NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
and Nature of Operations
Superior
Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”)
is a drilling and completion tool technology company providing solutions for the oil and natural gas drilling industry. The Company,
designs, engineers, manufactures, sells, and repairs drilling and completion tools.
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.
Basis
of Presentation
The
Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted
in the United States of America (“GAAP”). The consolidated financial statements include the accounts of Superior Drilling
Products Inc. and all of its wholly-owned subsidiaries. All significant intercompany accounts have been eliminated in consolidation.
The Company does not have investments in any unconsolidated subsidiaries.
In
April 2012, the JOBS Act was enacted. Section 107 of the JOBS Act provides that an emerging growth company can utilize the extended
transition period provided in Section 7(a)(2)(B) of the Securities Act for implementing new or revised accounting standards. In
other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise
apply to nonissuers. We have elected to delay such adoption of new or revised accounting standards, and as a result, we may not
implement new or revised accounting standards on the relevant dates on which adoption of such standards is required for other
issuer companies.
Subject
to certain conditions set forth in the JOBS Act, as an emerging growth company, we intend to rely on certain of these exemptions,
including without limitation, providing an auditor’s attestation report on our system of internal controls over financial
reporting pursuant to Section 404 and implementing any requirement that may be adopted regarding mandatory audit firm rotation
or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor
discussion and analysis). These exemptions will apply for a period of five years following the completion of our IPO, which occurred
in May 2014, although if the market value of our common stock that is held by nonaffiliates exceeds $700 million as of any June
30 before that time, we would cease to be an emerging growth company as of the following December 31.
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.
Revenue
Recognition
We
are a drilling and completion tool technology company and we generate revenue from the refurbishment, manufacturing, repair, and
sale of drill string tools. Our manufactured products are produced in a standard manufacturing operation, even when produced to
our customer’s specifications. We also earn royalty fees under certain arrangements for the tools we sell. In May 2016,
the Company entered into an agreement with DTI to be our exclusive distributor of the Drill-N-Ream tool in the United States and
Canada. This agreement began the change of direction of our business from renting tools to selling tools.
Tool
sales, rentals and other related 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
: 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. The Company may act as an agent by billing
and collecting its customers’ tool rental revenue. When we are an agent for our customer, revenue is presented in the statement
of operations on a net basis. At December 31, 2017, our accounts receivable and accounts payable related to transactions we performed
as an agent for our customers were not material.
Contract
Services
Drill
Bit Manufacturing and Refurbishment
: Since 1996, we have refurbished PDC drill bits for Baker Hughes. We are currently operating
under a four-year vendor agreement with Baker Hughes that was renewed in 2013 (the “Vendor Agreement”). We recognize
revenue for our PDC drill bit services upon shipment of the drill bit. Shipping and handling costs related to refurbishing services
are paid directly by Baker Hughes at the time of shipment. By contract, we can only refurbish and manufacture oil or gas drill
bits for Baker Hughes, but we are not contractually prohibited from manufacturing drill bits for the mining industry.
Cash
and cash equivalents
Cash
and cash equivalents consist of cash on deposit. We maintain cash deposits with financial institutions that may exceed federally
insured limits at times. We have chosen credible institutions and believe our risk of loss is negligible.
Fair
Value of Financial Instruments
The
Company’s financial instruments consist of cash and cash equivalents, receivables, payables, and bank debt. The Company
believes that the carrying values of these instruments on the accompanying consolidated balance sheets approximate their fair
values.
Accounts
Receivable and Allowance for Doubtful Accounts
Accounts
receivable are generally due within 60 days of the invoice date. No interest is charged on past-due balances. We grant credit
to our customers based upon an evaluation of each customer’s financial condition. We periodically monitor the payment history
and ongoing creditworthiness of our customers. An allowance for doubtful accounts is established at a level estimated by management
to be adequate based upon various factors including historical experience, aging status of customer accounts, payment history
and financial condition of our customers. The allowance for doubtful accounts was $18,450 and $9,000 as of December 31, 2017,
and 2016, respectively.
Inventories
Inventories
consist of raw materials, work-in-process and finished goods and are stated at the lower of cost, determined using the weighted-average
cost method, or net realizable value. Finished goods inventories include raw materials, direct labor and production overhead.
The Company regularly reviews inventories on hand and current market conditions to determine if the cost of finished goods inventories
exceed current market prices and impairs the cost basis of the inventory accordingly.
Property,
Plant and Equipment
Property,
plant and equipment is stated at cost. The cost of ordinary maintenance and repair is charged to operating expense, while replacement
of critical components and major improvements are capitalized. Depreciation or amortization of property and equipment, including
assets held under capital leases, is calculated using the straight-line method over the asset’s estimated useful life as
follows:
Buildings
and leasehold Improvements
|
|
|
2-39
years
|
|
Machinery,
equipment and rental tools
|
|
|
18
months -10 years
|
|
Furniture
and fixtures
|
|
|
7
years
|
|
Transportation
equipment
|
|
|
5
- 30 years
|
|
Computer
equipment and software
|
|
|
3-5
years
|
|
Property,
plant and equipment is reviewed for impairment on an annual basis or whenever events or changes in circumstances indicate the
carrying value of an asset or asset group may not be recoverable. Indicative events or circumstances include, but are not limited
to, matters such as a significant decline in market value or a significant change in business climate. An impairment loss is recognized
when the carrying value of an asset exceeds the estimated undiscounted future cash flows from the use of the asset and its eventual
disposition. The amount of impairment loss recognized is the excess of the asset’s carrying value over its fair value. Assets
to be disposed of are reported at the lower of the carrying value or the fair value less cost to sell. Upon sale or other disposition
of an asset, the Company recognizes a gain or loss on disposal measured as the difference between the net carrying value of the
asset and the net proceeds received.
