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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2022

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 001-36453

 

Superior Drilling Products, Inc.

(Exact name of registrant as specified in its charter)

 

Utah   46-4341605
(State or other jurisdiction of
incorporation or organization)		   (IRS Employer
Identification No )

 

1583 South 1700 East

Vernal, Utah 84078

(Address of principal executive offices)

 

435-789-0594

(Issuer’s telephone number)

 

 

(Former name, address, and fiscal year, if changed since last report)

 

Securities Registered Pursuant to Section 12(b) of the Exchange Act:

 

Title of each class:   Trading Symbol(s)   Name of each exchange on which registered:
Common Stock, $0.001 par value   SDPI   NYSE American

 

Securities Registered Pursuant to Section 12(g) of the Exchange Act: None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or such shorter period that the Registrant was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

There were 28,235,001 shares of common stock, $0.001 par value, issued and outstanding as of May 13, 2022.

 

 

 

 

 

 

Superior Drilling Products, Inc.

FORM 10-Q

 

QUARTER ENDED March 31, 2022

 

TABLE OF CONTENTS

 

  Page
   
PART I-FINANCIAL INFORMATION  
   
Item 1. Financial Statements 3
   
Condensed Consolidated Balance Sheets (Unaudited) at March 31,2022 and December 31, 2021 3
   
Condensed Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2022 and 2021 4
   
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited) for the three months ended March 31, 2022 and 2021 5
   
Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2022 and 2021 6
   
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15
   
Item 4. Controls and Procedures 21
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 22
   
Item 1A. Risk Factors 22
   
Item 6. Exhibits 22
   
Signatures 23

 

2

 

 

PART I - FINANCIAL INFORMATION.

 

Item 1. Financial Statements

 

Superior Drilling Products, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

 

   March 31, 2022   December 31, 2021 
ASSETS          
Current assets          
Cash  $2,854,093   $2,822,100 
Accounts receivable, net   3,155,906    2,871,932 
Prepaid expenses   248,502    435,595 
Inventories   1,024,345    1,174,635 
Other current assets   55,744    55,159 
Total current assets   7,338,590    7,359,421 
Property, plant and equipment, net   7,480,390    6,930,329 
Intangible assets, net   194,444    236,111 
Right of use assets   18,873    20,518 
Other noncurrent assets   65,880    65,880 
Total assets  $15,098,177   $14,612,259 
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities          
Accounts payable  $1,245,122   $1,139,091 
Accrued expenses   609,991    467,462 
Income tax payable   212,878    206,490 
Current portion of operating lease liability   11,561    13,716 
Current portion of financial obligation   67,853    65,678 
Current portion of long-term debt, net of discounts   2,116,480    2,195,759 
Total current liabilities   4,263,885    4,088,196 
Operating lease liability   7,312    6,802 
Long-term financial obligation, less current portion   4,093,686    4,112,658 
Long-term debt, less current portion, net of discounts   225,396    256,675 
Total liabilities   8,590,279    8,464,331 
Commitments and contingencies (Note 11)   -      
Shareholders’ equity          
Common stock - $0.001 par value; 100,000,000 shares authorized; 28,235,001 shares issued and outstanding, respectively   28,235    28,235 
Additional paid-in-capital   43,281,334    43,071,201 
Accumulated deficit   (36,801,671)   (36,951,508)
Total shareholders’ equity   6,507,898    6,147,928 
Total liabilities and shareholders’ equity  $15,098,177   $14,612,259 

 

The accompanying notes are an integral part of these condensed unaudited consolidated financial statements.

