We
believe that the Drill-N-Ream’s rapid adoption and continued use by operators validates its effectiveness and industry acceptance.
In fact, leading operators have begun to standardize their drilling assembly with a Drill-N-Ream tool. In addition, we understand
that a number of customers have rented the Drill-N-Ream tool after first trying competitive products. We expect the above factors
to support increasing interest in, and revenue from, the Drill-N-Ream tool over the next several years as more well operators’
reports of its effectiveness are transmitted through word-of-mouth by an increasing user base to other well operators globally.
Strider
Technology. The Strider technology utilizes its unique patented design to reduce drill string friction on horizontal wells,
resulting in improved rates of penetration and cost savings. The Strider technology is designed to help dissipate the inertial
drag of a horizontal drill string by generating rhythmic pulses that break the frictional connection between the drill strings
and well bore greatly enhancing drilling rates. Its revolutionary engineering provides a cost-effective alternative to conventional
downhole vibration tools.
The
Strider technology is composed of two main parts, a hydraulic channeling chamber (HCC) and a rhythmic pulsation chamber (RPC).
The RPC contains a precisely engineered, high speed pulse-valve that systematically restricts flow area. During flow restriction,
or “closure”, the ideal amount of fluid is allowed to continue down hole. This perfectly controlled hydraulic flow
produces an optimal pulse frequency, which is preferred for bottom hole assembly equipment. The optimal pulse frequency also allows
for placement of the Strider technology closer to the bit than typical oscillation tools.
We
believe that our Strider technology is at the forefront of drill string tool technological development for horizontal drilling.
We also believe our Strider technology offers significant advantages over our competitors drill string stimulation tools.
V-Stream
advanced conditioning system (“V-Stream”). The V-Stream tool is an integral spiral blade stabilizer and is engineered
to combine stabilization with reaming. A cavity or plenum in the middle of the blades facilitates enhanced fluid flow for cuttings
transport and reduces torque when compared with typical stabilizers with similar overall blade length. Non-active cutters at gauge
enable the V-Stream to remove formation and condition the hole while controlling deviation. With these unique features, the V-Stream
will stabilize the BHA and condition the hole simultaneously to optimize the drilling operations.
Our
Strategy for Growth
We
intend to pursue the following growth strategies as we seek to expand our market share and solidify our position as a competitive
drilling tool manufacturer in the drilling industry:
Leverage
highly advanced tool technologies. We currently have two highly differentiated advanced drilling tool technologies
that address challenges encountered in the oil and gas drilling marketplace.
Expand
our channels to market. We are leveraging existing distribution channels in the exploration and production industry. As noted
earlier, in May 2016, we entered into an agreement with DTI, establishing DTI as the distributor of our patented Drill-N-Ream
tool in the United States and Canada onshore and offshore markets. As a result of this agreement, our technology has penetrated
the market more efficiently leveraging DTI’s long-term relationships with end users. We are also evaluating opportunities
to further our reach into North America market.
We
are expanding our channels to market and our geographic presence, especially in the Middle East as evidenced by agreements that we entered into with Weatherford in December 2017, Odfjell Drilling in November
2018 and NESR in 2019. We expect to add additional distributors as we expand our tool offering. We also expect to leverage
our distributor and customer relationships to identify needs for new tool development and to use these channels to market a broadened
product offering as it is developed.
Strengthen
and support our employees. Our experienced employees and management team are some of our most valuable resources. Attracting,
training, and retaining key personnel, has been and will continue to be critical to our success. To achieve our goals, we intend
to remain focused on providing our employees with training, personal and professional growth opportunities, as well as adding
performance-based incentives, including opportunities for stock ownership, and other competitive benefits. We are also working
with the local university and high school to develop and teach local programs in machining and engineering expertise and technical
resources.
Seek
strategic acquisitions to enhance or expand our product lines. While capital constraints are currently requiring us to focus
on organic growth, we may identify new technologies to add to our arsenal of tools for the exploration and production industry.
In analyzing new acquisitions, we intend to pursue opportunities that complement our existing product line and/or that are geographically
situated within our current market. We believe that strategic acquisitions will enable us to exploit economies of scale in the
areas of finance, human resources, marketing, administration, information technology, and legal, while also providing cross-marketing
opportunities among our drill tool product offerings.
New
Product Development and Intellectual Property
Our
sales and earnings are influenced by our ability to successfully provide the high-level service and state-of-the-art products
that our customers demand, which in turn relies on our ability to develop new processes, technology, and products. We have also
historically dedicated additional resources toward the development of new technology and equipment to enhance the effectiveness,
safety, and efficiency of the products and services we provide. We expect that with our extensive knowledge and experience in
the oilfield industry, we can identify additional challenges with directional drilling, and then design and develop tools that
will help our customers with their drilling challenges. Further development of additional drill string components will become
increasingly important to our business as we continue to grow through both organic expansion and strategic acquisitions.
Research
and development costs were approximately $1,427,000 for the year ended December 31, 2019, compared with $1,265,000 for
the year ended December 31, 2018. Costs included in research and development included payroll for engineers, materials for Strider,
legal costs relating to our patents, and third party engineering costs. Research and development costs represented 8%
of our 2019 revenue as we continued to maintain our commitment to new product development.
Although
we highly value our proprietary products and technology, we also depend on our technological capabilities, customer service-oriented
culture, and application of our know-how to distinguish ourselves from our competitors. We also consider the services and products
we provide to our customers, our customer relationships, and the technical knowledge and skill of our personnel, to be more important
than our registered intellectual property in our ability to compete. While we stress the importance of our research and development
programs, the technical challenges and market uncertainties associated with the development and successful introduction of new
and updated products are such that we cannot assure investors that we will realize any particular amount of future revenue from
the services and related products resulting from our research and development programs.
Suppliers
and Raw Materials
We
acquire supplies, component parts, products and raw materials from suppliers, including steel suppliers, foundries, forge shops
and original equipment manufacturers. The prices we pay for our raw materials may be affected by, among other things, energy,
industrial diamond, steel and other commodity prices, tariffs and duties on imported materials and foreign currency exchange rates.
Certain of our component parts, products or specific raw materials are only available from a limited number of suppliers.
Our
ability to obtain suitable quality raw materials and components, such as PDC’s, steel and flux, solder and heating elements,
is critical to our ability to remanufacture Baker Hughes drill bits, and to manufacture the Drill-N-Ream tool and Strider technology
tools and other future drill line products. In order to purchase raw materials and components in timely and cost-effective manner,
we have developed both domestic and international sourcing connections and arrangements. We maintain quality assurance and testing
programs to analyze and test these raw materials and components in order to assure their compliance with our rigorous specifications
and standards. We generally try to purchase our raw materials from multiple suppliers, so we are not dependent on any one supplier,
but this is not always possible.
