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 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.
Segment
Reporting
We
operate as a single operating segment, which reflects how we manage our business. We operate in North America and the Middle East. See
Note 13 – Geographical Operations Information.
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
account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), except for tool
rental revenue. Under ASC 606 revenue is measured based on a consideration specified in a customer’s contract, excluding any sale
incentives and taxes collected on behalf of third parties. Revenue is recognized when a customer obtains control of promised goods or
services in an amount that reflects the consideration that we expect to receive for those goods or services. To recognize revenue, we
(i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction
price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, we
satisfy the performance obligation(s). Shipping and handling costs incurred are accounted for as fulfillment costs and are included in
cost of revenues in the statements of operations.
Tool
sales, rentals and other related revenue
Tool
and Product Sales: Revenue 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 under ASC Topic 842, Leases (“ASC 842”). While the duration of the rents varies
by job and number of runs, the rental terms are generally less than one month; are typically based on the price per run or footage drilled;
and do not have any minimum rental payments or term. Tool rental revenue is recognized upon completion of the customer’s job for
which the tool was rented.
Other
Related Revenue: We receive revenue from the repair of tools and recognize revenue 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 the shipping point. Shipping and handling costs related to refurbishing services are paid directly by the customer at the time
of shipment. By contract, we can only refurbish and manufacture oil or gas drill bits for Baker Hughes, but we are not contractually
prohibited from manufacturing drill bits for the mining industry.
See
Note 2– Revenue.
Cash
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, 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 due to the
relatively short period to maturity for these instruments.
Accounts
Receivable and Allowance for Doubtful Accounts
Domestically accounts receivable are generally
due within 60 days of the invoice date. Internationally our due date terms are generally 90 days from 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 $0
as of both December 31, 2021 and 2020.
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.
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.
A
disposal group that is classified as held for sale is initially measured at the lower of its carrying amount or fair value less any costs
to sell. Any loss resulting from this measurement is recognized in the period in which the held for sale criteria are met.
Subsequent
changes in the fair value of a disposal group less any costs to sell are reported as an adjustment to the carrying amount of the disposal
group, as long as the new carrying amount does not exceed the carrying amount of the asset at the time it was initially classified as
held for sale. Upon determining that a disposal group meets the criteria to be classified as held for sale, the Company reports the assets
and liabilities of the disposal group for all periods presented in the line items assets held for sale and liabilities held for sale,
respectively, in the consolidated balance sheets.
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, is calculated
using the straight-line method over the asset’s estimated useful life as follows:
SCHEDULE OF ASSET'S ESTIMATED USEFUL LIFE
Buildings
and leasehold Improvements |
|
2-39
years |
Machinery,
equipment and rental tools |
|
18
months -10 years |
Office
equipment, fixtures and software |
|
3-7
years |
Transportation
equipment |
|
5
- 30 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 5 to 9 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.
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. 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. At December 31, 2021, the balance of the assets and liabilities of operating
lease right-of-use assets and lease liabilities was $20,518. 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 an estimate of 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.
Research
and Development
We
expense research and development costs as they are incurred. For the years ended December 31, 2021 and 2020, these expenses were approximately
$672,000 and $790,000, 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.
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 are presented as a direct reduction from the carrying amount of the note
payable. For calendar years 2021 and 2020, the amortized debt issuance costs were $18,522
and $18,524,
respectively.
Share
Based Compensation
Share-based
compensation expense related to stock option and restricted stock awards, is recognized based on the grant-date fair values. The Company
recognizes compensation expense on a straight-line basis over the requisite service period of the award.
Concentrations
and Credit Risk
The
Company has two significant customers that represented 83% and 80% of our revenue for the years ended December 31, 2021 and 2020, respectively.
These customers had approximately $1,910,000 and $436,000 in accounts receivable at December 31, 2021 and 2020, respectively.