 

3

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

   2022   2021 
   For the Three Months 
   Ended March 31, 
   2022   2021 
         
Revenue          
Tool revenue  $2,769,247   $1,663,763 
Contract services   1,360,917    760,890 
           
Total Revenue   4,130,164    2,424,653 
           
Operating costs and expenses          
Cost of revenue   1,767,903    1,175,593 
Selling, general and administrative expenses   1,646,643    1,515,590 
Depreciation and amortization expense   410,733    690,074 
           
Total operating costs and expenses   3,825,279    3,381,257 
           
Operating income (loss)   304,885    (956,604)
           
Other income (expense)          
Interest income   197    48 
Interest expense   (123,861)   (138,057)
Gain (loss) on disposition of assets, net   -    10,000 
Total other expense   (123,664)   (128,009)
           
Income (loss) before income taxes   181,221    (1,084,613)
Income tax expense   (31,384)   (17,180)
           
Net income/(loss)  $149,837   $(1,101,793)
           
Basic loss earnings per common share  $.01   $(0.04)
Basic weighted average common shares outstanding   28,235,001    25,762,342 
Diluted loss per common share  $0.01   $(0.04)
Diluted weighted average common shares outstanding   28,305,101    25,762,342 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Shareholders’ Equity

(Unaudited)

 

   Shares   Par Value   Capital   Deficit   Equity 
   Common Stock   Additional
Paid-in		   Accumulated   Total
Shareholders’		 
   Shares   Par Value   Capital   Deficit   Equity 
Balance – December 31, 2021   28,235,001   $28,235   $43,071,201   $(36,951,508)  $6,147,928 
                          
Stock-based compensation expense   -    -    210,133    -    210,133 
Net income   -    -    -    149,837    149,837 
                          
Balance – March 31, 2022   28,235,001   $28,235   $43,281,334   $(36,801,671)  $6,507,898 
                          
Balance – December 31, 2020   25,762,342   $25,762   $40,619,620   $(36,421,707)  $4,223,675 
                          
Stock-based compensation expense   -    -    167,472    -    167,472 
Net income   -    -    -    (1,101,793)   (1,101,793)
                          
Balance – March 31, 2021   25,762,342   $25,762   $40,787,092   $(37,523,500)  $3,289,354 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   2022   (Restated) 2021 
   For the Three Months 
   Ended March 31, 
   2022   (Restated) 2021 
Cash Flows From Operating Activities          
Net loss  $149,837   $(1,101,793)
Adjustments to reconcile net loss to net cash from operating activities:          
Depreciation and amortization expense   410,733    690,074 
Stock-based compensation expense   210,133    167,473 
(Gain) loss on disposition of assets, net   -    (10,000)
Amortization of deferred loan costs   4,631    4,631 
Changes in operating assets and liabilities:          
Accounts receivable   (283,974)   (256,215)
Inventories   150,290    23,925 
Prepaid expenses and other noncurrent assets   186,508    (17,841)
Accounts payable and accrued expenses   248,560    688,449 
Income tax payable   6,388    16,380 
Net Cash From Operating Activities   1,083,106    205,083 
Cash Flows From Investing Activities          
Purchases of property, plant and equipment   (919,127)   (74,956)
Proceeds from sale of fixed assets   -    50,000 
Net Cash From Investing Activities   (919,127)   (24,956)
Cash Flows From Financing Activities          
Principal payments on debt   (131,978)   (135,403)
Payments on revolving loan   (21,541)   (280,245)
Proceeds received on revolving loan   21,533    536,331 
Net Cash From Financing Activities   (131,986)   120,683 
Net Change in Cash   31,993    300,810 
Cash at Beginning of Period   2,822,100    1,961,441 
Cash at End of Period  $2,854,093   $2,262,251 
Supplemental information:          
Cash paid for Interest  $122,157   $130,363 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

6

 

 

Superior Drilling Products, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

March 31, 2022

 

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 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 headquarters and manufacturing operations are located in Vernal, Utah.

 

Our subsidiaries include (a) Superior Drilling Solutions, LLC (previously known as Superior Drilling Products, LLC), a Utah limited liability company (“SDS”), together with its wholly owned subsidiary Superior Design and Fabrication, LLC, a Utah limited liability company (“SDF”), (b) Extreme Technologies, LLC, a Utah limited liability company (“ET”), (c) Meier Properties Series, LLC, a Utah limited liability company (“MPS”), (d) Meier Leasing, LLC, a Utah limited liability company (“ML”), and (e) Hard Rock Solutions, LLC (“HR” or “Hard Rock”).