The
price and availability of commodities and components, in particular steel, can have an impact on our operations. We have no assurance
that we will be able to continue to purchase these raw materials on a timely basis or at historical prices.
Proprietary
Rights
We
rely primarily on a combination of patent, trade secret, copyright and trademark laws, confidentiality procedures, and other intellectual
property protection methods to protect our proprietary technology. Mr. Meier currently has U.S. patent applications pending, and
related international patent applications pending as co-inventor, and individually with respect to the Strider technology and
other pending drilling tools. There is no assurance that our patent applications will result in issued patents, that the existing
patents or that any future patents issued to us will provide any competitive advantages for their products or technology, or that,
if challenged, the patents issued to us will be held valid and enforceable. Despite our precautions, unauthorized parties may
attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Existing intellectual property
laws afford only limited protection and policing violations of such laws is difficult. The laws of certain countries in which
our products are or may be used by our customers do not protect our products and intellectual property rights to the same extent
as do the laws of the United States. There is no assurance that these protections will be adequate or that our competitors will
not independently develop similar technology, gain access to our trade secrets or other proprietary information, or design around
our patents.
We
may be required to enter into costly litigation to enforce our intellectual property rights or to defend infringement claims by
others. Such infringement claims could require us to license the intellectual property rights of third parties. There is no assurance
that such licenses would be available on reasonable terms, or at all.
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 court ordered the Company to serve discovery requests
upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit an inspection of the Accused Product.
Stabil Drill filed a motion for summary judgement and the Company is in the process of responding and cross-moving for patent
infringement. 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.
Competition
Drill
Bit Refurbishing. The primary competitors for our drill bit refurbishing services are the in-house units at Hughes Christensen,
the division of Baker Hughes responsible for drill bits. Other drill bit manufacturers also have in-house refurbishing units,
but they are not our competitors because of our exclusive contract with Baker Hughes.
Drilling
Enhancement Tools. The primary competitors for our Drill-N-Ream tool are several single-section reaming tool manufacturers,
including Baker Oil Tools (a division of Baker Hughes), NOV, Schlumberger and Tercel, and one dual-section reaming tool manufactured
by Stabil Drill (which is the subject of the lawsuit described above). We believe that the Drill-N-Ream tool is the only
patented dual-section or dual cutting structure drill string reamer on the market today. We believe that distinction will allow
us to continue building on the Drill-N-Ream tool’s first-mover advantage.
We
believe that our Strider technology is at the forefront of drill string tool technological development for horizontal drilling.
There are existing tools that would compete with the Strider, such as the Agitator tool marketed by NOV. However, we believe
our Strider technology offers significant advantages over the Agitator.
Customers
Our
customer agreements provide certain exclusive rights in our U.S. and Canada markets and therefore result in a high concentration
of revenue dependent upon a limited number of customers. For the years ended December 31, 2019 and 2018, two customers represented
92% and 95% of our total revenue, respectively.
Manufacturing
We
manufacture our solutions, as well as custom products, in our state-of-the-art drill tool fabrication facility where we operate
a technologically-advanced PDC drill bit refurbishing facility, as well as a state-of-the-art, high-tech drilling and completion
tool engineering design and manufacturing operation. We manufacture our drill string enhancement tools, including the patented
Drill- N-Ream tool and the patented Strider technology, and conduct our new product research and development from this facility.
We
employ a senior work force with specialized training and extensive experience related to drill bit refurbishing and drill and
completion tool manufacturing. They produce our products and services using a suite of highly technical, purpose-built equipment,
much of which we design and manufacture for our proprietary use. Our manufacturing equipment and products use advanced technologies
that enable us to increase efficiency, enhance product integrity, improve efficiency and safety, and solve complex drilling tool
problems.
Cyclicality
We
are substantially dependent on conditions in the oil and gas industry, including the level of exploration, development and production
activity of, and the corresponding capital spending by, oil and natural gas companies. The level of exploration, development and
production activity is directly affected by trends in oil and natural gas prices, which has historically been volatile, and by
capital spending discipline imposed by customers.
Declines,
as well as anticipated declines, in oil and gas prices could negatively affect the level of these activities and capital spending,
which could adversely affect demand for our products and services and, in certain instances, result in the cancellation, modification
or rescheduling of existing and expected orders and the ability of our customers to pay us for our products and services. These
factors could have an adverse effect on our revenue and profitability.
Seasonality
Our
business is not significantly impacted by seasonality, although our fourth quarter has historically been negatively impacted by
holidays and our clients’ budget cycles. A small portion of the revenue we generate from selected operations may benefit
from higher first quarter activity levels, as operators take advantage of the winter freeze to gain access to remote drilling
and production areas. In the past, some of our revenue in Alaska and Canada has declined during the second quarter due
to warming weather conditions that resulted in thawing, softer ground, difficulty accessing drill sites and road bans that curtailed
drilling activity.
Environmental,
Health and Safety Regulation
Our
operations are subject to numerous stringent and complex laws and regulations governing the discharge of materials into the environment,
health and safety aspects of our operations, or otherwise relating to human health and environmental protection, and we have put
a strong focus on these issues.
We
designed and built our Vernal facility as a fully-contained business park, except for the city sewer connection. Underlying our
entire facility, including parking lots and runoff storage areas, is a complete capture and containment field that collects all
building drainage and ground run off in isolated tanks. Captured drainage and runoff, as well as all hazardous waste generated
in our manufacturing processes is regularly removed from our facility by a certified hazardous waste disposal company. Any changes
in environmental laws and regulations or in enforcement policies that result in more stringent and costly waste handling, storage,
transport, disposal, or remediation requirements could have a material adverse effect on our operations and financial position.
Moreover, accidental releases or spills of regulated substances may occur in the course of our operations, and we cannot assure
you that we will not incur significant costs and liabilities as a result of such releases or spills, including any third-party
claims for damage to property, natural resources or persons. Failure to comply with these laws or regulations or to obtain or
comply with permits may result in the assessment of administrative, civil and criminal penalties, imposition of remedial or corrective
action requirements, and the imposition of orders or injunctions to prohibit or restrict certain activities or force future compliance.
The
following is a summary of the more significant existing environmental, health and safety laws and regulations to which our business
operations are subject and for which compliance could have a material adverse impact on our capital expenditures, results of operations
or financial position.
Hazardous
Substances and Waste. The Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes,
regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under
the auspices of the EPA, the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with
their own, more stringent requirements. We are required to manage hazardous and non-hazardous wastes in compliance with RCRA and
its state counterparts.