We
had two significant vendors that represented 13% of our purchases and had approximately $136,000 in accounts payable at December 31,
2021. The Company had one vendor that represented 13% of our purchases for the year ended December 31, 2020. This vendor had approximately
$61,000 in accounts payable at December 31, 2020.
Restatement
of the Consolidated Financial Statements
The
purpose of this restatement is to correct an error in the Company’s previously issued financial statements for the year ended December
31, 2020 in connection with the classification of $945,707 of inventory converted to property, plant and equipment reported within the
Supplemental Information section of the Statement of Cash Flows. The $945,707 in inventory converted to property, plant and equipment
has now been re-classified to purchases of property, plant and equipment in the Cash Flows from Investing Activities section of the Statement
of Cash Flows.
There
was no effect of the restatement to the Company’s consolidated balance sheet, consolidated statement of operations and consolidated
statement of changes in stockholders’ deficit for the year ended December 31, 2020.
In
accordance with the guidance provided by the SEC’s Staff Accounting Bulletin 99, Materiality (“SAB 99”) and Staff Accounting
Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements
(“SAB 108”), the Company has determined that the impact of adjustments relating to the correction of this accounting error
are not material to previously issued annual audited financial statements.
The
effects of the restatement on the Company’s consolidated statement of cash flows for the year ended December 31, 2020 are as follows:
SCHEDULE
OF RESTATEMENT OF CONSOLIDATED STATEMENT OF CASH FLOWS
|
| |
December 31, 2020 | |
|
| |
As Reported | | |
As Restated | |
- |
Net cash provided in operating activities | |
| 575,239 | | |
| 1,520,946 | |
- |
Net cash used in investing activities | |
| (71,806 | ) | |
| (1,017,513 | ) |
There
was no impact to net cash provided by financing activities within our consolidated statement of cash flows nor was there an impact on
the net change in cash resulting from restatement.
Reclassifications
Certain
prior year amounts have been reclassified on the balance sheet to conform to the current year presentation. The reclassifications were
within accounts payable and accrued expenses and did not impact net income. In addition, there was a reclass in note 12 for 2020.
Recent
Accounting Pronouncements
There
are no recently issued accounting pronouncements that we have not yet adopted that we believe will have a material effect on our financial
statements.
NOTE
2. 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 revenue.
All
of our contracts are less than one year in duration. We do not disclose the value of unsatisfied performance obligations for (i) contracts
with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have
the right to invoice for services performed.
Disaggregation
of Revenue
Approximately
87% of our revenue is from the United States and approximately 13% is from the Middle East for the year ended December 31, 2021. For
the year ended December 31, 2020, approximately 82% of our revenue was from the United States and approximately 18% was from the Middle
East.
Revenue
disaggregated by revenue source are as follows:
SCHEDULE OF REVENUE DISAGGREGATED BY REVENUE
| |
December 31, | |
| |
2021 | | |
2020 | |
| |
| | |
| |
Tool Revenue: | |
| | | |
| | |
Tool and product sales | |
$ | 2,610,500 | | |
$ | 1,145,520 | |
Tool rental | |
| 1,716,556 | | |
| 1,884,329 | |
Other related revenue | |
| 4,917,426 | | |
| 4,020,687 | |
Total Tool Revenue | |
| 9,244,482 | | |
| 7,050,536 | |
| |
| | | |
| | |
Contract Services | |
| 4,091,667 | | |
| 3,420,262 | |
| |
| | | |
| | |
Total Revenue | |
$ | 13,336,149 | | |
$ | 10,470,798 | |
Contract
Costs
We
do not incur any material costs of obtaining contracts.
Contract
Balances
Under
our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional.
Accordingly, our contracts do not give rise to contract assets or liabilities under Topic 606.