Intangible
Assets
The
Company’s intangible assets with finite lives consist of developed technology, customer contracts and relationships, and
trade names and trademarks.
The
cost of intangible assets with finite lives is amortized using the straight-line method over the estimated period of economic
benefit, ranging from 3 to 17 years. Asset lives are adjusted whenever there is a change in the estimated period of economic benefit.
No residual value has been assigned to these intangible assets.
Intangible
assets with finite lives are tested for impairment whenever events or changes in circumstances indicate the carrying value may
not be recoverable. These conditions may include a change in the extent or manner in which the asset is being used or a change
in future operations. The Company assesses the recoverability of the carrying amount by preparing estimates of future revenue,
margins, and cash flows. If the sum of expected future cash flows (undiscounted and without interest charges) is less than the
carrying amount, an impairment loss is recognized. The impairment loss recognized is the amount by which the carrying amount exceeds
the fair value. Fair value of these assets may be determined by a variety of methodologies, including discounted cash flow models.
Research
and Development
We
expense research and development costs as they are incurred. For the years ended December 31, 2017 and 2016, these expenses were
approximately $746,000 and $1,200,000, respectively, and are included in the selling, general, and administrative expenses in
the statement of operations.
Earnings
(Loss) Per Share
Basic
earnings (loss) per common share is calculated by dividing net income (loss) available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income
(loss) attributable to common shareholders by the weighted average number of common shares outstanding, including potentially
dilutive common share equivalents, if the effect is dilutive. Potentially dilutive common shares equivalents include stock options
and warrants. Approximately 250,000 warrants and 144,000 options to purchase our common stock were excluded from this calculation
because they were antidilutive for the year ended December 31, 2017.
Income
Taxes
The
Company recognizes an asset or liability for the deferred tax consequences of all temporary differences between the tax basis
of assets or liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts
in future years when the reported amounts of the asset or liabilities are recovered or settled and for operating loss carry forwards.
These deferred tax assets and liabilities are measured using the enacted tax rates that will be in effect when the differences
are expected to reverse and the carry forwards are expected to be realized. Deferred tax assets are reviewed periodically for
recoverability and a valuation allowance is provided as necessary.
Debt
Issuance Costs
Costs
related to debt issuance are capitalized and amortized as interest expense over the term of the related debt using the straight-line
method, which approximates the effective interest method. Upon the repayment of debt, the Company accelerates the recognition
of an appropriate amount of the costs as interest expense. Debt issuance costs related to the Hard Rock Note are presented as
a direct reduction from the carrying amount of the note payable. As of December 31, 2017 and 2016, the debt issuance costs were
$77,641 and $153,503, respectively.
Share
Based Compensation
Share
based compensation expense for share based payments, related to stock option and restricted stock awards, is recognized based
on their grant-date fair values. The Company recognizes compensation expense, net of estimated forfeitures, on a straight-line
basis over the requisite service period of the award. Estimated forfeitures are based on historical experience.
Concentrations
and Credit Risk
The
Company has two significant customers that represented 97% and 63% of our revenue for the years ended December 31, 2017 and 2016,
respectively. These customers had approximately $2,523,000 and $650,000 in accounts receivable at December 31, 2017 and 2016,
respectively.
Assets
and Liabilities Held for Sale
The
Company classifies disposal groups as held for sale in the period in which all of the following criteria are met: (1) management,
having the authority to approve the action, commits to a plan to sell the disposal group; (2) the disposal group is available
for immediate sale in its present condition subject only to terms that are usual and customary for sales of such disposal groups;
(3) an active program to locate a buyer or buyers and other actions required to complete the plan to sell the disposal group have
been initiated; (4) the sale of the disposal group is probable, and transfer of the disposal group is expected to qualify for
recognition as a completed sale, within one year, except if events of circumstances beyond the Company’s control extend
the period of time required to sell the disposal group beyond one year; (5) the disposal group is being actively marketed for
sale at a price that is reasonable in relation to its current fair value; and (6) actions required to complete the plan indicate
that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. See Note 10 –
Related Party Transactions.
Recently
Issued Accounting Standards
In
May 2014, the Financial Accounting Standards Board (the “FASB”) issued an accounting standards update for “Revenue
from Contracts with Customers,” which supersedes the revenue recognition requirements in “Topic 605, Revenue Recognition.”