The
Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), also known as the Superfund
law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered
to be responsible for the release of a hazardous substance into the environment. These persons include the owner or operator of
the site where the release occurred, and anyone who disposed or arranged for the disposal of a hazardous substance released at
the site. We currently own, lease, or operate numerous properties that have been used for manufacturing and other operations for
many years. We also contract with waste removal services and landfills. These properties and the substances disposed or released
on them may be subject to CERCLA, RCRA and analogous state laws. Under such laws, we could be required to remove previously disposed
substances and wastes, remediate contaminated property, or perform remedial operations to prevent future contamination. In addition,
it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly
caused by hazardous substances released into the environment.
Water
Discharges. The Federal Water Pollution Control Act (the “Clean Water Act”) and analogous state laws impose
restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances,
into “Waters of the United States,” including wetlands. The discharge of pollutants into regulated waters is prohibited,
except in accordance with the terms of a permit issued by the EPA or an analogous state agency. A responsible party includes the
owner or operator of a facility from which a discharge occurs. The Clean Water Act and analogous state laws provide for administrative,
civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act of 1990, impose rigorous requirements
for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation,
and damages in connection with any unauthorized discharges. Further, proposed revisions to the definition of “Waters of
the United States” have been subject to judicial challenges and administrative action, resulting in uncertainty as to the
scope of the regulatory definition. Our obligations under the Clean Water Act could be expanded when the definition of “Waters
of the United States” is ultimately resolved.
Employee
Health and Safety. We are subject to a number of federal and state laws and regulations, including OSHA and comparable state
statutes, establishing requirements to protect the health and safety of workers. In addition, the OSHA hazard communication standard,
the EPA community right-to-know regulations under Title III of the federal Superfund Amendment and Reauthorization Act and comparable
state statutes require that information be maintained concerning hazardous materials used, stored, produced or released in our
operations and that this information be provided to employees, state and local government authorities and the public. Substantial
fines and penalties can be imposed and orders or injunctions limiting or prohibiting certain operations may be issued in connection
with any failure to comply with laws and regulations relating to worker health and safety.
Insurance
and Risk Management
We
maintain insurance coverage of types and amounts that we believe to be customary and reasonable for companies of our size and
with similar operations. In accordance with industry practice, however, we do not maintain insurance coverage against all of the
operating risks to which our business is exposed. Therefore, there is a risk our insurance program may not be sufficient to cover
any particular loss or all losses.
Currently,
our insurance program includes, among other things, general liability, umbrella liability, sudden and accidental pollution, personal
property, vehicle, workers’ compensation, directors and officers and employer’s liability coverage. Our insurance
includes various limits and deductibles or retentions, which must be met prior to or in conjunction with recovery.
Employees
As
of December 31, 2019, we had 63 full-time employees compared with 65 full-time employees at the same time in December 2018. We
generally have been able to locate and engage highly qualified employees as needed. None of our employees are covered by an ongoing
collective bargaining agreement, and we have experienced no work stoppages. We consider our employee relations to be good.
Available
Information
We
are required to file annual, quarterly and current reports, proxy statements and certain other information with the SEC.
The
SEC maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC. Any documents filed by us with the SEC, including this Annual Report, can be
downloaded from the SEC’s website at www.SEC.gov.
Our
principal executive offices are located at 1583 South 1700 East, Vernal, Utah, 84078, and our telephone number at that address
is (435) 789-0594. Our website address is www.sdpi.com. Our periodic reports and other information filed with or furnished
to the SEC are available, free of charge, through our website, as soon as reasonably practicable after those reports and other
information are electronically filed with or furnished to the SEC. Information on our website or any other website is not incorporated
by reference into this Annual Report and does not constitute a part of this Annual Report.
ITEM
1A. Risk Factors
Risks
Related to Our Business and Industry
A
decline in expenditures by the oil and gas industry could impact our revenue and income and result in an impairment of our assets.
Our
business depends upon the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to
make capital expenditures on exploration, drilling and production operations. The level of capital expenditures is generally dependent
on the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand
for oil and gas, including:
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worldwide
economic activity;
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the
level of exploration and production activity;
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interest
rates and the cost of capital;
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new
tariffs by the United States or other countries;
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environmental
regulation;
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federal,
state and foreign policies regarding exploration and development of oil and gas;
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the
ability of OPEC to set and maintain production levels and pricing;
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governmental
regulations regarding future oil and gas exploration and production;
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the
cost of exploring and producing oil and gas;
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the
cost of developing alternative energy sources;
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the
availability, expiration date and price of leases;
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the
discovery rate of new oil and gas reserves;
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the
success of drilling for oil and gas in unconventional resource plays such as shale formations;
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technological
advances;
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weather
conditions.
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During 2020, there
have been dramatic changes in oil prices as a result of failed OPEC negotiations, including one of the worst single day drops
in prices in 20 years. We expect continued volatility in both crude oil and natural gas prices, as well as in the level of
drilling and production related activities, and we are unable to predict when or if prices will recover. Even during periods
of high prices for oil and natural gas, companies exploring for oil and gas may cancel or curtail programs, seek to renegotiate
contract terms, including the price of our products and services, or reduce their levels of capital expenditures for exploration
and production for a variety of reasons. These risks are greater during periods of low or declining commodity prices. Continued
significant or prolonged declines in hydrocarbon prices have had, and may continue to have, a material adverse effect on our results
of operations.
We
may be unable to maintain adequate liquidity and make payments on our debt.
At
December 31, 2019, we had working capital of approximately $826,000. 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.
While
we believe that our borrowing capacity and cash generated from operations will be sufficient to fund our operations for 2020,
our operational and financial strategies include managing our
operating costs, working capital and debt to enhance liquidity. We will continue to work to grow revenue and review additional
cost containment measures and be cash flow positive in 2020. 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 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 of April 5, July 5 and October 5 in 2020. If we are unable to make the remaining payments
required, we could lose our rights to market the Drill-N-Ream.
In
February 2019, we entered into a $4,300,000 Credit Agreement comprised of an $800,000 Term Loan and a $3,500,000
Revolving Loan. In December 2019, we increased the Term Loan to $1,000,000. As of December 31, 2019, we had $1,000,000
outstanding on the Term Loan and $193,286 outstanding on the Revolving Loan. If we are unable to make required payments under
the Credit Agreement, we would be in default thereunder, which would permit the holders of the indebtedness to accelerate the
maturity thereof, unless we are able to obtain, on a timely basis, a necessary waiver or amendment. Any waiver or amendment may
require us to revise the terms of the Credit Agreement which could increase the cost of our borrowings, require the payment
of additional fees, and adversely impact the results of our operations. Upon the occurrence of any event of default that is not
waived, the lenders could elect to exercise any of their available remedies, which include the right to not lend any additional
amounts or, in the event we have outstanding indebtedness under the Credit Agreement, to declare any outstanding indebtedness,
together which any accrued interest and other fees, to be immediately due and payable. If we are unable to repay the outstanding
indebtedness, if any, under the Credit Agreement when due, the lenders would be permitted to proceed against their collateral
and this could have a material adverse effect on our business and financial condition.