NOTE
3. INVENTORIES
Inventories
were comprised of the following:
SCHEDULE OF INVENTORIES
| |
December 31, 2021 | | |
December 31, 2020 | |
Raw material | |
$ | 769,547 | | |
$ | 733,734 | |
Work in progress | |
| 65,945 | | |
| 50,631 | |
Finished goods | |
| 339,143 | | |
| 235,643 | |
Inventories, net | |
$ | 1,174,635 | | |
$ | 1,020,008 | |
The
Company wrote off $0 and $4,800 related to slow moving inventory in 2021 and 2020, respectively.
NOTE
4. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
SCHEDULE OF PROPERTY, PLANT AND EQUIPMENT
| |
December 31, 2021 | | |
December 31, 2020 | |
Land | |
$ | 880,416 | | |
$ | 880,416 | |
Buildings | |
| 4,764,441 | | |
| 4,764,441 | |
Leasehold improvements | |
| 755,039 | | |
| 755,039 | |
Machinery, equipment, and rental tools | |
| 12,207,497 | | |
| 11,298,642 | |
Office equipment, fixtures and software | |
| 628,358 | | |
| 628,358 | |
Transportation assets | |
| 265,760 | | |
| 265,760 | |
Property, plant and equipment, gross | |
| 19,501,511 | | |
| 18,592,656 | |
Accumulated depreciation | |
| (12,571,182 | ) | |
| (11,057,558 | ) |
Property, plant and equipment,
net | |
$ | 6,930,329 | | |
$ | 7,535,098 | |
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 hangar in March 2020. In February 2021, the Company sold the hangar for a gain of $10,000 which was recorded in the first quarter
of 2021.
Depreciation
expense related to property, plant and equipment for the years ended December 31, 2021 and 2020 was $1,520,201 and $1,649,729 respectively.
NOTE
5. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
SCHEDULE OF INTANGIBLE ASSETS
| |
December 31, 2021 | | |
December 31, 2020 | |
Developed technology | |
$ | 7,000,000 | | |
$ | 7,000,000 | |
Customer contracts | |
| 6,400,000 | | |
| 6,400,000 | |
Trademarks | |
| 1,500,000 | | |
| 1,500,000 | |
| |
| 14,900,000 | | |
| 14,900,000 | |
Accumulated amortization | |
| (14,663,889 | ) | |
| (14,080,556 | ) |
| |
$ | 236,111 | | |
$ | 819,444 | |
Amortization
expense related to intangible assets for the years ended December 31, 2021 and 2020 was $583,333 and $1,166,667, 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, 2021, the Company will recognize the following amortization expense for the respective periods
ending December 31 noted below:
SCHEDULE OF FINITE-LIVED INTANGIBLE ASSETS, FUTURE AMORTIZATION EXPENSE
| |
| | |
2022 | |
| 166,667 | |
2023 | |
| 69,444 | |
Total | |
$ | 236,111 | |
During
the years ended December 31, 2021 and 2020, there were no impairments recognized related to other intangible assets.
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 in order to
take over the legal position as Tronco’s senior secured lender. Tronco is an entity owned by Troy and Annette Meier. Effective
August 2017, the Company fully reserved the related party note receivable of $6,979,043, which reduced the related party note receivable
balance to $0. The Company continues to hold the 8,267,860 shares of the Company’s common stock as collateral. The Company will
record a recovery of the loan upon receiving repayment of the note or interest in other income. On July 7, 2020, the Company entered
into an amended and restated loan agreement and note with Tronco changing the payment terms on the note. As amended, the interest rate
on the note is fixed at 2% per annum. The note matures with a balloon payment of all unpaid interest and principal due on December 31,
2022.
A
bonus was accrued but not paid to the Meiers during 2020. The Meiers did not make a Tronco interest payment in 2020. An after tax
bonus payable to the Meiers of $707,000
was applied towards the Tronco note comprising approximately $365,000
in interest and approximately $342,000
towards the principal amount of the note. The
Tronco note balance as of December 31, 2021 was approximately $6,749,000.
NOTE
7. LEASES
The
Company determines whether a contract is a lease, 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. See Note 10 – Financing Obligation regarding the
sale-leaseback of our Utah facilities.
