Notes
to Condensed Consolidated Financial Statements (Unaudited)
March
31, 2020
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, 2020 and 2019, 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, 2020 are not necessarily indicative
of the results of operations expected for the year ended December 31, 2020. 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,
2019 and 2018 and the notes thereto, which were included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2019, 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.
Leases
In
February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires assets and liabilities that arise from all
leases to be recognized on the balance sheet for lessees and expanded financial statement disclosures for both lessees and lessors.
We adopted the new standard effective January 1, 2020 and elected the modified retrospective transition method and as such, the
comparative financial information will not be restated and will continue to be reported under the lease standard in effect during
those periods. The adoption of this standard resulted in approximately $270,000 of additional assets and liabilities on our consolidated
balance sheet representing the recognition of operating lease right-of-use assets and operating lease liabilities.
Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liability represents
the Company’s obligation to make lease payments arising from the lease, both of which are recognized based on the present
value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months
or less at inception are not recorded on the condensed consolidated balance sheet and are expensed on a straight-line basis over
the lease term in the condensed consolidated statement of operations. The interest rate implicit in lease contracts is typically
not readily determinable. As a result, the Company utilizes its incremental borrowing rate to discount lease payments, which reflects
the fixed rate at which the Company believes it could borrow on a collateralized basis the amount of the lease payments in the
same currency, for a similar term, in a similar economic environment. See Note 7 – Leases.
Significant
Customers
For
the three months ended March 31, 2020, two customers represented 84% of our total revenue during the period. For the three
months ended March 31, 2019, two customers represented 93% of our total revenue during the period.
Significant
Vendors
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. The Company had one vendor that represented 10% of our purchases for the three
months ended March 31, 2019. This vendor had approximately $248,000 in accounts payable at March 31, 2019 and purchases in the
first quarter of 2019 from this vendor totaled approximately $248,000.
Recently
Issued Accounting Standards
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 changes
the impairment model for most financial assets and certain other instruments, including trade and other receivables, and requires
the use of a new forward-looking expected loss model that will result in the earlier recognition
of allowances for losses. Early adoption is permitted and entities must adopt the amendment using a modified retrospective approach
to the first reporting period in which the guidance is effective. For smaller reporting companies, as provided by Accounting Standards
Update 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842),
ASU 2016-13 is effective for annual periods, including interim periods within those annual periods, beginning after December 15,
2022. The adoption of ASU 2016-13 is currently not expected to have a material effect on our consolidated financial statements.
In
December 2019, the FASB issued ASU No. 2019-12, Income Taxes (“Topic 740”) - Simplifying the Accounting for Income
Taxes. ASU 2019-12 is intended to simplify accounting for income taxes. It removes certain exceptions to the general principles
in Topic 740 and amends existing guidance to improve consistent application. ASU 2019-12 is effective for annual periods, including
interim periods within those annual periods, beginning after December 15, 2020. The adoption of ASU 2019-12 is currently not expected
to have a material effect on our consolidated financial statements.
NOTE
2. 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.
Tool
Revenue
Tool
and Product Sales: Revenue for tool and product sales is recognized upon shipment of tools or products to the customer. Shipping
and handling costs related to tool and product sales are recorded gross as a component of both the sales price and cost of the
product sold.
Tool
Rental: Tool rental revenue is recognized upon completion of the customer’s job for which the tool was rented. While
the duration of the rents vary by job and number of runs, these rents are generally less than one month. The rental agreements
are typically based on the price per run or footage drilled and do not have any minimum rental payments or term.
Other
Related Revenue: We receive revenue from the repair of tools upon delivery of the repaired tool to the customer. We
earn royalty commission revenue when our customer invoices their customer for the use of our tools.
Contract
Services
Drill
Bit Manufacturing and Refurbishment: We recognize revenue for our PDC drill bit services upon transfer of control which we
determined to be upon shipment. Shipping and handling costs related to refurbishing services are paid directly by the customer
at the time of shipment. By contract, we can only refurbish and manufacture oil or gas drill bits for Baker Hughes, but we are
not contractually prohibited from manufacturing drill bits for the mining industry.