Failure
to generate sufficient revenue to make payments on the Hard Rock Note could result in our loss of the patents securing such note.
The
Hard Rock Note is secured by all of the patents, patents pending, other patent rights, and the Drill-N-Ream trademark purchased
in the Hard Rock acquisition (the “Drill-N-Ream Collateral”). If we do not have the funds necessary to make the future
payments under the Hard Rock Note and fail to make any payments as required thereunder, and we are unsuccessful in amending or
restructuring the payment terms, the holder of the Hard Rock Note could conduct a foreclosure sale on the Drill-N-Ream Collateral
in order to apply the proceeds thereof toward repayment of the Hard Rock Note and all foreclosure costs, and our subsidiary Superior
Drilling Solutions, LLC would be liable for any shortfall or receive any excess from the sales proceeds. The failure to retain
and use the Drill-N-Ream Collateral in our business could cause a significant loss of our investment and might have a material
adverse effect on our financial condition and results of operation, as well as our ability to grow our drill string tool business.
Our
level of indebtedness could adversely affect our future ability to raise additional capital to fund growth, limit our ability
to react to changes in our business or our industry and place us at a competitive disadvantage.
We
are required to make remaining payments on the Hard Rock Note of $3.0 million per year (plus accrued interest) in 2020. In
addition, we are required to make monthly payments of approximately $115,000 on our other indebtedness.
Our
level of debt and debt service requirements could have important consequences. For example, it could (i) result in a foreclosure
upon our key assets, (ii) increase our vulnerability to general adverse economic and industry conditions, (iii) limit our ability
to fund future capital expenditures and working capital, to engage in future acquisitions or development activities, or to otherwise
realize the value of our assets and opportunities fully because of the need to dedicate a substantial portion of our cash flow
from operations to payments on our debt, (iv) increase our cost of borrowing, (v) restrict us from making strategic acquisitions
or causing us to make non-strategic divestitures, (vi) limit our flexibility in planning for, or reacting to, changes in our business
or industry in which we operate, placing us at a competitive disadvantage compared with our competitors who are less leveraged
and (vii) impair our ability to obtain additional financing in the future.
There
may be significant annual and quarterly fluctuations in our operating results.
Significant
annual and quarterly fluctuations in our results of operations may be caused by, among other factors, our volume of revenue, the
timing of new product or service announcements, releases by us and our competitors in the marketplace of new products or services,
seasonality and general economic conditions. There can be no assurance that the level of revenue achieved by us in any particular
fiscal period will not be significantly lower than in other comparable fiscal periods. We believe quarter-to-quarter comparisons
of our revenue and operating results are not necessarily meaningful and should not be relied on as indicators of future performance.
Our operating expenses are relatively fixed in the short term and are based on management’s expectations of future revenue.
As a result, if future revenue is below expectations, net income or loss may be disproportionately affected by a reduction in
revenue, as any corresponding reduction in expenses may not be proportionate to the reduction in revenue.
Our
customer base is concentrated and the loss of, or nonperformance by, one or more of our significant customers could cause our
revenue to decline substantially.
We
had two large customers that comprised 92% of our total revenue in 2019 and 95% in 2018. It is likely that we will continue
to derive a significant portion of our revenue from a relatively small number of customers in the future. If a major customer
decided not to continue to use our services or has a significant reduction in its business, our revenue would decline and our
operating results and financial condition could be harmed. In addition, we are subject to credit risk due to the concentration
of our customer base. Any increase in the non-payment of and non-performance by our counterparties, either as a result of changes
in financial and economic conditions or otherwise, could have a material effect on our business, results of operations and financial
condition and could adversely affect our liquidity.
We
must continue to develop new technologies, methodologies and products on a timely and cost-effective basis to satisfy the needs
of our customers.
The
drilling industry is driven primarily by cost minimization, and our strategy is aimed at reducing drilling costs through the application
of new drill bit assembly and drill string tool technologies. Our continued success will depend on our ability to meet our customers’
changing needs, on a timely and cost-effective basis, by successfully enhancing our current products and processes; developing,
producing and marketing new products and processes; and responding to evolving industry standards and other technological changes.
We
cannot assure you that our products will be able to satisfy the specifications of our customers or that we will be able to perform
the testing necessary to prove that the product specifications are satisfied in the future, or that the costs of modifications
to our products to satisfy their requirements will not adversely affect our results of operations. Failure to meet our customer’s
demand for services may adversely affect our business. We may encounter resource constraints, competition, or other difficulties
that may delay our ability to expand our bit remanufacturing services to the level desired or required by our customer. If our
products are unable to satisfy such requirements, or we are unable to perform any required testing, our customers may cancel their
contracts and/or seek new suppliers, and our business, results of operations, cash flows or financial position may be adversely
affected.
We
have in the past identified material weaknesses, and if we fail to establish and maintain proper and effective internal controls,
our ability to produce accurate financial statements on a timely basis could be impaired, which could adversely affect our consolidated
operating results, our ability to operate our business, our stock price and investors’ views of us.
Our
management is responsible for establishing and maintaining adequate internal control over financial reporting to ensure that information
regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance
with GAAP, but in the past, we have identified material weaknesses in these controls. For example, in connection with management’s
assessment of our internal control over financial reporting, management identified an additional deficiency that constituted a
material weakness in our internal control over financial reporting as of December 31, 2018 relating to the errors in the accounting
related to the Tronco loan and other complex non-routine non-cash transactions. We remediated this material weakness as of December
31, 2019. While we believe we have appropriately remediated the previously disclosed material weakness in our internal control
over financial reporting related to the accounting for the Tronco loan and other complex non-routine non-cash transactions, we
can provide no assurances that other material weaknesses in our internal control over financial reporting, will not be identified
in the future.
Remediating
our material weaknesses has required substantial management time and attention, and ensuring that we have adequate internal control
over financial reporting and procedures in place to produce accurate financial statements on a timely basis will continue to be
a costly and time-consuming effort. Any failure to implement effective internal control over financial reporting in the future
or to maintain the remediation of our identified control deficiencies may result in additional errors, material misstatements
or delays in our financial reporting, failure to meet our financial reporting obligations or failure to avoid or detect fraud
in our financial reporting. This in turn would have a material adverse effect on our business and results of operations and could
have a substantial adverse impact on the trading price of our common stock and our relationships with customers and suppliers.