The
table below presents the lease related assets and liabilities recorded on the Company’s consolidated balance sheet as of December
31, 2021:
SCHEDULE OF LEASE RELATED ASSETS AND LIABILITIES
| |
Classification on Balance Sheet | |
December 31, 2021 | |
Assets | |
| |
| | |
Operating lease assets | |
Operating lease right of use assets | |
$ | 20,518 | |
Total lease assets | |
| |
$ | 20,518 | |
| |
| |
| | |
Liabilities | |
| |
| | |
Current liabilities | |
| |
| | |
Operating lease liability | |
Current operating lease liability | |
$ | 13,716 | |
Noncurrrent liabilities | |
| |
| | |
Operating lease liability | |
Long-term operating lease liability | |
| 6,802 | |
Total lease liability | |
| |
$ | 20,518 | |
The
lease expense and the cash paid under operating leases for the year ended December 31, 2021 was $48,621. At December 31, 2021, the weighted
average remaining lease terms were 0.97 years and the weighted average discount rate was 7.25%.
The
following is the aggregate future lease payments for operating leases as of December 31, 2021:
SCHEDULE OF AGGREGATE FUTURE LEASE PAYMENTS FOR OPERATING LEASES
| |
| | |
2022 | |
| 15,252 | |
2023 | |
| 8,052 | |
Total undiscounted lease payments | |
| 23,304 | |
Less: effects of discounting | |
| (2,786 | ) |
Present value of lease payments | |
$ | 20,518 | |
NOTE
8. LONG-TERM DEBT
Long-term
debt is comprised of the following:
SCHEDULE OF LONG-TERM DEBT INSTRUMENTS
| |
December 31, 2021 | | |
December 31, 2020 | |
| |
| | |
| |
Hard Rock Note | |
$ | 750,000 | | |
$ | 1,500,000 | |
Credit Agreement | |
| 1,312,194 | | |
| 825,366 | |
Machinery loans | |
| 357,963 | | |
| 466,448 | |
Transportation loans | |
| 32,277 | | |
| 56,572 | |
| |
| 2,452,434 | | |
| 2,848,386 | |
Current portion of long-term debt | |
| (2,195,759 | ) | |
| (1,397,337 | ) |
| |
$ | 256,675 | | |
$ | 1,451,049 | |
Hard
Rock Note
In
2014, the Company purchased all of the interests of Hard Rock Solutions, LLC (“Hard Rock”). Consideration consisted of $12.5
million paid in cash at closing and a $12.5 million seller’s note (the “Hard Rock Note”). The Hard Rock Note and subsequent
amendments are secured by all of the patents, patents pending, other patent rights, and trademarks transferred to Hard Rock.
The
Hard Rock Note has a remaining balance of $750,000 as of December 31, 2021, accrues interest at 8.00% per annum and is fully payable
on October 5, 2022. The Company paid an interest payment on the note on January 20, 2022 of $17,589 and is obligated to pay interest
payments on April 5, 2022 and July 5, 2022. For the year ended December 31, 2021 the Company made a total of $104,877 in interest payments
related to the Hard Rock note.
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 $4,300,000 credit facility, which includes a $800,000 term loan (the “Term
Loan”) and a $3,500,000 line of credit (the “LOC”). As of December 31, 2021, we had approximately $333,000 outstanding
on the Term Loan and approximately $1,000,000 outstanding on the LOC. Amounts outstanding under the LOC 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.
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 LOC is classified as current
debt as a result of the required lockbox arrangement and the subjective acceleration clause. At December 31, 2021, we were in compliance
with the covenants in the Credit Agreement.