This accounting standard update provides new guidance concerning recognition and measurement of revenue and requires additional
disclosures about the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers. This new
guidance permits adoption through the use of either a full retrospective approach or a modified retrospective approach for annual
reporting periods beginning on or after December 15, 2016, with early adoption not permitted. In August 2015, FASB delayed
the effective date one year, and is effective for the Company’s fiscal year beginning January 1, 2019. The Company is currently
evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosure and will adopt
this standard on January 1, 2019.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases
,” which introduces the recognition of lease assets
and lease liabilities by lessees for all leases which are not short-term in nature. The new standard requires a modified retrospective
transition for capital or operating leases existing at or entered into after the beginning of the earliest comparative period
presented in the financial statements. The Company will adopt this guidance on January 1, 2019. The Company is currently evaluating
the impact the pronouncement will have on the consolidated financial statements and related disclosure and will adopt this standard
on January 1, 2019.
In
March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting’’, which simplifies several aspects of the accounting for employee share-based payment transactions,
including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in
the statement of cash flows. We adopted this guidance in the first quarter of 2018 and we do not expect the adoption of this standard
will have a material impact on our consolidated financial statements.
In
2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory” which requires an entity to measure
in scope inventory at the lower of cost and net realizable value. We adopted this guidance in the first quarter of 2018 and we
do not expect the adoption of this standard will have a material impact on our consolidated financial statements.
NOTE
2. LIQUIDITY
At
December 31, 2017, we had a working capital deficit of approximately $1,300,000. The Company’s manufacturing facility is
financed by a commercial bank loan with a lump sum principal payment of approximately $4,200,000 due at the maturity date on August
15, 2018 (see Note 8 – Long-Term Debt). The classification of this debt from long-term to short-term resulted in a working
capital deficit at December 31, 2017. The Company plans to work with its lender to refinance its commercial bank mortgage loan
in the first half of 2018. If we are unable to refinance our commercial bank loan that is collateralized by our property we may
disrupt our overall business operations and our ability to generate revenue and 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. See Note 8 – Long-Term Debt.
NOTE
3. PUBLIC OFFERING
On
September 30, 2016, we sold 5.75 million shares in a follow-on public offering of common stock for $1.00 per share. The transaction
closed on October 5, 2016. Net of underwriting and stock offering expenses of approximately $709,000, the net proceeds to the
Company were approximately $5.0 million. The Company used the proceeds to repay debt and used the remaining funds from the offering
and cash flows from operations to service on going debt obligations, which include real property leases and equipment loans, as
well as for general corporate purposes, including growth working capital.
NOTE
4. INVENTORIES
Inventories
were comprised of the following:
|
|
December
31,
2017
|
|
|
December
31,
2016
|
|
Raw
material
|
|
$
|
1,040,795
|
|
|
$
|
952,419
|
|
Work
in progress
|
|
|
77,702
|
|
|
|
90,017
|
|
Finished
goods
|
|
|
78,316
|
|
|
|
125,256
|
|
|
|
$
|
1,196,813
|
|
|
$
|
1,167,692
|
|
During
2016, the Company entered into a distribution agreement with Drilling Tools International (“DTI”), under which DTI
has a requirement to purchase our Drill-N-Ream tool for their rental tool business and achieve market share requirements in order
to maintain exclusive marketing rights for the Drill-N-Ream tool in the U.S. and Canada. This agreement began the change of direction
of our business from renting tools to selling tools. Due to this change in our business model, we moved tools with a net book
value of $225,710 from property, plant and equipment into inventory in 2016.
The
Company recorded an impairment loss in the cost of sales of $210,745 during the year ended December 31, 2016 relating to the discontinuation
of OrBit, a completion drill bit product line that was fully impaired to a net book value of $0.
The
Company recorded an impairment loss in the cost of sales of $147,801 during the year ended December 31, 2016 relating to several
Strider technologies which required several parts of these tools to be replaced.
There
were no impairment losses recorded by the Company during the year ended December 31, 2017.
NOTE
5. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
|
|
December
31,
2017
|
|
|
December
31,
2016
|
|
Land
|
|
$
|
880,416
|
|
|
$
|
880,416
|
|
Buildings
|
|
|
4,847,778
|
|
|
|
4,847,778
|
|
Leasehold
improvements
|
|
|
717,232
|
|
|
|
717,232
|
|
Machinery
and equipment
|
|
|
8,216,237
|
|
|
|
5,060,281
|
|
Machinery
under capital lease
|
|
|
-
|
|
|
|
2,322,340
|
|
Furniture
and fixtures
|
|
|
507,557
|
|
|
|
507,554
|
|
Transportation
assets
|
|
|
811,378
|
|
|
|
882,163
|
|
|
|
|
15,980,598
|
|
|
|
15,217,764
|
|
Accumulated
depreciation
|
|
|
(7,171,250
|
)
|
|
|
(6,149,405
|
)
|
|
|
$
|
8,809,348
|
|
|
$
|
9,068,359
|
|
During
the year ended December 31, 2016, we sold transportation assets, which were no longer necessary to our business, and rental tools
for proceeds of $415,817 and gain of $76,211.
In
2016, the Company recognized an impairment loss in the cost of sales of $211,056 related to the Open Hole Strider tool that had
been capitalized as part of fixed assets and inventory. It was determined that the tool design had limited market potential and
the Company decided to re-engineer the tool to be offered to a broader market.