Revenue
disaggregated by revenue source are as follows:
|
|
Three
months ended March 31,
|
|
|
|
2020
|
|
|
2019
|
|
|
|
|
|
|
|
|
Tool Revenue:
|
|
|
|
|
|
|
|
|
Tool
and product sales
|
|
$
|
990,734
|
|
|
$
|
1,507,160
|
|
Tool rental
|
|
|
777,253
|
|
|
|
245,602
|
|
Other
related revenue
|
|
|
1,844,931
|
|
|
|
1,691,147
|
|
Total Tool Revenue
|
|
|
3,612,918
|
|
|
|
3,443,909
|
|
|
|
|
|
|
|
|
|
|
Contract Services
|
|
|
1,744,845
|
|
|
|
1,592,437
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
5,357,763
|
|
|
$
|
5,036,346
|
|
Contract
Costs
We
do not incur any material costs of obtaining contracts.
Contract
Balances
Under
our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional.
Accordingly, our contracts do not give rise to contract assets or liabilities under ASC 606.
NOTE
3. INVENTORIES
Inventories
are comprised of the following:
|
|
March
31, 2020
|
|
|
December
31, 2019
|
|
Raw material
|
|
$
|
813,379
|
|
|
$
|
800,662
|
|
Work in progress
|
|
|
206,926
|
|
|
|
75,235
|
|
Finished goods
|
|
|
158,942
|
|
|
|
48,135
|
|
|
|
$
|
1,179,247
|
|
|
$
|
924,032
|
|
NOTE
4. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
March
31, 2020
|
|
|
December
31, 2019
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
Buildings
|
|
|
4,758,832
|
|
|
|
4,758,832
|
|
Building improvements
|
|
|
755,039
|
|
|
|
755,039
|
|
Machinery and equipment
|
|
|
10,259,311
|
|
|
|
10,343,486
|
|
Office equipment, fixtures and software
|
|
|
615,358
|
|
|
|
615,357
|
|
Transportation
assets
|
|
|
350,871
|
|
|
|
350,871
|
|
|
|
|
17,619,827
|
|
|
|
17,704,001
|
|
Accumulated
depreciation
|
|
|
(9,962,038
|
)
|
|
|
(9,658,309
|
)
|
|
|
$
|
7,657,789
|
|
|
$
|
8,045,692
|
|
In
2019, the Company decided to sell the Company airplane and related hangar. Accordingly, these assets are reported as assets held
for sale on our balance sheet as of December 31, 2019 at their carrying value, which is lower than the expected fair value less
costs to sell. In February 2020, the Company sold the airplane for a gain of approximately $142,000. The Company recorded
a $30,000 impairment related to the hanger in March 2020 and expects a sale of the hanger to be completed in the next 12 months.
Depreciation
expense related to property, plant and equipment for the three months ended March 31, 2020 and 2019 was $469,098 and $399,438,
respectively. The increase in machinery and equipment was mostly the result of building tool inventory for the Middle East operations.
NOTE
5. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
March
31, 2020
|
|
|
December
31, 2019
|
|
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
|
|
|
(13,205,555
|
)
|
|
|
(12,913,889
|
)
|
|
|
$
|
1,694,445
|
|
|
$
|
1,986,111
|
|
Amortization
expense related to intangible assets was $291,666 and $611,667 for the three months ended March 31, 2020 and 2019.
Annually,
and more often as necessary, we will perform an evaluation of our intangible assets for indications of impairment. If indications
exist, we will perform an evaluation of the fair value of the intangible assets and, if necessary, record an impairment charge.
As of March 31, 2020, the Company reviewed the net balance of the intangible assets and determined no impairment was needed.
NOTE
6. RELATED PARTY NOTE RECEIVABLE
In
January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy
Corporation (“Tronco”), a party related to us through common control, in order to take over the legal position as
Tronco’ s senior secured lender. Effective August 2017, the Company fully reserved the related party note receivable of
$6,979,043, which reduced the related party note receivable balance to $0. The Company continues to hold the 8,267,860 shares
of the Company’s common stock as collateral. The Company will record a recovery of the loan upon receiving repayment of
the note or interest in other income. Interest only is due December 31, 2020 and 2021, with a balloon payment of all unpaid interest
and principal due upon maturity on December 31, 2022. The interest rate on the note is 5.0% at March 31, 2020.
7.
LEASES
The
Company determines whether a contract is or contains a lease at inception of the contract and whether that lease meets the classification
criteria of a finance or operating lease. The Company discounts lease payments based on an estimate of its incremental borrowing
rate as the Company’s leases do not provide a readily determinable implicit rate.
The
Company leases certain facilities in Texas, Utah and Dubai under long-term operating leases with lease terms of one year to two
years. Effective January 1, 2020, the Company adopted the provision of ASC 842 Leases.