The
interest rate for the Term Loan and the LOC is prime plus 2%. At December 31, 2021, the interest rate for the Term Loan was 8.85%, which
includes a 3.6% management fee rate. Even if our borrowings under the LOC are less than $1,000,000, we still pay interest as if we had
borrowed $1,000,000. At December 31, 2021, we had approximately $9,700 of accrued interest. The obligations of the Company under the
Credit Agreement are secured by a security interest in substantially all of the tangible and intangible assets of the Company, other
than any assets owned by the Company that constitute real property (and fixtures affixed to such real property), certain excluded equipment
or intellectual property. A collateral management fee is payable monthly on the used portion of the LOC and Term Loan. 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.
Equipment
Loans
The
Company has purchased equipment and financed the purchases with a financing company and a bank. At December 31, 2021, the balance outstanding
for the equipment loans was approximately $357,963. Monthly payments are approximately $11,830, the interest rate ranges from 5.9% to
8.06%, and the notes mature in November 2024 and February 2025.
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, 2021, one vehicle loan was outstanding in the amount of $32,277 bearing interest of 6.99%, a maturity
date of June 2024 and is collateralized by the vehicle. The monthly payment is $1,169, including principal and interest.
Future
annual maturities of total debt are as follows (1):
SCHEDULE OF FUTURE ANNUAL MATURITIES OF TOTAL DEBT
Year | |
| |
2022 | |
| 2,214,283 | |
2023 | |
| 140,967 | |
2024 | |
| 115,165 | |
2025 | |
| 3,632 | |
Total debt | |
$ | 2,474,047 | |
(1) |
Excludes
discounts for debt issuance costs. |
NOTE
9. FINANCING OBLIGATION
On
December 7, 2020, the Company entered into a sale agreement (the “Sale Agreement”). Pursuant to the terms of the Sale Agreement,
the Company sold land and property related to the Company’s headquarters and manufacturing facility in Vernal, Utah (the “Property”)
for a purchase price of $4,448,500. Concurrent with the sale of the Property, the Company entered into a fifteen-year lease agreement
(the “Lease Agreement”), whereby the Company will lease back the Property at an annual rate of $311,395 with payments made
monthly, subject to annual rent increases of 1.5%. Under the Lease Agreement, the Company has an option to extend the term of the lease
and to repurchase the Property. Due to this repurchase option, the Company was unable to account for the transfer as a sale under ASC
Topic 842, Leases, and as such, the transaction is a failed sale-leaseback that is accounted for as a financing transaction.
The
Company received cash of $1,622,106, retired real estate debt of $2,638,773 and recorded a financing obligation liability of $4,260,879
related to the transaction. There was no gain recorded since sale accounting was precluded. The financing obligation has an implied interest
rate of 6.0%. At the conclusion of the fifteen-year lease period, the financing obligation residual will be $2,188,710, which will correspond
to the carrying value of the property. The Company paid $61,616 and $25,950 of principal in 2021 and 2020, respectively. The balance
of the financing obligation at December 31, 2021 was $4,178,336.