Depreciation
expense related to property, plant and equipment for the year ended December 31, 2017 and 2016 was $1,229,932 and $1,844,582 respectively.
NOTE
6. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
|
|
December
31,
2017
|
|
|
December
31,
2016
|
|
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
|
|
|
(8,767,222
|
)
|
|
|
(6,320,556
|
)
|
|
|
$
|
6,132,778
|
|
|
$
|
8,579,444
|
|
Amortization
expense related to intangible assets for the years ended December 31, 2017 and 2016 was $2,446,666 and $2,446,667, respectively.
These
intangible assets will be amortized over their expected useful lives using the straight-line method, which is a weighted-average
amortization period of 6.3 years. As of December 31, 2017, the Company will recognize the following amortization expense for the
respective periods ending December 31 noted below:
2018
|
|
|
2,446,667
|
|
2019
|
|
|
1,700,000
|
|
2020
|
|
|
1,166,667
|
|
2021
|
|
|
583,334
|
|
Thereafter
|
|
|
236,110
|
|
Total
|
|
$
|
6,132,778
|
|
During
the years ended December 31, 2017 and 2016, there were no impairments recognized related to other intangible assets.
NOTE
7. RELATED PARTY NOTE RECEIVABLE
In
January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy
Corporation (“Tronco”), a party related to us through common control, in order to take over the legal position as
Tronco’ s senior secured lender. That agreement provided that, upon our full repayment of the Tronco loan from the proceeds
of the Offering, the lender would assign to us all of its rights under the Tronco loan, including all of the collateral documents.
On May 30, 2014, we closed our purchase of the Tronco loan for a total payoff of $8.3 million, including principal, interest,
and early termination fees. As a result of that purchase, we became Tronco’ s senior secured lender, and as a result are
entitled to receive all proceeds from sales of the Tronco-owned collateral, as discussed below.
The
interest rate on the note is 4.5%. We earned interest of $338,204 and $311,979 in the years ending December 31, 2017 and 2016,
respectively.
On
March 28, 2017, the Company and Tronco finalized an agreement with a third party and pursuant to this agreement, the third party
acquired all of the Ohio assets of Tronco for $550,000. As Tronco’s senior secured lender, we agreed to release our lien
and security interest on these assets in accordance with the agreement. The Company agreed to a non-cash receipt of the $550,000
from Tronco by reducing our bonus accrual liabilities, which was earned by the Meiers in 2014, but not paid, and was recorded
in other long-term liability. As a result of this agreement, we reduced both the other long-term liability and the Tronco related
party note receivable during the first quarter of 2017.
On
August 8, 2017, the Board of Directors agreed to extend the terms of the Tronco loan to interest only payments due December 31,
2017, 2018, 2019, 2020, and 2021, with a balloon payment of all unpaid interest and principal due upon full maturity on December
31, 2022.
On
December 4, 2017, as part of the annual awards made to employees of the Company, the Board of Directors approved grants of restricted
stock units to Troy and Annette Meier with an approximate value of $587,500. The Board and the Meiers decided in lieu of making
such awards, the dollar value of such awards would be used to pay the annual interest on the Tronco note of $34,992, and the principal
on the Tronco note of $379,507 in 2017. The remainder of approximately $173,000 were remitted for taxes on the Meiers behalf.
See Note 12 – Share-Based Compensation.
We
have the direct legal right to enforce the collateral and guaranty agreements entered into in connection with the Tronco loan
and to collect Tronco’s collateral sales proceeds, in order to recover the loan purchase amount. The Tronco loan continues
to be secured by the first position liens on all of Tronco assets, as well as by the guarantees of Troy and Annette Meier (the
“Meier Guaranties”), which are directly payable to and legally enforceable by us. In addition, the Meiers have provided
us with stock pledges in which they pledge all of their shares of our common stock held by their family entities (the “Meier
Stock Pledge”), as collateral for the Meiers guaranties until full repayment of Tronco loan. The pledged shares, which are
subject to insider timing requirements and volume limitations under Rule 144 of the Securities Act and required periodic black-out
periods, are being held in third-party escrow until full repayment of the Tronco loan. The Company holds 8,267,860 shares and
530,725 restricted stock units as collateral for the Tronco note as of December 31, 2017.
NOTE
8. LONG-TERM DEBT
Long-term
debt is comprised of the following:
|
|
December
31,
2017
|
|
|
December
31,
2016
|
|
Real
estate loans
|
|
$
|
4,518,424
|
|
|
$
|
7,264,036
|
|
Hard
Rock Note, net of discount
|
|
|
7,422,912
|
|
|
|
7,846,497
|
|
Machinery
loans
|
|
|
513,317
|
|
|
|
684,921
|
|
Transportation
loans
|
|
|
353,400
|
|
|
|
398,929
|
|
|
|
|
12,808,053
|
|
|
|
16,194,383
|
|
Current
portion of long-term debt
|
|
|
(6,101,678
|
)
|
|
|
(2,905,682
|
)
|
|
|
$
|
6,706,375
|
|
|
$
|
13,288,701
|
|
Real
Estate Loans
Our
manufacturing facility was financed by a commercial bank loan requiring monthly payments of approximately $39,000, including principal
and interest at 5.25%. A lump sum principal payment of approximately $4,200,000 is due at the maturity date of this loan on August
15, 2018.