 

Basis of Presentation

 

The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of Superior Drilling Products Inc. and all of its wholly-owned subsidiaries. All significant intercompany accounts have been eliminated in consolidation. The Company does not have investments in any unconsolidated subsidiaries.

 

Unaudited Interim Financial Presentation

 

These unaudited interim condensed consolidated financial statements for the three months ended March 31, 2022 and 2021, and the related footnote disclosures included herein, are unaudited. However, in the opinion of management, these unaudited condensed consolidated interim financial statements have been prepared on the same basis as the audited financial statements and reflect all adjustments necessary to fairly state the results for such periods. The results of operations for the three months ended March 31, 2022 are not necessarily indicative of the results of operations expected for the year ended December 31, 2022. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2021 and the notes thereto, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission (the “SEC”).

 

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 9.

 

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, share-based compensation expense, and valuation allowances for accounts receivable, inventories, and deferred tax assets.

 

7

 

 

Concentrations of Credit Risk

 

The Company has two significant customers that represented 90% and 85% of its revenue for the three months ended March 31, 2022 and 2021, respectively. These customers had approximately $2,137,000 and $846,000 in accounts receivable as of March 31, 2022 and 2021, respectively.

 

The Company had two vendors that represented 13% of its purchases for the three months ended March 31, 2022. These vendors had approximately $122,000 in accounts payable as of March 31, 2022 and purchases in the three months of ended March 31, 2022 from these vendors totaled approximately $274,000. The Company had two vendors that represented 22% of its purchases for the three months ended March 31, 2021. These vendors had approximately $221,000 in accounts payable as of March 31, 2021 and purchases in the three months ended March 31, 2021 from these vendors totaled approximately $239,000.

 

 

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 March 31, 2021 in connection with the classification of $65,720 of inventory converted to property, plant and equipment reported within the Supplemental Information section of the Statement of Cash Flows. The $65,720 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 condensed consolidated balance sheet, condensed consolidated statement of operations and condensed consolidated statement of shareholders’ equity for the quarter ended March 31, 2021.

 

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 and unaudited interim financial statements.

 

The effects of the restatement on the Company’s consolidated statement of cash flows for the quarter ended March 31, 2021 are as follows:

 

      March 31, 2021  
      As Reported     As Restated  
- Net cash from operating activities     139,363       205,083  
- Net cash from investing activities     40,764       (24,956 )

 

There was no impact to net cash provided from financing activities within our consolidated statement of cash flows nor was there an impact on the net change in cash resulting from restatement.

 

Uncertain Tax Matters

 

The Company believes it has appropriately accrued for the expected outcome of uncertain tax matters and believes such liabilities represent a reasonable provision for taxes ultimately expected to be paid; however, these liabilities may need to be adjusted as new information becomes known and as tax examinations continue to progress, or as settlements or litigations occur.

 

8

 

 

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.

 

Income Tax Expense

 

The Company recorded income tax expense during the quarter of $31,384 with income before income taxes of $181,221. In the U.S. the Company has not generated a tax liability due to incurring taxable losses.

 

NOTE 2. REVENUE

 

Our revenue is derived from short-term contracts. Revenue is recognized when we satisfy a performance obligation by transferring control of the promised goods or services to our customers at a point in time, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. We also assess our customer’s ability and intention to pay, which is based on a variety of factors including our customer’s historical payment experience and financial condition. Payment terms and conditions vary, although terms generally include a requirement of payment within 30 days.

 

Revenue generally does not include right of return or other significant post-delivery obligations. Revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. We elected to treat shipping and handling costs as a fulfillment cost instead of as a separate performance obligation. We recognize the cost for shipping and handling when incurred as an expense in cost of sales.

 

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.

 

9

 

 

Disaggregation of Revenue

 

Approximately 91% of our revenue is from North America and approximately 9% is from the Middle East for the three months ended March 31, 2022. For the three months ended March 31, 2021, approximately 86% of our revenue was from North America and approximately 14% was from the Middle East.