The
financing obligation is summarized below:
SCHEDULE OF FINANCING OBLIGATION
| |
December 31, 2021 | |
Finance obligations for sale-leaseback transactions | |
$ | 4,178,336 | |
Current principal portion of finance obligation | |
| (65,678 | ) |
Non-current portion of finance obligation | |
$ | 4,112,658 | |
The
following is the aggregate future lease payments that include principal and interest for the finance obligation as of December 31, 2021:
SCHEDULE OF AGGREGATE FUTURE LEASE PAYMENTS FOR THE FINANCE OBLIGATION
| |
| | |
2022 | |
| 316,384 | |
2023 | |
| 321,130 | |
2024 | |
| 325,947 | |
2025 | |
| 330,836 | |
2026 | |
| 335,799 | |
Thereafter | |
| 3,257,778 | |
Total undiscounted lease payments | |
| 4,887,874 | |
Residual value of the property (included in the future payments) | |
| 2,188,711 | |
Less: effects of discounting | |
| (2,898,249 | ) |
Present value of lease payments | |
$ | 4,178,336 | |
NOTE
10. COMMITMENTS AND CONTINGENCIES
We
are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company
filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana, Lafayette Division, asserting
that Stabil Drill Specialties, LLC’s (“Stabil Drill”) Smoothbore Eccentric Reamer infringes the patents of Extreme
Technologies (one of our subsidiaries) on our patented Drill-N-Ream well bore conditioning tool. The lawsuit was subsequently moved from
Louisiana to the United States District Court for the Southern District of Texas, Houston Division. Additionally, on May 20, 2019, Extreme
Technologies, LLC sued Short Bit & Tool Co. and Lot William Short, Jr. (“Defendants”) in the Northern District of Texas-Dallas
Division for their work manufacturing the Smoothbore Eccentric Reamer for Stabil Drill. The Dallas lawsuit is stayed pending resolution
of the first-filed, Houston suit. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company, filed for bankruptcy,
which resulted in a brief, automatic stay of the litigation. Superior Energy Services announced on February 2, 2021, that it successfully
completed its financial restructuring and emerged from Chapter 11 bankruptcy, but this bankruptcy did not affect Extreme’s claims
against Superior’s subsidiary Stabil Drill. On March 9, 2021, the Court lifted the automatic bankruptcy stay, and on May 12, 2021,
the Court denied Stabil Drill’s motion for summary judgment of non-infringement. The parties are preparing this case for trial
and expect a jury trial setting in late 2022 or early 2023.
NOTE
11. INCOME TAXES
Components
of income tax expense are as follows:
SCHEDULE OF COMPONENTS OF INCOME TAX BENEFIT
| |
For the Year Ended December 31, 2021 | | |
For the Year Ended December 31, 2020 | |
Current income taxes: | |
| | | |
| | |
Federal | |
$ | - | | |
$ | - | |
State | |
| 5,964 | | |
| 10,481 | |
International | |
| 104,787 | | |
| 104,515 | |
Current provision for income taxes | |
| 110,751 | | |
| 114,996 | |
Deferred provision (benefit) for income taxes: | |
| | | |
| | |
Federal | |
| - | | |
| - | |
State | |
| - | | |
| - | |
Deferred provision (benefit) for income taxes | |
| - | | |
| - | |
Provision for income taxes | |
$ | 110,751 | | |
$ | 114,996 | |
The
non-current deferred tax assets and liabilities consist of the following:
SCHEDULE OF DEFERRED TAX ASSETS AND LIABILITIES
| |
| | |
| |
Deferred tax assets: | |
| | |
| |
263A adjustment | |
$ | 14,204 | | |
$ | 12,133 | |
Accrued expenses | |
| - | | |
| 183,282 | |
Prepaid expenses | |
| (27,498 | ) | |
| (15,458 | ) |
Stock compensation | |
| 159,315 | | |
| 122,191 | |
Stock option | |
| 71,251 | | |
| 70,201 | |
Amortization of intangibles | |
| 2,661,090 | | |
| 2,839,598 | |
Net operating loss | |
| 3,246,413 | | |
| 2,898,078 | |
Allowances | |
| 1,632,266 | | |
| 1,686,952 | |
Sale-leaseback – lease liability | |
| 1,010,467 | | |
| 1,008,663 | |
Others | |
| 22,181 | | |
| 20,102 | |
Total non-current deferred tax assets | |
| 8,789,689 | | |
| 8,825,742 | |
| |
| | | |
| | |
Deferred tax liabilities: | |
| | | |
| | |
| |
| | | |
| | |