In
February 2017, the Company sold real estate to Superior Auto Body (“SAB”), a related party, for the net proceeds of
$2.5 million. The cash received from the sale was used to pay down the $2.5 million loan balance on the property. As part of the
sale, the Company released 541,000 shares of the Meiers common stock from the collateral for the Tronco note (see Note 10 –
Related Party Transactions).
Hard
Rock Note
In
2014, the Company purchased all of the interests of 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 the patents, patents pending, other patent rights, and trademarks transferred to Hard Rock by Hard Rock in the closing of the
acquisition. At issuance, the fair value of the Hard Rock Note was determined to be $11,144,000, which was less than the face
value due to a below-market interest rate. The resulting discount of $1,356,000 is amortized to interest expense using the effective
interest method, totaling approximately $76,000 and $108,000 during 2017 and 2016, respectively.
On
August 10, 2016, certain of our subsidiaries entered into an amended and restated note with the seller in our acquisition of Hard
Rock Solutions, LLC. As amended and restated, the Hard Rock Note accrues interest at 5.75% per annum and matures on January 15,
2020. In 2016, we paid interest of $769,582 and a principal payment of $2,000,000, of which $1,000,000 was paid with 700,000 restricted
shares of common stock on August 10, 2016 (having an agreed per share value of $1.43). During the year ending December 31, 2017,
we paid interest of $515,452 and made an advanced principal payment of $500,000. Subsequent to year end, we made the accrued interest
payments related to the note on January 15, 2018 of $70,890 and made a $500,000 principal payment. The following remaining payments
are required under the current terms of the Hard Rock note: in 2018, $500,000 in principal plus accrued interest on each of May
15 and July 15, 2018 and in 2019, $1,000,000 in principal plus accrued interest on each of January 15, March 15, May 15 and July
15, 2019. The remaining balance of principal of $2,000,000 and accrued interest on the Hard Rock Note are due on January 15, 2020.
Bridge
Financing
On
August 8, 2016, we entered into a private transaction with a private investor pursuant to which we issued a promissory note in
the aggregate principal amounts of $1,000,000 and a warrant to purchase up to an aggregate of 250,000 shares of our common stock,
subject to certain adjustments to the number of shares and the exercise price described in the warrants. These warrants were valued
at $112,024, based on using the Black Scholes model and were recorded as a liability and treated as derivatives. The variable
inputs used in the Black Scholes calculation were; expected volatility of 95%, discount rate of 0.72% and the term of the warrants
of 5 years. Once the indebtedness was paid off on October 5, 2016, and the final number of shares were known, the liability was
removed and the warrants were included in equity.
Transportation
Loans
Vehicles
Our
loans for Company vehicles and other transportation are with various financing parties we have engaged with in connection with
the acquisition of the vehicles. As of December 31, 2017, the loans bear interest ranging from 0%-8.29% with maturity dates ranging
from December 2018 through October 2021, and are collateralized by the vehicles. Our cumulative monthly payment under these loans
as of December 31, 2017 was approximately $3,200, including principal and interest.
Airplane
Loan
Our
loan for the Company airplane bears interest at 7.35%, requires monthly payments of principal and interest of approximately $3,500,
matures in May of 2026 and is collateralized by the airplane.
Future
annual maturities of total debt are as follows (1) :
Year
|
|
|
|
2018
|
|
$
|
6,742,484
|
|
2019
|
|
|
4,496,556
|
|
2020
|
|
|
2,232,023
|
|
2021
|
|
|
87,321
|
|
2022
|
|
|
63,451
|
|
Thereafter
|
|
|
145,041
|
|
Total
debt
|
|
$
|
13,766,876
|
|
(1)
|
Excludes
discounts for debt issuance costs.
|
NOTE
9. COMMITMENTS AND CONTINGENCIES
We
are subject to litigation that arises from time to time in the ordinary course of our business activities. We are not currently
involved in any litigation which management believes could have a material effect on our financial position or results of operations,
except as follows:
In
October 2013, Del-Rio Resources, Inc. (“Del-Rio”) filed suit, on its own behalf and derivatively on behalf of Philco
Exploration, LLC (“Philco”), against the following co-defendants (a) Tronco Ohio, LLC and Tronco, (b) the lender on
the Tronco loan, ACF Property Management, Inc. (p.k.a. Fortuna Asset Management, LLC,) (“ACF”), (c) Troy and Annette
Meier personally, and several of their family trusts, (d) Meier Family Holding Company, LLC and Meier Management Company, LLC,
and (e) SDS and MPS in the Eighth Judicial District Court, Uintah County, Utah Cause #130800125 (the “Suit”). On May
11, 2017, pursuant to a mediation proceeding, all of the plaintiffs and remaining defendants in the Suit executed a Settlement
Agreement whereby each of the parties have released all of their claims against the other parties to the Suit without liability
effective as of March 22, 2017. Such release includes the Company’s two subsidiaries that were a party to the Suit, SDS
and MPS, as well as Troy and Annette Meier personally and all of their family trusts named as defendants in the Suit. As a result
of the execution of the Settlement Agreement, a Stipulated Motion for Dismissal with Prejudice was filed with the Court which
includes a form of Order of Dismissal with Prejudice (the “Court Order”). On May 15, 2017, the Court Order was executed
by the judge and the Suit was formally dismissed with prejudice.