 

Revenue disaggregated by revenue source are as follows:

 

   2022   2021 
  

Three months ended

March 31,

 
   2022   2021 
         
Tool Revenue:          
Tool and product sales  $664,300   $495,000 
Tool rental   385,150    336,453 
Other related revenue   1,719,797    832,310 
Total Tool Revenue   2,769,247    1,663,763 
           
Contract Services   1,360,917    760,890 
           
Total Revenue  $4,130,164   $2,424,653 

 

Contract Costs

 

We do not incur any material costs of obtaining contracts.

 

Contract Balances

 

Under our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional. Accordingly, our contracts do not give rise to contract assets or liabilities under ASC 606.

 

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NOTE 3. INVENTORIES

 

Inventories are comprised of the following:

 

   March 31, 2022   December 31, 2021 
Raw material  $835,614   $769,547 
Work in progress   112,643    65,945 
Finished goods   76,088    339,143 
Inventories, net  $1,024,345   $1,174,635 

 

NOTE 4. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are comprised of the following:

 

   March 31, 2022   December 31, 2021 
Land  $880,416   $880,416 
Buildings   4,764,441    4,764,441 
Building improvements   755,039    755,039 
Machinery and equipment   13,126,624    12,207,497 
Office equipment, fixtures and software   628,356    628,358 
Transportation assets   265,760    265,760 
Property, plant and equipment, gross   20,420,636    19,501,511 
Accumulated depreciation   (12,940,246)   (12,571,182)
Property, plant and equipment, net  $7,480,390   $6,930,329 

 

The Company sold its airplane hangar for a gain of $10,000 in February 2021.

 

Depreciation expense related to property, plant and equipment for the three months ended March 31, 2022 and 2021 was $369,066 and $398,408, respectively.

 

NOTE 5. INTANGIBLE ASSETS

 

Intangible assets are comprised of the following:

 

   March 31, 2022   December 31, 2021 
Developed technology  $7,000,000   $7,000,000 
Customer contracts   6,400,000    6,400,000 
Trademarks   1,500,000    1,500,000 
Intangible assets, gross   14,900,000    14,900,000 
Accumulated amortization   (14,705,556)   (14,663,889)
Intangible assets, net  $194,444   $236,111 

 

Amortization expense related to intangible assets for the three months ended March 31, 2022 and 2021 was $41,667 and $291,666, respectively.

 

NOTE 6. RELATED PARTY NOTE RECEIVABLE

 

In January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy Corporation 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 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. The Tronco note balance, including accrued interest, as of March 31, 2022 was approximately $6,783,000 and December 31, 2021 was approximately $6,749,000. The Company continues to hold 8,267,860 shares of the Company’s stock as collateral.

 

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NOTE 7. LONG-TERM DEBT

 

Long-term debt is comprised of the following:

 

   March 31, 2022   December 31, 2021 
Hard Rock Note  $750,000   $750,000 
Credit Agreement   1,233,483    1,312,194 
Machinery loans   329,160    357,963 
Transportation loans   29,233    32,277 
Long term debt, Total   2,341,876    2,452,434 
Less:          
Current portion   (2,116,480)   (2,195,759)
Long-term debt, net  $225,396   $256,675 

 

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 March 31, 2022, 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 prior to the full payment due on October 5, 2022. In April, the Company made the accrued interest payment of $12,328.77.

 

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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”). 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.

 

As of March 31, 2022, we had approximately $250,000 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. As of March 31, 2022, 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%. As of March 31, 2022, the interest rate for the Term Loan was 9.10%, 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. As of March 31, 2022, we had approximately $10,000 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.

 

NOTE 8. 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 is estimated to be $2,188,710, which corresponds to the carrying value of the property. The balance of the financing obligation as of March 31, 2022 and December 31, 2021 was $4,161,539 and $4,178,336, respectively.