Depreciation on sale-leaseback fixed assets | |
| (942,799 | ) | |
| (967,055 | ) |
Depreciation on fixed assets | |
| (46,881 | ) | |
| (251,190 | ) |
Total non-current deferred tax liabilities | |
| (989,680 | ) | |
| (1,218,245 | ) |
| |
| | | |
| | |
Net non-current deferred tax assets/liabilities | |
| 7,800,010 | | |
| 7,607,497 | |
Less: Valuation Allowance | |
| (7,800,010 | ) | |
| (7,607,497 | ) |
Total deferred tax assets / liabilities | |
$ | - | | |
$ | - | |
The
Company’s tax expense differs from the statutory tax benefit for the years ended December 31, 2021 and 2020
and the reconciliation is as follows:
SCHEDULE
OF STATUTORY TAX BENEFIT
| |
For the Year Ended December 31, 2021 | | |
For the Year Ended December 31, 2020 | |
| |
| | |
| |
Tax benefit at federal statutory rate | |
$ | (88,001 | ) | |
$ | (696,124 | ) |
State income taxes | |
| 4,712 | | |
| 8,280 | |
Foreign income taxes | |
| 79,445 | | |
| - | |
Permanent differences | |
| 38,458 | | |
| (219,880 | ) |
Change in valuation allowance | |
| 192,512 | | |
| 903,335 | |
Other adjustment/tax expense true-up | |
| - | | |
| 79,651 | |
Other - State rate effect | |
| (13,532 | ) | |
| (92,760 | ) |
Change in status | |
| (125,747 | ) | |
| 66,835 | |
Other | |
| 22,904 | | |
| 65,659 | |
Provision for income taxes | |
$ | 110,751 | | |
$ | 114,996 | |
In
calendar years 2021 and 2020, the Company paid no income taxes and approximately $14,000, respectively.
We
have total federal income tax Net Operating Loss (NOL) carryforwards of $13,424,000 of which $10,067,000 pertains to pre-2018 losses
and $3,357,000 pertains to post-2017 losses. The pre-2018 losses will begin to expire between 2035 and 2037. The post-2017 losses can
be carried forward indefinitely, however, only 80% of these losses can offset taxable income.
We
believe that it is more likely than not that the benefit from these NOL carryforwards will not be realized. In recognition of this risk,
we have provided a valuation allowance of $3,246,000 on these deferred tax assets.
In
accordance with the accounting under ASC Topic 740, the Company has recorded a liability for an uncertain tax position taken on its international
income tax returns. Penalties related to this income tax liability are included as a component of income tax expense in the accompanying
statements of operations.
The
Company had approximately 206,000 and $106,000 of accrued income tax payable, including accrued penalties, as of December 31, 2021, and
2020, respectively, which are included as a separate line in current liabilities in the accompanying balance sheets. The amount of penalties
charged to income tax expense as a result of this uncertain tax position was $6,000 and $ 0 for the years ended December 31, 2021, and
2020, respectively.
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 2020, the Company’s board of directors approved an additional 2,543,448
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 5,576,326. As of December 31, 2021, there were 455,000 remaining shares that can be granted under the Company’s
2015 Incentive Plan.
Restricted
stock units
On
August 9, 2021, the Board of Directors granted 1,231,541 restricted stock units from the 2015 Incentive Plan to executive management
and directors based on the average price of the Company’s common stock on the date of the grant. These restricted units will vest
over a three - year period.
On
August 7, 2020, the Board of Directors granted 1,544,719 restricted stock units from the 2015 Incentive Plan to executive management
and directors based on the average price of the Company’s common stock on the date of the grant. These restricted units will vest
over a three - year period.
Compensation
expense recognized for grants of restricted stock vesting under the 2015 Incentive Plan was approximately $754,000
and $545,000
for the years ending December 31, 2021 and 2020,
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 2.25 years equaled approximately $1,603,321 at December 31, 2021. These shares vest over three years.