Our
management does not expect that our internal control over financial reporting will prevent or detect all errors and all fraud.
A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control
system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of
fraud, if any, within the Company will have been detected. As discussed in this Annual Report on Form 10-K, our Audit Committee
and management have identified control deficiencies in the past and may identify additional deficiencies in the future.
Our
related party transactions with the Meiers and their affiliated entities may cause conflicts of interests that may adversely affect
us.
We
have entered into, and may, in the future, enter into various transactions and agreements with the Meiers and their affiliated
entities. We believe that the transactions and agreements that we have entered into with the Meiers are on terms that are at least
as favorable as could reasonably have been obtained at such time from third parties. However, these relationships could create,
or appear to create, potential conflicts of interest when our board of directors is faced with decisions that could have different
implications for us and the Meiers or their affiliates. The appearance of conflicts, even if such conflicts do not materialize,
might adversely affect the public’s perception of us, as well as our relationship with other companies and our ability to
enter into new relationships in the future, which may have a material adverse effect on our ability to do business.
Our
customers’ industries are undergoing continuing consolidation that may impact our results of operations.
The
oil and gas industry is rapidly consolidating and, as a result, some of our largest customers have consolidated and are using
their size and purchasing power to seek economies of scale and pricing concessions. This consolidation may result in reduced capital
spending by some of our customers or the acquisition of one or more of our primary customers, which may lead to decreased demand
for our products and services. We cannot assure you that we will be able to maintain our level of sales to a customer that has
consolidated or replace that revenue with increased business activity with other customers. As a result, the acquisition of one
or more of our primary customers, such as Baker Hughes and DTI, may have a significant negative impact on our results of operations,
financial position or cash flows. We are unable to predict what effect consolidations in the industry may have on price, capital
spending by our customers, our market share and selling strategies, our competitive position, our ability to retain customers
or our ability to negotiate favorable agreements with our customers.
We
may be unable to successfully compete with other manufacturers of drilling equipment.
Several
of our competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources
than ours and which have been engaged in the manufacturing business for a much longer time than us. If these competitors substantially
increase the resources they devote to developing and marketing competitive products and services, we may not be able to compete
effectively. Similarly, consolidation among our competitors could enhance their competing market share, product and service offerings
and financial resources, further intensifying competition.
We
are dependent on key personnel who may be difficult to replace.
Our success is dependent
to a significant degree upon the business expertise and continued contributions of our founders and senior management team. In
particular, we are dependent upon the efforts and services of our founders, Mr. Troy Meier, our Chairman and Chief Executive Officer
(“CEO”), and Ms. Annette Meier, our President and Chief Operating Officer (“COO”), because
of their knowledge, experience, skills, and relationships with major clients and the other members of our management team. Our
future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical,
managerial, marketing and customer service personnel. Competition for such personnel in is intense, and we cannot assure you that
we will be able to successfully attract, integrate or retain sufficiently qualified personnel. Our inability to retain these types
of individuals could have a material adverse effect on our business, results of operations and financial condition.
Increases
in the cost of raw materials used in our manufacturing processes could negatively impact our profitability.
We
rely on the availability of volume and quality of synthetic diamond cutters for drill bit refurbishment and manufacturing and
for our drill string tool manufacturing business. In addition, we must have a reliable source of steel available for manufacturing
which is both of sufficient quality, and available at a cost-effective price. We do not have fixed price contracts or arrangements
for all of the raw materials and other supplies that we purchase. Baker Hughes provides the diamond cutters for our drill bit
refurbishment. However, sourcing cost-effective supplies of quality steel in the relatively low volumes that our tool manufacturing
requires can be challenging. Shortages of, and price increases for, steel and other raw materials and supplies that we use in
our business may occur. Future shortages or price fluctuations in synthetic diamond cutters or steel could have a material adverse
effect on our ability to conduct either our drill bit refurbishment or our drill tool manufacturing in a timely and cost-effective
manner.
We
depend on third-party suppliers for timely deliveries of raw materials, and our results of operations could be adversely affected
if we are unable to obtain adequate supplies in a timely manner.
Our manufacturing operations depend upon obtaining adequate supplies
of raw materials from third parties. Events beyond our control may impact the ability of these third parties to deliver raw materials.
Any interruption in the supply of raw materials needed to manufacture our products could adversely affect our business, results
of operations and reputation with our customers.
We
may be exposed to unforeseen risks in our product manufacturing and processes which could adversely affect our financial conditions
and results of operations.
We
operate our business from our Vernal, Utah headquarters. A natural disaster, extended utility failure or other significant event
at our facility could significantly affect our ability to manufacture sufficient quantities of key products or otherwise deliver
products to meet customer demand or contractual requirements which may result in a loss of revenue and other adverse business
consequences. In addition, the equipment and management systems necessary for our operations are subject to wear and tear, break
down and obsolescence, which could cause them to perform poorly or fail, resulting in fluctuations in manufacturing efficiencies
and production costs. Significant manufacturing fluctuations may affect our ability to deliver products to our customers on a
timely basis and we may suffer financial penalties and a diminution of our commercial reputation and future product orders. Additionally,
some of our business may in the future be conducted under fixed price contracts. Fluctuations in our manufacturing process, or
inaccurate estimates and assumptions used in pricing our contracts, even if due to factors out of our control, may result in cost
overruns which we may be required to absorb. Any shut down of our manufacturing facility, reductions in our manufacturing process
or efficiency, or cost overruns could adversely affect our business, financial condition and results of operations.
The
outbreak of the recent coronavirus (“COVID-19”), or an outbreak of another highly infectious or contagious disease,
could adversely affect our business, financial condition and results of operations.
Our
business is dependent upon the willingness and ability of its customers to conduct transactions with us. The spread of a highly
infectious or contagious disease, such as COVID-19, could cause severe disruptions in the worldwide economy, which could in turn
disrupt the business, activities, and operations of our customers, as well our business and operations. Moreover, since the beginning
of January 2020, the coronavirus outbreak has caused significant disruption in the financial markets both globally and in the
United States. The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, may result in a significant
decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly
in the event of a spread of COVID-19 or an outbreak of an infectious disease in our market areas. A spread of COVID-19, or an
outbreak of another contagious disease, could also negatively impact the availability of our key personnel necessary to conduct
our business. Such a spread or outbreak could also negatively impact the business and operations of third party service providers
who perform critical services for our business. If COVID-19, or another highly infectious or contagious disease, spreads or the
response to contain COVID-19 is unsuccessful, we could experience a material adverse effect on its business, financial condition,
and results of operations.