 

The financing obligation is summarized below:

 

   March 31, 2022   December 31, 2021 
Finance obligations for sale-leaseback transactions  $4,161,539   $4,178,336 
Current principal portion of finance obligation   (67,853)   (65,678)
Non-current portion of finance obligation  $4,093,686   $4,112,658 

 

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NOTE 9. GEOGRAPHICAL OPERATIONS INFORMATION

 

The following summarizes revenue by geographic location:

 

   2022   2021 
  

Three months ended

March 31,

 
   2022   2021 
         
Revenue:          
North America  $3,745,014   $2,092,200 
Middle East  $385,150   $332,453 
Revenues  $4,130,164   $2,424,653 

 

The following summarizes net property, plant and equipment by geographic location:

 

   March 31, 2022   December 31, 2021 
Property, plant and equipment, net:          
North America  $5,456,973   $5,762,066 
Middle East   2,023,417    1,168,263 
Property, plant and equipment, net  $7,480,390   $6,930,329 

 

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, LLC (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 Technologies claims against 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. SHAREHOLDERS’ EQUITY

 

The Company is authorized to issue 100,000,000 shares of common stock, par value $0.001. As of March 31, 2022 and December 31, 2021, the number of common shares issued and outstanding was 28,235,001.

 

The Company did not grant stock options or stock awards during the three months ended March 31, 2022 and 2021, respectively.

 

NOTE 12. SUBSEQUENT EVENTS

 

On March 22, 2022, the Company entered into an agreement with Mazak to purchase a new CNC machine for $956,000. A down payment of $286,800 was used to secure the asset. The machine was received on 4/14/2022 and, upon acceptance of the machine, the Company will finance the remaining balance of $669,200.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

Introduction

 

The following discussion and analysis was prepared to supplement information contained in the accompanying financial statements and is intended to provide certain details regarding our financial condition as of March 31, 2022, and our results of operations for the three months ended March 31, 2022 and 2021. It should be read in conjunction with the unaudited financial statements and notes thereto contained in this Quarterly Report on Form 10-Q (this “Quarterly Report”) as well as our audited financial statements for the years ended December 31, 2021 and 2020, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission (the “SEC”).

 

Unless the context requires otherwise, references to the “Company” or to “we,” “us,” or “our” and other similar terms are to Superior Drilling Products, Inc. and all of its subsidiaries.

 

Forward- Looking Statements

 

This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control of the Company. You can identify the Company’s forward-looking statements by the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe” and similar expressions, or by the Company’s discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurances can be given that these expectations will prove to be correct. The forward-looking statements contained in or incorporated by reference into this Form 10-K are largely based on our expectations, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors. Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control, including:

 

  ● the continued impact of COVID-19 on domestic and global economic conditions and the future impact of such conditions on the oil and gas industry and the demand for our services;
     
  ● the volatility of oil and natural gas prices;
     
  ● the cyclical nature of the oil and gas industry;
     
  ● availability of financing and access to capital markets;
     
  ● our reliance on significant customers;
     
  ● consolidation within our customers’ industries;
     
  ● competitive products and pricing pressures;

 

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  ● our ability to develop and commercialize new and/or innovative drilling and completion tool technologies;
     
  ● fluctuations in our operating results;
     
  ● our dependence on key personnel;
     
  ● costs and availability of raw materials;
     
  ● our dependence on third party suppliers;
     
  ● unforeseen risks in our manufacturing processes;
     
  ● the need for skilled workers;
     
  ● our ability to successfully manage our growth strategy;
     
  ● unanticipated risks associated with, and our ability to integrate, acquisitions;
     
  ● current and potential governmental regulatory actions in the United States and regulatory actions and political unrest in other countries, specifically the Middle East region and Eastern Europe;
     
  ● the potential impact of the coronavirus, variants of the coronavirus or other major health crises on our business and results of operations, including the impact to our supply chain;
     
  ● terrorist threats or acts, war and civil disturbances;
     
  ● our ability to protect our intellectual property;
     
  ● impact of environmental matters, including future environmental regulations;
     
  ● implementing and complying with safety policies;
     
  ● breaches of security in our information systems and other cybersecurity risks;
     
  ● related party transactions with our founders; and
     
  ● risks associated with our common stock.