NOTE
10. RELATED PARTY TRANSACTIONS
Notes
Payable
In
2014, the Company issued notes payable to related parties in the amount of $2 million. The notes bear interest at 7.5% and were
scheduled to mature on January 2, 2017. The Company did not pay these notes upon maturity as the Company and the related parties
informally agreed to offset these notes payable with the related-party note receivable. During the year, the Company made principal
payments and interest payments of $80,000 related to the notes payable. Additionally, the Company applied $207,942 in principal
and interest due to the Company on the related party note receivable (see Note 6 – Related Party Note Receivable) during
the year ended December 31, 2017 and reduced the balance to $0 as of December 31, 2017.
Superior
Auto Body
On
January 1, 2016, the Company completed the divestiture of our interest in Superior Auto Body and Paint, LLC, by selling the remaining
ownership interests in the business operations to a third party. The Company received $101,400 in proceeds.
The
Company leased certain of its facilities to Superior Auto Body (“SAB”). We recorded rental income from the related
party in the amounts of $199,902 for the years ended December 31, 2016 and 2015. As discussed below, in 2017, we sold the facilities
that had been leased to SAB and accordingly, we will no longer receive this rental income.
In
2016, the Company recognized an impairment loss of $840,380 related to SAB. This loss was recorded in 2016 and the asset was classified
as held for sale. In February 2017, the Company sold real estate to SAB for the net proceeds of $2.5 million. The cash received
from the sale was used to pay down the $2.5 million loan balance on the property. As part of the sale, the Company released 547,000
shares of the Meiers common stock from the collateral for the Tronco Note. Prior to the sale, the Company held 8,814,860 common
stock shares as collateral for the Tronco Note. After the sale in 2017, the Company holds 8,267,860 shares as collateral for the
Tronco Note (see Note 7 – Related Party Note Receivable).
NOTE
11. INCOME TAXES
Components
of income tax benefit are as follows:
Current
income taxes:
|
|
For
the Year
Ended
December 31,
2017
|
|
|
For
the Year
Ended
December 31,
2016
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
|
-
|
|
|
(2,000
|
)
|
Current
provision for income taxes
|
|
|
|
|
|
|
(2,000
|
)
|
Deferred
provision (benefit) for income taxes:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
-
|
|
|
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Deferred
provision (benefit) for income taxes
|
|
|
-
|
|
|
|
-
|
|
Provision
for income taxes
|
|
$
|
|
|
|
$
|
(2,000
|
)
|
The
non-current deferred tax assets and liabilities consist of the following:
Deferred
tax assets:
|
|
|
|
|
|
|
263A
adjustment
|
|
$
|
14,326
|
|
|
$
|
21,595
|
|
Accrued
expenses
|
|
|
-
|
|
|
|
305,024
|
|
Stock
compensation
|
|
|
48,489
|
|
|
|
55,624
|
|
Stock
option
|
|
|
44,922
|
|
|
|
60,970
|
|
Amortization
of intangibles
|
|
|
2,796,867
|
|
|
|
3,791,944
|
|
Net
operating loss
|
|
|
2,999,467
|
|
|
|
4,263,351
|
|
Others
|
|
|
12,660
|
|
|
|
11,887
|
|
Total
non-current deferred tax assets
|
|
|
5,916,731
|
|
|
|
8,510,395
|
|
|
|
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
|
|
Prepaid
expenses
|
|
|
(23,301
|
)
|
|
|
(24,908
|
)
|
Depreciation
on fixed assets
|
|
|
(853,089
|
)
|
|
|
(1,008,413
|
)
|
Total
non-current deferred tax liabilities
|
|
|
(876,390
|
)
|
|
|
(1,033,321
|
)
|
|
|
|
|
|
|
|
|
|
Net
non-current deferred tax assets/liabilities
|
|
|
5,040,341
|
|
|
|
7,477,074
|
|
Less:
Valuation Allowance
|
|
|
(5,040,341
|
)
|
|
|
(7,477,074
|
)
|
Total
deferred tax liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
Reconciliation
of the tax rate to the U.S. federal statutory tax rate which relate to the year ended December 31, 2017 and 2016 is as follows:
|
|
For
the Year Ended
December 31, 2017
|
|
|
For
the Year Ended
December 31, 2016
|
|
|
|
|
|
|
|
|
Tax
at federal statutory rate
|
|
$
|
(80,922
|
)
|
|
$
|
(3,104,489
|
)
|
State
income taxes
|
|
|
-
|
|
|
|
(1,320
|
)
|
Permanent
differences
|
|
|
118,253
|
|
|
|
196,479
|
|
Change
in valuation allowance
|
|
|
(2,436,734)
|
|
|
|
3,191,794
|
|
Other
- State rate effect
|
|
|
(9,578
|
)
|
|
|
(272,768
|
)
|
Change
in status
|
|
|
2,408,980
|
|
|
|
14,216
|
|
Other
|
|
|
-
|
|
|
|
(25,912
|
)
|
Provision
for income taxes
|
|
$
|
-
|
|
|
$
|
(2,000
|
)
|
On
December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the 2017 Tax Cuts and Jobs
Act (“2017 Tax Reform”). The 2017 Tax Reform significantly revises the future ongoing U.S. corporate income tax by,
among other things, lowering U. S. corporate income tax rates and implementing a territorial tax system.