We
may be unable to employ enough skilled and qualified workers to sustain or expand our current operations.
Our
operations require personnel with specialized skills and experience. The supply of skilled and experienced personnel may not be
sufficient to meet current or expected demand. Any significant increase in the wages paid by competing employers could result
in a reduction of our skilled labor force, increases in the wage rates that we must pay, or both. If any of these events were
to occur, our capacity could be diminished, our ability to respond quickly to customer demands or strong market conditions may
be inhibited and our growth potential impaired, any of which could have a material adverse effect on our business, financial condition
and results of operations.
If
we are not able to manage our growth strategy successfully, our business, and results of operations may be adversely affected.
Our
growth strategy includes acquisitions and the development and implementation of new product designs and improvements, which presents
numerous managerial, administrative, operational, and other challenges. Our ability to manage the growth of our operations will
depend on our ability to develop systems and services and related technologies to meet evolving industry requirements and at prices
acceptable to our customers to compete in the industry in which we operate. Our ability to compete effectively will also depend
on our ability to continue to obtain patents on our proprietary technology and products. Although we do not consider any single
patent to be material to our business, the inability to protect our future innovations through patents could have a material adverse
effect. In addition, our growth will increase our need to attract, develop, motivate, and retain both our management and professional
employees. The inability of our management to manage our growth effectively or the inability of our employees to achieve anticipated
performance could have a material adverse effect on our business.
Acquisitions
and investments may not result in anticipated benefits and may present risks not originally contemplated, which could have a material
adverse effect on our financial condition, results of operations and cash flows.
Our
growth strategy includes acquiring other companies that complement our service offerings or broaden our technical capabilities
and geographic presence. From time to time, we evaluate purchases and sales of assets, businesses or other investments. These
transactions may not result in the anticipated realization of savings, creation of efficiencies, offering of new products or services,
generation of cash or income or reduction of risk. In addition, acquisitions may be financed by borrowings, requiring us to incur
debt, or by the issuance of our common stock. These transactions involve numerous risks, and we cannot ensure that:
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any
acquisition would be successfully integrated into our operations and internal controls;
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the
due diligence conducted prior to an acquisition would uncover situations that could result in financial or legal exposure;
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the
use of cash for acquisitions would not adversely affect our cash available for capital expenditures and other uses;
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any
disposition, investment, acquisition or integration would not divert management resources from the operation of our business;
or
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any
disposition, investment, acquisition or integration would not have a material adverse effect on our financial condition, results
of operations or cash flows.
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Our
inability to integrate acquisitions successfully could impede us from realizing all of the benefits of the acquisitions which
could have a material adverse effect on our financial condition and results of operations.
If
we are unable to successfully integrate future acquisitions, we could be impeded from realizing all of the anticipated benefits
of those acquisitions and could weaken our business operations. The integration process may disrupt our business and, if implemented
ineffectively, may preclude realization of the anticipated benefits expected by us and could harm our results of operations. In
addition, the overall integration of the combining companies may result in unanticipated problems, expenses, liabilities and competitive
responses, and may cause our stock price to decline. The difficulties of integrating an acquisition include, among others:
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unanticipated
issues in integration of information, communications, and other systems;
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unanticipated
incompatibility of logistics, marketing, and administration methods;
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maintaining
employee morale and retaining key employees;
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integrating
the business cultures of both companies;
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preserving
important strategic client relationships;
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coordinating
geographically separate organizations; and
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consolidating
corporate and administrative infrastructures and eliminating duplicative operations.
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Even
if the operations of an acquisition are integrated successfully, we may not realize the anticipated benefits of the acquisition,
including the synergies, cost savings or growth opportunities that we expect. These benefits may not be achieved within the anticipated
time frame, or at all. Failing to realize the benefits could have a material adverse effect on our financial condition and results
of operations.
Conditions
in the global financial system may have impacts on our business and financial position that we currently cannot predict.
Uncertainty
in the credit markets may negatively impact the ability of our customers to finance purchases of our products and services and
could result in a decrease in, or cancellation of, orders or adversely affect the collectability of our receivables. If the availability
of credit to our customers is reduced, they may reduce their drilling and production expenditures, thereby decreasing demand for
our products and services, which could have a negative impact on our financial position. Additionally, unsettled conditions could
have an impact on our suppliers, causing them to be unable to meet their obligations to us. Although we do not currently anticipate
a need to access the credit markets in the short term, a prolonged constriction on future lending by banks or investors could
result in higher interest rates on future debt obligations or could restrict our ability to obtain sufficient financing to meet
our long-term operational and capital needs.
In
addition, the global financial system may be impacted by the effects of global health epidemics and concerns. Weakness or deterioration of the global economy could reduce our customers’ spending levels and
could impact our revenues and operating results. We are unable to predict the effect of this on our business and results of operations.
A
terrorist attack or armed conflict could harm our business.
Terrorist
activities, anti-terrorist efforts and other armed conflicts involving the United States or other countries may adversely affect
the United States and global economies and could prevent us from meeting our financial and other obligations. If any of these
events occur, the resulting political instability and societal disruption could reduce overall demand for oil and natural gas,
potentially putting downward pressure on demand for our services and causing a reduction in our revenue. Oil and natural gas related
facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral
to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of
these threats, and some insurance coverage may become more difficult to obtain, if available at all.
Materials
and minerals used in our manufacturing process may become subject to laws and regulations that may expose us to significant costs
and liabilities.
The
diamonds comprising the diamond cutting discs used in our operations are synthetic and manufactured in the United States, South
Africa and China. Neither those diamond cutters nor any other minerals used in our operations are currently identified as “conflict
minerals” in the Dodd-Frank Wall Street Reform and Consumer Protection Act. However, we cannot predict or control if the
United States Secretary of State will or will not identify one of the minerals used in our manufacturing process as a conflict
mineral. Should the materials used in our manufacturing process be designated as a conflict mineral, we will be required to file
Form SD with the SEC and conduct the required diligence to determine the source of the conflict mineral in connection with such
disclosure. Any increased costs and expenses associated with this could have a material adverse impact on our financial condition
and results of operations.
The
use and protection of our proprietary technology will affect our success. There are limitations to our intellectual property rights
in our proprietary technology, and thus our right to exclude others from the use of such proprietary technology.
Our
success will be affected by our development and implementation of new product designs and improvements and by our ability to protect
and maintain critical intellectual property assets related to these developments. Although in many cases our products are not
protected by any registered intellectual property rights, in other cases we rely on a combination of patents and trade secret
laws to establish and protect this proprietary technology.