 

Many of these factors are beyond our ability to control or predict. These factors are not intended to represent a complete list of the general or specific factors that may affect us. The events in Ukraine, Russia, and the surrounding areas may result in political instability and may add a potential risk.

 

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In addition, management’s assumptions about future events may prove to be inaccurate. All readers are cautioned that the forward-looking statements contained in this Quarterly Report on Form 10-Q are not guarantees of future performance, and we cannot assure any reader that such statements will be realized or that the forward-looking events and circumstances will occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to factors described in “Item 1A. Risk Factors” in our annual report on form 10-K for the year ended December 31, 2021 and in our subsequent SEC filings. All forward-looking statements speak only as of the date they are made. We do not intend to update or revise any forward-looking statements as a result of new information, future events or otherwise, except as required by law. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

 

Executive Summary

 

We innovate, design, engineer, manufacture, sell, and repair drilling and completion tools in the United States, Canada, and the Middle East.

 

We currently have three basic operations:

 

  ● Our emerging technology business that manufactures the Drill-N-Ream tool, our innovative drill string enhancement tool, and Strider technology and other tools,
     
  ● Our PDC drill bit and other tool refurbishing and manufacturing service, and emerging technologies business that manufactures the Drill-N-Ream tool, our innovative drill string enhancement tool, the Strider technology and other tools, and
     
  ● Our new product development business that conducts our research and development, and designs our horizontal drill string enhancement tools, other down-hole drilling technologies, and drilling tool manufacturing technologies.

 

Our strategy for growth is to expand the global market penetration of our current drilling tool solutions and to leverage our expertise in drilling tool technologies and precision machining in order to broaden our product offerings and solutions for the oil and gas industry, as well as other industries that require precision machining and quality. We believe through our patented technologies, as well as technologies under development, that we can offer the oil and gas industry the solutions it demands to improve drilling efficiencies and reduce production costs.

 

Recent Developments and Trends

 

Currently we are experiencing raw material delays and difficulties in hiring and retaining direct laborers. The COVID-19 pandemic has caused and continues to cause disruption to the U.S. and global economies, including the impact of government and company actions to reduce the spread of the virus and consumer behavior in response to the same; and, although the United States and other countries have continued to roll out vaccinations, it is uncertain how quickly and effectively such vaccinations will be distributed or help to control the spread of COVID-19 and its variants. We continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. Although we are unable to predict the total impact of the COVID-19 pandemic on our business, results of operations, liquidity or capital resources at this time, we expect we may be negatively affected if the pandemic and related public health measures result in substantial manufacturing or supply chain problems, disruptions in local and global future economies, volatility in the global financial markets, overall reductions in demand, delays in payment, restrictions on the shipment of our products, or other ramifications. These current conditions are a result of COVID-19.

 

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The Russia – Ukraine conflict is a global concern. The Company does not have any direct exposure to Russia or Ukraine through its operations, employee base, investments or sanctions. The Company does not receive goods or services sourced from those countries, does not anticipate any disruption in its supply chain and has no business relationships, connections to or assets in Russia, Belarus or Ukraine. No impairments to assets have been made due to the conflict. The global oil industry has been impacted by this situation, but the Company’s operations and business in the Middle East has not been disrupted to date. The increase in oil producing activities in the United States has benefitted the Company’s operations. We are unable at this time to know the full ramifications of the Russia – Ukraine conflict and its effects on our business.

 

The total U.S. rig count as reported by Baker Hughes as of April 29, 2022 was 698 rigs, an increase of 112 rigs from the rig count as of December 31, 2021. We expect North American onshore activity to continue to improve throughout 2022 compared with 2021.