We
have reasonably estimated the effects of the 2017 Tax Reform and recorded provisional amounts in our financial statements as of
December 31, 2017. This amount is primarily comprised of the re-measurement of federal net deferred tax liabilities resulting
from the permanent reduction in the U.S. statutory corporate tax rate to 21% from 35%. We also recorded a corresponding decrease
in our valuation allowance for the impact of the 2017 Tax Reform of approximately $5.040 million, with minimal to no effect of
our current statement of operations.
We
will continue to monitor additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies,
so we may make adjustments to the provisional amounts (if any). However, management’s opinion is that future adjustments
due to the 2017 Tax Reform should not have a material impact on the company’s provision for income taxes.
NOTE
12. SHARE-BASED COMPENSATION
In
2014, the Company’ s Board of Directors approved that the Directors stock compensation would be included in the Employee
Stock Incentive Plan (“Stock Plan”) that reserves 1,724,128 shares of common stock for issuance. Equity and equity-based
compensation plans are intended to make available incentives that will assist us in attracting, retaining, and motivating employees,
officers, consultants, and directors by allowing them to acquire an ownership interest in our business, and, as a result, encouraging
them to contribute to our success. We may provide these incentives through the grant of stock options, stock appreciation rights,
restricted stock, restricted stock units, performance shares and units, and other cash-based or stock-based awards. As a result,
we expect to incur non-cash, stock-based compensation expenses in future periods. The Board of Directors has frozen the 2014 Incentive
Plan, such that no future grants of awards will be made and the 2014 Incentive Plan shall only remain in effect with respect to
awards under that Plan outstanding as of June 15, 2015 until they expire according to their terms.
In
2015, our stockholders approved the Superior Drilling Company, Inc. 2015 Long Term Incentive Plan (the “2015 Incentive Plan”).
The purpose of the 2015 Incentive Plan is to advance the interests of the Company and its stockholders by providing an incentive
to attract, retain and reward persons performing services for the Company and its affiliates and by motivating such persons to
contribute to the growth and profitability of the Company and our affiliates. In 2017, the Company’s board of directors
approved an additional 1,440,000 shares of the Company’s common stock to be added to the 2015 Incentive Plan. Subject to
adjustment as provided in the 2015 Incentive Plan, the maximum aggregate number of shares of the Company’ s common stock
that may be issued with respect to awards under the 2015 Incentive Plan is 2,992,905. As of December 31, 2017, there were 1,264,613
shares outstanding with respect to awards granted under the Company’s 2015 Incentive Plan.
Restricted
stock units -
On November 10, 2016, the Board of Directors granted 600,000 restricted stock units from the Company’
s 2015 Incentive Plan to executive management and directors based on the closing price of the Company’ s common stock on
the date of the grant. These restricted units will vest over a three-year period.
On
December 4, 2017, the Board of Directors granted 267,443 restricted stock units from the Company’s 2015 incentive plan to
executive management and directors based on the closing price of the Company’s common stock on the date of the grant. These
restricted units will vest over a three - year period.
During
2017, the Board of Directors granted 15,135 restricted stock units from the Company’s 2015 incentive plan to a contractor
based on the closing price of the Company’s common stock on the date of the grant. These restricted units will vest over
a three - year period.
On
December 4, 2017, the Board of Directors approved grants of restricted stock units to Troy and Annette Meier with an approximate
value of $587,500. The Board and the Meiers decided in lieu of making such awards, the dollar value of such awards would be used
to pay interest and principal on the Tronco Note (see Note 7-Related Party Note Receivable ).
Compensation
expense recognized for grants vesting under the 2014 Incentive Plan was approximately $142,000 and $233,000 for the years ending
December 31, 2017 and 2016, respectively. Compensation expense recognized for grants of restricted stock vesting under the 2015
Incentive Plan was approximately $456,000 and $406,000 for the years ending December 31, 2017 and 2016, respectively. The Company
recognized compensation expense and recorded it as share-based compensation in the consolidated statement of operations.
Total
unrecognized compensation expense related to unvested restricted stock units expected to be recognized over the remaining weighted
vesting period of 2.56 years equaled approximately $534,000 at December 31, 2017. These shares vest over three years.