We
currently hold multiple U.S. patents and have multiple pending patent applications for products and processes in the U.S. and
certain non-U.S. countries. Patent rights give the owner of a patent the right to exclude third parties from making, using, selling,
and offering for sale the inventions claimed in the patents in the applicable country. Patent rights do not necessarily grant
the owner of a patent the right to practice the invention claimed in a patent, but merely the right to exclude others from practicing
the invention claimed in the patent. It may also be possible for a third party to design around our patents. Furthermore, patent
rights have strict territorial limits. Some of our work will be conducted in international waters and therefore may not fall within
the scope of any country’s patent jurisdiction. We may not be able to enforce our patents against infringement occurring
in international waters and other “non-covered” territories. Also, we do not have patents in every jurisdiction in
which we conduct business and our patent portfolio will not protect all aspects of our business and may relate to obsolete or
unusual methods, which would not prevent third parties from entering the same market.
We
attempt to limit access to and distribution of our technology by customarily entering into confidentiality and/or license agreements
with our employees, customers and potential customers and suppliers. Our rights in our confidential information, trade secrets,
and confidential know-how will not prevent third parties from independently developing similar information. Publicly available
information (e.g. information in expired issued patents, published patent applications, and scientific literature) can also be
used by third parties to independently develop technology. We cannot provide assurance that this independently developed technology
will not be equivalent or superior to our proprietary technology.
Our
competitors may infringe upon, misappropriate, violate or challenge the validity or enforceability of our intellectual property
and we may not able to adequately protect or enforce our intellectual property rights in the future.
Our
businesses and our customers’ businesses are subject to environmental laws and regulations that may increase our costs,
limit the demand for our products and services or restrict our operations.
Our
operations and the operations of our customers are also subject to federal, state, local and foreign laws and regulations relating
to the protection of human health and the environment. These environmental laws and regulations affect the products and services
we design, market and sell, as well as the facilities where we manufacture our products. For example, our operations are subject
to numerous and complex laws and regulations that, among other things, may regulate the management and disposal of hazardous and
non-hazardous wastes; require acquisition of environmental permits related to our operations; restrict the types, quantities and
concentrations of various materials that can be released into the environment; limit or prohibit operation activities in certain
ecologically sensitive and other protected areas; regulate specific health and safety criteria addressing worker protection; require
compliance with operational and equipment standards; impose testing, reporting and record-keeping requirements; and require remedial
measures to mitigate pollution from former and ongoing operations at our facilities or at facilities where wastes generated by
our operations have been disposed. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative
or civil penalties or other enforcement, and criminal prosecution. We are required to invest financial and managerial resources
to comply with such environmental, health and safety laws and regulations and anticipate that we will continue to be required
to do so in the future. In addition, environmental laws and regulations could limit our customers’ exploration and production
activities. These laws and regulations change frequently, which makes it impossible for us to predict their cost or impact on
our future operations. For example, there has been a wide-ranging policy debate, both nationally and internationally, regarding
the impact of greenhouse gases and possible means for their regulation. In addition, efforts have been made and continue to be
made in the international community toward the adoption of international treaties or protocols that would address global climate
change issues, such as the annual United Nations Climate Change Conferences. Following a finding by the EPA that certain greenhouse
gases represent a danger to human health, the EPA has expanded its regulations relating to those emissions and has adopted rules
imposing permitting and reporting obligations. The results of the permitting and reporting requirements could lead to further
regulation of these greenhouse gases by the EPA. To date, there has been no significant legislative progress in cap and trade
proposals or greenhouse gas emission reductions. The adoption of legislation or regulatory programs to reduce greenhouse gas emissions
could also increase the cost of consuming, and thereby reduce demand for, the hydrocarbons that our customers produce. Consequently,
such legislation or regulatory programs could have an adverse effect on our financial condition and results of operations. It
is too early to determine whether, or in what form, further regulatory action regarding greenhouse gas emissions may ultimately
be adopted or what specific impact a new regulatory action might have on us or our customers. Generally, the anticipated regulatory
actions do not appear to affect us in any material respect that is different, or to any materially greater or lesser extent, than
other companies that are our competitors. However, our business and prospects could be adversely affected to the extent laws are
enacted or modified or other governmental action is taken that prohibits or restricts our customers’ exploration and production
activities or imposes environmental protection requirements that result in increased costs to us or our customers.
Environmental
laws may provide for “strict liability” for damages to natural resources or threats to public health and safety, rendering
a party liable for environmental damage without regard to negligence or fault on the part of such party. Some environmental laws
and regulations provide for joint and several strict liability for remediation of spills and releases of hazardous substances.
In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous
substances, as well as damage to natural resources. These laws and regulations also may expose us to liability for the conduct
of or conditions caused by others, or for our acts that were in compliance with all applicable laws and regulations at the time
such acts were performed. Any of these laws and regulations could result in claims, fines or expenditures that could be material
to results of operations, financial position and cash flows.
Our
failure to implement and comply with our safety program could adversely affect our operating results or financial condition.
Our
safety program is a fundamental element of our overall approach to risk management, and the implementation of the safety program
is a significant issue in our dealings with our clients. Unsafe job sites and office environments have the potential to increase
employee turnover, increase the cost of a project to our clients, expose us to types and levels of risk that are fundamentally
unacceptable, and raise our operating costs. The implementation of our safety processes and procedures are monitored by various
agencies and rating bureaus, and may be evaluated by certain clients in cases in which safety requirements have been established
in our contracts. If we fail to comply with safety regulations or maintain an acceptable level of safety at our facilities we
may incur fines, penalties or other liabilities, or may be held criminally liable. We may incur additional costs to upgrade equipment
or conduct additional training, or otherwise incur costs in connection with compliance with safety regulations. Failure to maintain
safe operations or achieve certain safety performance metrics could disqualify us from doing business with certain customers,
particularly major oil companies.
Our
products are used in operations that are subject to potential hazards inherent in the oil and gas industry and, as a result, we
are exposed to potential liabilities that may affect our financial condition and reputation.