 

The Middle East market is a softer market due to the COVID-19 impact. Although this segment of our business is rebounding, the improvements are at a slower rate compared with the Company’s domestic market.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Three Months Ended March 31,2022 Compared with the Three Months Ended March 31, 2021

 

The following table represents summary consolidated operating results for the periods indicated:

 

   Three-Months Ended March 31, 
(in thousands)  2022   2021     
Tool revenue   2,769    67%   1,664    69%
Contract services   1,361    33%   761    31%
Revenue   4,130    100%   2,425    100%
Operating costs and expenses   3,825    93%   3,381    139%
Operating income (loss)   305    7%   (956)   (39)%
Other expense   (124)   (4)%   (128)   (5)%
Income tax expense   (31)   (1)%   (17)   (1)%
Net income (loss)   150    4%   (1,101)   (45)%

 

Material changes of certain items in our statements of operations included in our financial statements for the comparative periods are discussed below. Comparisons are to the prior-year period unless stated otherwise.

 

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Three Months Ended March 31, 2022 Compared with the Three Months Ended March 31, 2021

 

Revenue. Our revenue increased approximately $1,705,000 or 70%. Tool revenue increased $1,105,000 or 66% from the prior-year period while contract services increased $600,000 or 79%. Revenue increased as the Company had improved capacity to meet growing demand for bit and other toll manufacturing services as well as continued growth in the number of end users and percentage of rigs using our Drill-N-Ream tool. Higher Contract Services revenue also grew with improved capacity to deliver on increased volume for drill bit and other toll refurbishment services. Demand growth reflects customers increasing the use of outsource manufacturing and refurbishment services and increased drilling activity driven by improved market conditions for the oil & gas industry.

 

Operating Costs and Expenses. Total operating costs and expenses increased approximately $444,000 for the three-month period ended March 31, 2022.

 

  ● Cost of revenue increased approximately $592,000 due to higher volume. As a percentage of revenue, cost of revenue was 43% and 48% of revenue for the three months ended March 31, 2022 and 2021, respectively. The decline in the cost of revenue as a percent of revenue was the result of strong operating leverage from higher volume.
     
  ● Selling, general and administrative expenses increased approximately $131,000 due in part to an approximate increase in equity compensation expense of $34,000, payroll and tax expenses of $196,000, legal expenses of $9,000, insurance expenses of $9,000 and board compensation of $14,000. Conversely, consulting expenses decreased by approximately $39,000 and tax, audit and related SEC expenses decreased by $92,000.
     
  ● Depreciation and amortization expense decreased approximately $279,000, or 40%, to $411,000. The decrease was primarily a result of fully amortizing a portion of the Company’s intangible assets and fully depreciating manufacturing center equipment.

 

Other Expense. Other expense primarily consists of interest expense and interest income.

 

  ● Interest expense for the three months ended March 31, 2022 and 2021 was approximately $124,000 and $138,000, respectively.

 

Income Tax Expense. Income tax expense increased by approximately $14,000 from the prior year due to increased foreign income taxes due to increased revenues from foreign sources.

 

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Liquidity and Capital Resources

 

As of March 31, 2022, we had working capital of approximately $3,094,000. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments. Our operational and financial strategies include managing our operating costs and capital spending to reflect revenue trends, accelerating collections of international receivables, and controlling our working capital and debt to enhance liquidity. We will continue to work to grow revenue and manage costs and expect to be cash flow positive in 2022. If we are unable to do this, we may not be able to, among other things, (i) maintain our current general and administrative spending levels; (ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital requirements. We cannot provide any assurance that financing will be available to us in the future on acceptable terms.

 

The Hard Rock Note had a remaining balance of $750,000 as of March 31, 2022, accrues interest at 8.00% per annum and is fully payable with accrued interest on October 5, 2022.

 

Our Credit Agreement facilitated by Austin Financial Services (“AFS”) is comprised of $800,000 Term Loan and $3,500,000 Line of Credit (“LOC”). As of March 31, 2022, we had approximately $250,000 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. A collateral management fee is payable monthly on the used portion of the LOC and Term Loan. If our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. As of March 31, 2022 we had approximately $10,000 of accrued interest combined between the two loans.

 

The interest rate for the Term Loan and the LOC is prime plus 2%. As of March 31, 2022 the interest rate for both loans was 9.10%, which includes a 3.6% management fee rate. The obligations of the Company under the agreement are secured by a security interest in substantially all of the tangible and intangible assets of the Company, other than any assets owned by the Company that constitute real property (and fixtures affixed to such real property), certain excluded equipment, intellectual property, or aircraft. The Credit Agreement matures on February 20, 2023, and the Company plans to refinance this credit facility.