The
following table summarizes RSU activity for the years ended December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
Number
of Restricted Stock Units
|
|
|
Weighted
-
Average Grant
Date Fair Value
|
|
|
Number
of Restricted Stock Units
|
|
|
Weighted
-
Average Grant
Date Fair Value
|
|
Unvested
RSU’ s at beginning of period
|
|
|
702,608
|
|
|
$
|
1.31
|
|
|
|
407,493
|
|
|
$
|
2.48
|
|
Granted
|
|
|
282,578
|
|
|
|
1.27
|
|
|
|
600,000
|
|
|
|
0.97
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
(17,342
|
)
|
|
|
1.62
|
|
Vested
|
|
|
(337,991
|
)
|
|
|
1.64
|
|
|
|
(287,543
|
)
|
|
|
2.22
|
|
Unvested
RSU’ s at end of period
|
|
|
647,195
|
|
|
$
|
1.12
|
|
|
|
702,608
|
|
|
$
|
1.31
|
|
Stock
Options -
On March 4, 2016, the Board of Directors granted options to acquire 78,944 shares of stock from the Company’
s 2015 Incentive Plan to officers and employees based on the closing price of the Company’ s common stock on the date of
the grant, which was $1.73. These options vested 100% on the grant date and have a ten-year term expiring on March 4, 2026. The
fair value of the vested stock options was calculated using the Black-Scholes model with a volatility and discount rate over the
expected term of each employee.
On
March 18, 2016, the Board of Directors granted options to acquire 81,714 shares of stock from the Company’ s 2015 Incentive
Plan to officers and employees based on the closing price of the Company’ s common stock on the date of the grant, which
was $1.67. These options vested 100% on the grant date and have a ten-year term expiring on March 18, 2026. The fair value of
the vested stock options was calculated using the Black-Scholes model with a volatility and discount rate over the expected term
of each employee.
On
March 31, 2016, the Board of Directors granted options to acquire 148,475 shares of stock from the Company’ s 2015 Incentive
Plan to directors, officers and employees based on the closing price of the Company’ s common stock on the date of the grant,
which was $1.37. These options vested 100% on the grant date and have a ten-year term expiring on March 31, 2026. The fair value
of the vested stock options was calculated using the Black-Scholes model with a volatility and discount rate over the expected
term of each employee.
These
three issuances of options issued during March 2016 were part of decreasing the base salary of employees and directors in exchange
for salary for options plan, issued out of the 2015 Incentive Plan.
On
December 5, 2016, the Board of Directors granted 5,000 stock options from the Company’ s 2015 Incentive Plan to officers
and employees based on the closing price of the Company’ s common stock on the date of the grant, which was $1.20. These
options vested 33% on the first anniversary of the grant date, 33% on the second anniversary of the grant date and 34% on third
anniversary of the grant date.
On
December 22, 2016, the Board of Directors granted 54,200 stock options from the Company’ s 2015 Incentive Plan to officers
and employees based on the closing price of the Company’ s common stock on the date of the grant, which was $1.11. These
options vested 33% on the first anniversary of the grant date, 33% on the second anniversary of the grant date and 34% on the
third anniversary of the grant date.
On
December 1, 2017, the Board of Directors granted 67,500 stock options from the Company’s 2015 Incentive plan to officers
and employees based on the Company’s common stock on the date of grant, which was $1.30. These options vest 33% on the first
anniversary of the grant date, 33% on the second anniversary of the grant date, and 34% on the third anniversary of the grant
date.
Compensation
expense recognized for option grants vesting under the 2015 Incentive Plan was approximately $15,000 and $145,000 for the years
ending December 31, 2017 and 2016. The Company recognized compensation expense and recorded it as share-based compensation in
the consolidated condensed statement of operations.
The
following table summarizes stock options outstanding and changes during the years ended December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
Number
of Stock Options
|
|
|
Weighted
- Average Exercise Price
|
|
|
Number
of Stock Options
|
|
|
Weighted
- Average Exercise Price
|
|
Stock
options outstanding at beginning of period
|
|
|
425,000
|
|
|
$
|
1.52
|
|
|
|
86,500
|
|
|
$
|
1.85
|
|
Granted
|
|
|
67,500
|
|
|
|
1.30
|
|
|
|
368,333
|
|
|
|
1.47
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
(6,701
|
)
|
|
|
1.44
|
|
|
|
(10,325
|
)
|
|
|
1.85
|
|
Canceled
or forfeited
|
|
|
(26,972
|
)
|
|
|
1.28
|
|
|
|
(19,508
|
)
|
|
|
1.85
|
|
Stock
options outstanding at end of period
|
|
|
458,827
|
|
|
|
1.50
|
|
|
|
425,000
|
|
|
$
|
1.52
|
|
Stock
options exercised at end of period
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
The
fair value of stock options granted to employees and directors in 2017 was estimated at the grant date using the Black-Scholes
option pricing model using the following assumptions:
Expected
volatility
|
|
|
59
|
%
|
Discount
rate
|
|
|
1.90
|
%
|
Expected
life (years)
|
|
|
3
|
|
Dividend
yield
|
|
|
N/A
|
|
Option
pricing models require the input of highly subjective assumptions, including the expected price volatility. Expected price volatility
is based on the historical volatility of our common stock. Changes in the subjective input assumptions can materially affect the
fair value estimate. The expected term of the options granted is derived from the output of the option pricing model and represents
the period of time that the options granted are expected to be outstanding. The discount rate for the periods within the contractual
term of the option is based on the U.S. Treasury yield curve in effect at the date of grant.