Our
products are used in potentially hazardous drilling, completion and production applications in the oil and gas industry where
an accident or a failure of a product can potentially have catastrophic consequences. Risks inherent to these applications, such
as equipment malfunctions and failures, equipment misuse and defects, explosions, blowouts and uncontrollable flows of oil, natural
gas or well fluids and natural disasters, on land or in deep water or shallow-water environments, can cause personal injury, loss
of life, suspension of operations, damage to formations, damage to facilities, business interruption and damage to or destruction
of property, surface water and drinking water resources, equipment and the environment. In addition, we provide certain services
that could cause, contribute to or be implicated in these events. If our products or services fail to meet specifications or are
involved in accidents or failures, we could face warranty, contract or other litigation claims, which could expose us to substantial
liability for personal injury, wrongful death, property damage, loss of oil and gas production, and pollution and other environmental
damages. Our insurance policies may not be adequate to cover all liabilities. Further, insurance may not be generally available
in the future or, if available, insurance premiums may make such insurance commercially unjustifiable. Moreover, even if we are
successful in defending a claim, it could be time-consuming and costly to defend.
In
addition, the frequency and severity of such incidents could affect operating costs, insurability and relationships with customers,
employees and regulators. In particular, our customers may elect not to purchase our products or services if they view our safety
record as unacceptable, which could cause us to lose customers and substantial revenue. In addition, these risks may be greater
for us because we may acquire companies that have not allocated significant resources and management focus to quality, or safety
requiring rehabilitative efforts during the integration process. We may incur liabilities for losses associated with these newly
acquired companies before we are able to rehabilitate such companies’ quality, safety and environmental programs.
Our
information systems may experience an interruption or breach in security.
We
rely on our proprietary production management technology which has changed how users connect to our knowledge and other information
technology (“IT”) systems to conduct our business. Despite our security and back-up measures, our IT systems are vulnerable
to computer viruses, natural disasters and other disruptions or failures. The failure of our IT systems to perform as anticipated
for any reason or any significant breach of security could disrupt our business and result in numerous adverse consequences, including
reduced effectiveness and efficiency of our operations and those of our customers, inappropriate disclosure of confidential information,
increased overhead costs, loss of intellectual property and damage to our reputation, which could have a material adverse effect
on our business and results of operations. In addition, we may be required to incur significant costs to prevent or respond to
damage caused by these disruptions or security breaches in the future.
Cybersecurity
breaches and other disruptions could compromise our information and operations, and expose us to liability, which would cause
our business and reputation to suffer.
In
the ordinary course of our business, we collect and store sensitive data in our data centers and on our networks, including intellectual
property, proprietary business information, information regarding our customers, suppliers and business partners, and personally
identifiable information of our employees. The secure processing, maintenance and transmission of this information is critical
to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable
to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our
networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or
other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal
information, regulatory penalties, disruption of our operations, damage to our reputation, and loss of confidence in our services,
which could adversely affect our business.
Our
information technology infrastructure is critical to the efficient operation of our business and essential to our ability to perform
day-to-day operations. Breaches in our information technology infrastructure or physical facilities, or other disruptions, could
result in damage to our assets, safety incidents, damage to the environment, potential liability or the loss of contracts, and
have a material adverse effect on our operations, financial position and results of operations.
Possible
new tariffs could have a material adverse effect on our business.
The
United States has recently announced the implementation of new tariffs on imported steel, and is also considering tariffs on additional
items. There is a concern that the imposition of additional tariffs by the United States could result in the adoption of additional
tariffs by other countries as well. Any resulting trade war could negatively impact the global market for oil field products and
services and could have a significant adverse effect on our business. While it is too early to predict how the recently enacted
tariffs on steel will impact our business, the imposition of tariffs on items we import from other countries could increase our
costs and could result in lowering our gross margin on products sold.
Risks
Relating to Our Common Stock
As
a smaller reporting company, we are subject to scaled disclosure requirements that may make it more challenging for investors
to analyze our results of operations and financial prospects.
Currently,
we are a “smaller reporting company,” meaning that our outstanding common stock held by non-affiliates had a market
value of less than $250 million as of June 30, 2019. As a “smaller reporting company,” we are able to provide simplified
executive compensation disclosures in our filings; are exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act
requiring that independent registered public accounting firms provide an attestation report on the effectiveness of internal control
over financial reporting; and have certain other decreased disclosure obligations in our SEC filings, including, being required
to provide only two years of audited financial statements in annual reports. Consequently, it may be more challenging for investors
to analyze our results of operations and financial prospects.
As
long as we are substantially controlled by the Meiers, the ability of our stockholders to influence the outcome of matters will
be limited.
The
Meiers continue to own a substantial portion of our outstanding common stock and serve on our Board of Directors. As long as they
have substantial voting control of our company, SDPI will have the ability to take many stockholder actions, including the election
or removal of directors, irrespective of the vote of, and without prior notice to, any other stockholder. As a result, the Meiers
will have the ability to influence or control all matters affecting us, including:
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the
composition of our board of directors and, through our board of directors, decision-making with respect to our governance
and business direction and policies, including the appointment and removal of our officers;
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any
determinations with respect to acquisitions of businesses, mergers or other business combinations and change of control transactions;
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our
acquisition or disposition of assets; and
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our
capital structure.
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The
market price of our common stock has been and may continue to be volatile.
The
trading price of our common stock and the price at which we may sell common stock in the future are subject to large fluctuations
in response to any of the following:
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limited
trading volume in our common stock;
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quarterly
variations in operating results;
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general
financial market conditions;
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the
prices of natural gas and oil;
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announcements
by us and our competitors;
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our
liquidity;
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changes
in government regulations;
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our
ability to raise additional funds;
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our
involvement in litigation; and
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other
events.
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We
do not anticipate paying dividends on our common stock in the near future.
We
have not paid any dividends in the past and do not intend to pay cash dividends on our common stock in the foreseeable future.
We currently intend to retain any earnings for the future operation and development of our business. In addition, under Utah law
no distribution may be made if, after giving it effect: (a) we would be unable to pay our debts as they come due, or (b) our total
assets would be less than our total liabilities. We can provide no assurance that those restrictions will not prevent us from
paying a dividend in future periods.
We
may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.
Our
articles of incorporation authorize us to issue, without the approval of our shareholders, one or more classes or series of preferred
stock having such designations, preferences, limitations and relative rights, including preferences over our common stock respecting
dividends and distributions, as our board of directors may determine. The terms of one or more classes or series of preferred
stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock
the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified
transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred
stock could affect the residual value of the common stock.
Certain
provisions in our organizational documents could delay or prevent a change in control.
The
existence of some provisions in our organizational documents could delay or prevent a change in control of our company, even if
that change would be beneficial to our shareholders. Our articles of incorporation and bylaws contain provisions that may make
acquiring control of our company difficult, including:
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provisions
regulating the ability of our shareholders to nominate directors for election or to bring matters for action at annual meetings
of our shareholders;
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limitations
on the ability of our shareholders to call a special meeting and act by written consent;
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the
authorization given to our board of directors to issue and set the terms of preferred stock; and
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establishment
of a classified board of directors.
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