The
table below presents the lease related assets and liabilities recorded on the Company’s consolidated balance sheet as of
March 31, 2020:
|
|
Classification
on Balance Sheet
|
|
March
31, 2020
|
|
Assets
|
|
|
|
|
|
|
Operating
lease assets
|
|
Operating
lease right of use assets
|
|
$
|
238,791
|
|
Total lease assets
|
|
|
|
$
|
238,791
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
Operating lease
liability
|
|
Current operating lease liability
|
|
$
|
149,811
|
|
Noncurrrent liabilities
|
|
|
|
|
|
|
Operating
lease liability
|
|
Long-term operating
lease liability
|
|
|
88,980
|
|
Total lease liability
|
|
|
|
$
|
238,791
|
|
The
lease expense and the cash paid under operating leases for the three months ended March 31, 2020 was $49,780. At March 31, 2020,
the weighted average remaining lease terms were 2.05 years and the weighted average discount rate was 7.25%.
The
following is the aggregate future lease payments for operating leases as of March 31, 2020:
2020 (remaining)
|
|
$
|
127,189
|
|
2021
|
|
|
90,042
|
|
2022
|
|
|
23,304
|
|
2023
|
|
|
16,104
|
|
Total undiscounted lease payments
|
|
|
256,639
|
|
Less: effects
of discounting
|
|
|
(17,848
|
)
|
Present value of lease payments
|
|
$
|
238,791
|
|
NOTE
8. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
March
31, 2020
|
|
|
December
31, 2019
|
|
Real estate loans
|
|
$
|
2,853,776
|
|
|
$
|
2,938,191
|
|
Hard Rock Note
|
|
|
2,250,000
|
|
|
|
3,000,000
|
|
Credit Agreement
|
|
|
1,828,686
|
|
|
|
1,134,626
|
|
Machinery loans
|
|
|
625,852
|
|
|
|
580,185
|
|
Transportation
loans
|
|
|
77,982
|
|
|
|
298,404
|
|
|
|
|
7,636,296
|
|
|
|
7,951,406
|
|
Less:
|
|
|
|
|
|
|
|
|
Current portion
|
|
|
(5,054,692
|
)
|
|
|
(4,102,542
|
)
|
Long-term debt,
net
|
|
$
|
2,581,604
|
|
|
$
|
3,848,864
|
|
Real
Estate Loans
On
February 1, 2019, we signed a loan agreement for $3,129,861 refinancing our commercial bank loan which is secured by our Vernal,
Utah Campus. We paid $1,000,000 towards the previous loan that was scheduled to mature on February 15, 2019, upon refinancing.
The loan requires monthly payments of approximately $43,000, including principal and interest at 7.25%, and is secured by the
land and buildings at our Vernal, Utah Campus. A balloon payment of approximately $2,500,000 is due upon maturity on February
15, 2021.
Hard
Rock Note
In
2014, the Company purchased all of the interests of Hard Rock Solutions, LLC (“Hard Rock”). Consideration consisted
of $12.5 million paid in cash at closing and a $12.5 million seller’s note (the “Hard Rock Note”). The Hard
Rock Note and subsequent amendments are secured by all of the patents, patents pending, other patent rights, and trademarks transferred
to Hard Rock.
In
April 2020, the Company amended and restated the Hard Rock Note (see Note 11 – Subsequent Events). Prior to this amendment,
the Company was required to pay principal payments of $750,000 (plus accrued interest) on January 5, April 5, July 5 and October
5 in 2020. The Company paid $803,630 of principal and accrued interest on January 5, 2020, and $790,223 of principal
and accrued interest on April 5, 2020. On April 5, 2020, the remaining principal balance of the Hard Rock Note is $1,500,000.
Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued interest only on
July 5 and October 5, 2020; accrued interest on January 5, April 5, July 5 and October 5 in 2021 and 2022; and $750,000
(plus accrued interest) on July 5, 2021 with the remaining balance of principal and accrued interest on the Hard Rock Note due
on October 5, 2022.
As
of March 31, 2020, the $750,000 principal paid in April
2020 has been classified as short term debt, and the remaining balance of $1,500,000 has been classified as long term debt.