 

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Cash Flows

 

Three-Months Ended March 31, 2022 Compared with the Three- Months Ended March 31, 2021

 

Net cash provided by operating activities was approximately $1,083,000 and $205,000 for the three months ended March 31, 2022 and 2021, respectively. For the three months ended March 31, 2022, the Company had approximately $152,000 of net income, approximately $308,000 increase in the changes of the current assets and liabilities accounts, depreciation, and amortization expense of approximately $411,000. For the three months ended March 31, 2021 the Company had approximately $1,102,000 of net loss approximately $455,000 increase in the change in current assets and liabilities accounts, and depreciation and amortization expense of approximately $690,000.

 

Net cash used in investing activities for the three months ended March 31, 2022 was approximately $919,000, which includes a down payment for new equipment and an investment in our Middle East tools, compared with $25,000 for the three months ended March 31, 2021 for the purchase of equipment net of proceeds from the sale of the company’s airplane hangar of $50,000 in 2021.

 

Net cash used in financing activities was approximately $132,000 for the three months ended March 31, 2022. Net cash provided by financing activities was approximately $121,000 for the three months ended March 31, 2021. Net borrowings on the line of credit was approximately $256,000 during the three months ended March 31, 2021 compared with zero in the same period of 2022.

 

Critical Accounting Policies

 

The discussion of our financial condition and results of operations is based upon our consolidated condensed financial statements, which have been prepared in accordance with U.S. GAAP. During the preparation of our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. While we believe that the estimates and assumptions used in the preparation of our consolidated condensed financial statements are appropriate, actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated condensed financial statements. Our estimates and assumptions are evaluated periodically and adjusted when necessary. The more significant estimates affecting amounts reported in our consolidated condensed financial statements include, but are not limited to: stock based compensation, determining the allowance for doubtful accounts, valuation of inventories, recoverability of long-lived assets, useful lives used in calculating depreciation and amortization, and valuation of intangible assets.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2022.

 

Changes in Internal Controls over Financial Reporting

 

There has been no change in our internal control over financial reporting that occurred during the first quarter of 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Internal Controls and Procedures

 

This quarterly report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’ s registered public accounting firm due to a transaction period established by the rules of the Securities and Exchange Commission for newly public companies. Under these rules, we will not be required to include an attestation report for so for as long as we are a “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act.

 

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PART II

 

Item 1. Legal Proceedings

 

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, LLC (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 Technologies, LLC’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.

 

Item 1A. Risk Factors

 

As of the date of this filing, the Company remains subject to the risk factors previously disclosed in Part I, Item 1A “Risk Factors” in our 2021 Annual Report on Form 10-K.

 

We are a smaller reporting company and are not required to present this information.

 

Item 6. Exhibits

 

The exhibits listed below are filed as part of this report:

 

Exhibit No.   Description
     
31.1*   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for G. Troy Meier.
     
31.2*   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Christopher D. Cashion.
     
32.1**   Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for G. Troy Meier.**
     
32.2**   Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Christopher D. Cashion.**
     
101.INS *   Inline XBRL Instance
     
101.XSD *   Inline XBRL Schema
     
101.CAL *   Inline XBRL Calculation
     
101.DEF *   Inline XBRL Definition
     
101.LAB *   Inline XBRL Label
     
101.PRE *   Inline XBRL Presentation
     
104   Cover Page Interactive Data File (embedded within the Inline XBRL document)

 

** Furnished herewith.

* Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  SUPERIOR DRILLING PRODUCTS, INC.
     
May 13, 2022 By: /s/ G. TROY MEIER
    G. Troy Meier, Chief Executive Officer
    (Principal Executive Officer)
     
May 13, 2022 By: /s/ CHRISTOPHER CASHION
    Christopher Cashion, Chief Financial Officer
    (Principal Financial Officer and Principal Accounting Officer)

 

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