The
following table summarizes RSU activity for the years ended December 31, 2021 and 2020:
SCHEDULE OF SHARE-BASED COMPENSATION, RESTRICTED STOCK UNITS AWARD ACTIVITY
| |
2021 | | |
2020 | |
| |
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 | |
| 1,796,897 | | |
$ | 0.71 | | |
| 706,394 | | |
$ | 1.24 | |
Granted | |
| 1,231,541 | | |
| 0.76 | | |
| 1,544,719 | | |
| 0.59 | |
Forfeited | |
| (10,000 | ) | |
| 0.59 | | |
| (110,000 | ) | |
| 0.59 | |
Vested | |
| (733,528 | ) | |
| 0.83 | | |
| (344,216 | ) | |
| 1.29 | |
Unvested RSU’s at end of period | |
| 2,284,910 | | |
$ | 0.70 | | |
| 1,796,897 | | |
$ | 0.71 | |
Stock
Options
On
August 9, 2021 the Board of Directors approved to be granted 74,996
stock options under the 2015 Incentive Plan to
employees. These options were granted to employees on December 10, 2021 at a grant price of $0.78.
The fair value, based on the Black-Scholes
option pricing model, on the date of grant was $0.31.
The
options vest 33.3%
on the grant date, 33.3%
on the first anniversary of the grant date and 33.4%
on the second anniversary of the grant date.
The
Company recognized stock-based compensation expense of approximately $3,000 during the year ended December 31, 2021 related to
stock options.
The
following table summarizes stock options outstanding and changes during the years ended December 31, 2021 and 2020:
SCHEDULE OF SHARE-BASED COMPENSATION, STOCK OPTIONS, ACTIVITY
| |
2021 | | |
2020 | |
| |
Number of Stock Options | | |
Weighted - Average Exercise Price | | |
Number of Stock Options | | |
Weighted - Average Exercise Price | |
Stock options outstanding at beginning of period | |
| 498,277 | | |
$ | 1.53 | | |
| 588,133 | | |
$ | 1.50 | |
Granted | |
| 74,996 | | |
| 0.78 | | |
| - | | |
| - | |
Exercised | |
| (1,865 | ) | |
| 0.86 | | |
| - | | |
| - | |
Expired | |
| (172,828 | ) | |
| 1.67 | | |
| (51,971 | ) | |
| 1.40 | |
Canceled or forfeited | |
| - | | |
| - | | |
| (37,885 | ) | |
| 1.19 | |
Stock options outstanding at end of period | |
| 398,580 | | |
$ | 1.34 | | |
| 498,277 | | |
$ | 1.53 | |
Stock options exercisable at end of period | |
| 321,586 | | |
$ | 1.47 | | |
| 481,076 | | |
$ | 1.55 | |
The
fair value of stock options granted to employees and directors in 2021 was estimated at the grant date using the Black-Scholes option
pricing model using the following assumptions:
SCHEDULE OF SHARE-BASED PAYMENT AWARD, STOCK OPTIONS, VALUATION ASSUMPTIONS
Expected volatility | |
| 59.50 | % |
Discount rate | |
| 1.25 | % |
Expected life (years) | |
| 2 | |
Dividend yield | |
| NA | |
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.
NOTE
13. GEOGRAPHICAL OPERATIONS INFORMATION
The
following summarizes revenue by geographic location:
SCHEDULE OF REVENUE AND PROPERTY, PLANT AND EQUIPMENT BY GEOGRAPHIC LOCATION
| |
For the Year Ended December 31, 2021 | | |
For the Year Ended December 31, 2020 | |
| |
| | |
| |
Revenue: | |
| | | |
| | |
North America | |
$ | 11,619,593 | | |
$ | 8,590,933 | |
International | |
$ | 1,716,556 | | |
$ | 1,879,865 | |
| |
$ | 13,336,149 | | |
$ | 10,470,798 | |
The
following summarizes net property, plant and equipment by geographic location:
SCHEDULE
OF NET PROPERTY, PLANT AND EQUIPMENT BY GEOGRAPHIC LOCATION
| |
December 31, 2021 | | |
December 31, 2020 | |
Property, plant and equipment, net: | |
| | | |
| | |
North America | |
$ | 5,762,066 | | |
$ | 6,008,431 | |
International | |
| 1,168,263 | | |
| 1,526,667 | |
| |
$ | 6,930,329 | | |
$ | 7,535,098 | |