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, 2020, $966,050
was outstanding on the Revolving Loan. Amounts outstanding under the revolver at any time
may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem
appropriate if it determines that there has been a material adverse effect; less a dilution reserve as determined by AFS in its
sole good faith discretion, plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion
may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c)
the borrowing base reserve as may be determined from time to time by AFS. Amounts outstanding on the Revolving Loan as
of March 31, 2020, may not exceed $1,634,183, which is based on a calculation applying 85% of accounts receivable and 50%
of inventory. A collateral management fee is payable monthly on the used portion of the Revolving Loan and Term Loan. If our borrowings
are less than $1,000,000 then we pay interest as if we had borrowed $1,000,000. At March 31, 2020, we had approximately $17,000
of accrued interest.
The
Credit Agreement contains various restrictive covenants that, among other things, limit or restrict the ability of the borrowers
to incur additional indebtedness; incur additional liens; make dividends and other restricted payments; make investments; engage
in mergers, acquisitions and dispositions; make optional prepayments of other indebtedness; engage in transactions with affiliates;
and enter into restrictive agreements. The Credit Agreement does not include any financial covenants. If an event of default occurs,
the lenders are entitled to accelerate the advances made thereunder and exercise rights against the collateral. Borrowing under
the Revolving Loan is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration
clause. At March 31, 2020, 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, 2020, the interest rate was 10.35%, which
includes a 3.6% management fee rate. The obligations of the borrowers under the agreement are secured by a security interest
in substantially all of the tangible and intangible assets of the borrowers, other than any assets owned by the borrowers that
constitute real property (and fixtures affixed to such real property), certain excluded equipment, intellectual property, or aircraft.
The Credit Agreement matures on February 20, 2023, subject to early termination pursuant to the terms of the agreement or extension
as may be agreed by the parties.
NOTE
9. TOTAL EQUITY
A
summary of changes in total equity for the three months ended March 31, 2020 and 2019 is presented below:
|
|
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
|
|
|
|
Common
Stock
|
|
|
Additional
Paid-in
|
|
|
Accumulated
|
|
|
Total
Shareholders
|
|
|
|
Shares
|
|
|
Par
Value
|
|
|
Capital
|
|
|
Deficit
|
|
|
Equity
|
|
Balance - December 31, 2018
|
|
|
25,018,098
|
|
|
$
|
25,018
|
|
|
$
|
39,440,611
|
|
|
$
|
(32,055,410
|
)
|
|
$
|
7,410,219
|
|
Stock-based compensation
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
181,852
|
|
|
|
-
|
|
|
|
181,852
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(245,876
|
)
|
|
|
(245,876
|
)
|
Balance - March 31, 2019
|
|
|
25,018,098
|
|
|
$
|
25,018
|
|
|
$
|
39,622,463
|
|
|
$
|
(32,301,286
|
)
|
|
$
|
7,346,195
|
|
NOTE
10. GEOGRAPHICAL OPERATIONS INFORMATION
The
following summarizes revenue by geographic location:
|
|
Three
months ending March 31, 2020
|
|
|
Three
months ending March 31, 2019
|
|
Revenue:
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
4,580,510
|
|
|
$
|
4,828,277
|
|
Middle
East
|
|
|
777,253
|
|
|
|
208,069
|
|
|
|
$
|
5,357,763
|
|
|
$
|
5,036,346
|
|
The
following summarizes net property, plant and equipment by geographic location:
|
|
March
31, 2020
|
|
|
December
31, 2019
|
|
Property, plant and equipment, net:
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
6,884,860
|
|
|
$
|
7,160,646
|
|
Middle
East
|
|
|
772,929
|
|
|
|
885,046
|
|
|
|
$
|
7,657,789
|
|
|
$
|
8,045,692
|
|
NOTE
11. 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. 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. We cannot predict the outcome of this matter, but our legal costs could have a material effect on our financial position
or results of operations in future periods. We are not currently involved in any other litigation which management believes could
have a material effect on our financial position or results of operations.
NOTE
12. SUBSEQUENT EVENTS
Amended
Hard Rock Note
On
May 6, 2020, certain subsidiaries the Company amended and restated the Hard Rock Note with the seller in the acquisition
of Hard Rock Solutions, LLC. As amended, the Hard Rock Note accrues interest at 8.00% per annum and matures and is now fully payable
on October 5, 2022. Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued
interest only on July 5 and October 5 2020; accrued interest on January 5, April 5, July 5 and October 5 in 2021 and 2022; and
$750,000 (plus accrued interest) on July 5, 2021 with the remaining balance of principal and accrued interest on the Hard Rock
Note due on October 5, 2022.
Amended
Customer Agreements
Effective
April 1, 2020, the Company entered into a First Amendment to Amended and Restated Distribution Agreement (the “DTI Amendment”)
with Drilling Tools International, Inc. (“DTI”), amending the agreement between Hard Rock and DTI dated August 30,
2016. Under the DTI Amendment, all charges for repair rates the Company provides to DTI are reduced by 10%. However, rates for
rush repairs are increased by 20% under the DTI Amendment. These rate changes are applicable through September 30, 2020, unless
extended on or prior to the expiration date by mutual written agreement.
Effective
May 1, 2020, a wholly-owned subsidiary of the Company entered into a First Amendment to Vendor Agreement (the “ Baker Hughes
Amendment”) with Baker Hughes Oilfield Operations LLC (“Baker Hughes”), amending their existing Vendor Agreement
dated April 1, 2018. Under the Baker Hughes Amendment, the Company may engage in other activity not related to or in competition
with the business of Baker Hughes to the extent that such other activity shall not be considered a breach of the Vendor Agreement.
Also under the Baker Hughes Amendment, charges for repair rates the Company provides to
Baker Hughes are reduced by 10%. Lastly, the exclusivity restrictions for drill bit repair was lifted by Baker Hughes.
Impact of Low Oil Prices and COVID-19
The significant decline in oil demand due
to COVID-19, coupled with the instability of oil prices caused by geopolitical issues and production levels, as well as limited
availability of storage capacity, have resulted in our customers announcing significant reductions to their capital expenditure
budgets for 2020. Management’s expectation is that demand for our products and services will be severely impacted for the
duration of 2020 and potentially beyond; however, we are currently unable to estimate the full impact to our business, how long
this significant drop in demand will last or the depth of the decline.
In
an effort to offset the reduction in revenue resulting from the weakened macroeconomic environment, we implemented certain cost
reduction measures in April 2020. These measures included, but were not limited to, the following:
|
●
|
20%
reduction of the base salary for the Company’s Chief Executive Officer, Chief Operating Officer, and Chief Financial
Officer;
|
|
|
|
|
●
|
20%
reduction in the base salaries of certain non-executive officers of the Company;
|
|
|
|
|
●
|
20%
reduction in fees to be paid to the independent directors on the Board for their service as directors;
|
|
|
|
|
●
|
5%
to 10% reduction in salaries of other members of the management team and salaried workforce; and
|
|
|
|
|
●
|
20%
reduction of the Company’s workforce.
|
We have also reduced our
planned capital expenditures for 2020 and we have decided to defer further investment in new technology development, including
our Strider technology.
While we believe that
our borrowing capacity, cash generated from operations and the proceeds of the Paycheck Protection Program
(“PPP”) loan (described below) will be sufficient to fund our operations until at least May 2021, our operational
and financial strategies include managing our operating costs, working capital and debt to enhance liquidity. We will
continue to work to minimize the decline in revenue and review additional cost containment measures in order to 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 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.
On April 21, 2020, the Company
received PPP loan proceeds of $891,600 under a promissory note from its existing commercial bank (the
“PPP Loan”). The PPP, established as part of the CARES Act, provides for loans to qualifying businesses for
amounts up to 2.5 times the average monthly payroll expenses of the qualifying business. The loans and accrued interest are
forgivable after eight weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll,
benefits, rent and utilities, and maintains its payroll levels.
The application for these funds required
the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing
operations of the Company. Some of the uncertainties related to the Company’s operations that are directly related to COVID-19
include, but are not limited to, the severity of the virus, the duration of the outbreak, governmental, business or other actions
(which could include limitations on operations or mandates to provide products or services), impacts on the supply chain, and
the effect on customer demand or changes to operations. In addition, the health of the Company’s workforce, and its
ability to meet staffing needs to continue to build, repair and distribute drilling tools, and other critical functions, are uncertain
and is vital to its operations.
The
PPP Loan certification further requires the Company to take into account our current business activity and our ability to access
other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business.
The Company had approximately $341,000 of available credit under the Credit Agreement as of April 21, 2020. Further, the Company
has a limited market capitalization and the Company’s shares have limited trading volume and as a result, the Company believes
it meets the certification requirements.
The term of the Company’s PPP Loan
is two years. The annual interest rate on the PPP Loan is 1% and no payments of principal or interest are due during the six-month
period beginning on the date of the PPP Loan.