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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 September 30, 2021

 

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 28,169,086 shares of common stock, $0.001 par value, issued and outstanding as of November 12, 2021.

 

 

 

 

 

 

Superior Drilling Products, Inc.

FORM 10-Q

 

QUARTER ENDED September 30, 2021

 

TABLE OF CONTENTS

 

  Page
   
PART I-FINANCIAL INFORMATION  
   
Item 1. Financial Statements 3
   
Condensed Consolidated Balance Sheets (Unaudited) at September 30, 2021 and December 31, 2020 3
   
Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2021 and 2020 4
   
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited) for the three and nine months ended September 30, 2021 and 2020 5
   
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2021 and 2020 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 20
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 21
   
Item 1A. Risk Factors 21
   
Item 6. Exhibits 23
   
Signatures 24

 

2

 

 

PART I - FINANCIAL INFORMATION.

 

Item 1. Financial Statements

 

Superior Drilling Products, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

 

    September 30, 2021     December 31, 2020  
ASSETS                
Current assets                
Cash   $ 2,469,398     $ 1,961,441  
Accounts receivable, net     2,046,073       1,345,622  
Prepaid expenses     266,371       90,269  
Inventories     1,067,738       1,020,008  
Asset held for sale     -       40,000  
Other current assets     47,692       40,620  
Total current assets     5,897,272       4,497,960  
Property, plant and equipment, net     6,963,777       7,535,098  
Intangible assets, net     277,778       819,444  
Right of use assets     22,192       99,831  
Other noncurrent assets     65,880       87,490  
Total assets   $ 13,226,899     $ 13,039,823  
LIABILITIES AND SHAREHOLDERS’ EQUITY                
Current liabilities                
Accounts payable   $ 802,157     $ 430,014  
Accrued expenses     1,887,693       1,091,519  
Income tax payable     177,822       106,446  
Current portion of operating lease liability     13,832       79,313  
Current portion of financial obligation     63,561       61,691  
Current portion of long-term debt, net of discounts     1,445,230       1,397,337  
Total current liabilities     4,390,295       3,166,320  
Operating lease liability     8,360       20,518  
Long-term financial obligation, less current portion     4,129,802       4,178,261  
Long-term debt, less current portion, net of discounts     1,118,953       1,451,049  
Total liabilities     9,647,410       8,816,148  
Commitments and contingencies (Note 11)     -          
Shareholders’ equity                
Common stock - $0.001 par value; 100,000,000 shares authorized; 26,429,955 and 25,762,342 shares issued and outstanding     26,430       25,762  
Additional paid-in-capital     41,149,551       40,619,620  
Accumulated deficit     (37,596,492 )     (36,421,707 )
Total shareholders’ equity     3,579,489       4,223,675  
Total liabilities and shareholders’ equity   $ 13,226,899     $ 13,039,823  

 

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

 

3

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

                         
    For the Three Months     For the Nine Months  
    Ended September 30,     Ended September 30,  
    2021     2020     2021     2020  
                         
Revenue                                
Tool revenue   $ 2,346,234     $ 1,190,929     $ 6,283,461     $ 6,147,280  
Contract services     1,215,685       356,513       3,102,219       2,782,313  
                                 
Total Revenue     3,561,919       1,547,442       9,385,680       8,929,593  
                                 
Operating costs and expenses                                
Cost of revenue     1,441,943       870,655       3,841,713       4,284,716  
Selling, general and administrative expenses     1,551,462       1,529,887       4,540,134       4,887,999  
Depreciation and amortization expense     405,225       693,259       1,680,804       2,134,398  
                                 
Total operating costs and expenses     3,398,630       3,093,801       10,062,651       11,307,113  
                                 
Operating income (loss)     163,289       (1,546,359 )     (676,971 )     (2,377,520 )
                                 
Other income (expense)                                
Interest income     49       145       147       5,775  
Interest expense     (130,221 )     (126,482 )     (413,798 )     (450,210 )
Impairment on asset held for sale     -       -       -       (30,000 )
Loan forgiveness     -       41,403       -       41,403  
Gain (loss) on disposition of assets, net     -       -       (1,187 )     142,234  
Total other expense     (130,172 )     (84,934 )     (414,838 )     (290,798 )
                                 
Income (loss) before income taxes     33,117       (1,631,293 )     (1,091,809 )     (2,668,318 )
Income tax expense     (39,327 )     (99,979 )     (82,976 )     (106,414 )
                                 
Net loss   $ (6,210 )   $ (1,731,272 )   $ (1,174,785 )   $ (2,774,732 )
                                 
Basic loss earnings per common share   $ (0.00 )   $ (0.07 )   $ (0.05 )   $ (0.11 )
Basic weighted average common shares outstanding     26,154,202       25,555,167       25,894,397       25,469,609  
Diluted loss per common share   $ (0.00 )   $ (0.07 )   $ (0.05 )   $ (0.11 )
Diluted weighted average common shares outstanding     26,154,202       25,555,167       25,894,397       25,469,609  

 

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

 

4

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Shareholders’ Equity

(Unaudited)

 

                                         
    Common Stock     Additional
Paid-in
    Accumulated     Total
Shareholders’
 
    Shares     Par Value     Capital     Deficit     Equity  
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 loss     -       -       -       (1,101,793 )     (1,101,793 )
                                         
Balance – March 31, 2021     25,762,342     $ 25,762     $ 40,787,092     $ (37,523,500 )   $ 3,289,354  
                                         
Stock-based compensation expense     -       -       167,033       -       167,033  
Net loss     -       -       -       (66,781 )     (66,781 )
                                         
Balance – June 30, 2021     25,762,342     $ 25,763     $ 40,954,125     $ (37,590,282 )   $ 3,389,606  
                                         
Stock-based compensation expense     667,613       667       195,426       -       196,093  
Net loss     -       -       -       (6,210 )     (6,210 )
                                         
Balance – September 30, 2021     26,429,955     $ 26,430     $ 41,149,551     $ (37,596,492 )   $ 3,579,489  
                                         

Balance - December 31, 2019

    25,418,126     $ 25,418     $ 40,069,391     $ (32,991,833 )   $ 7,102,976  
                                         
Stock-based compensation expense     -       -       106,996       -       106,996  
Net income     -       -       -       198,046       198,046  
                                         
Balance – March 31, 2020     25,418,126     $ 25,418     $ 40,176,387     $ (32,793,787 )   $ 7,408,018  
                                         
Stock-based compensation expense     16,650       17       104,988       -       105,005  
Net loss     -       -       -       (1,241,506 )     (1,241,506 )
                                         
Balance – June 30, 2020     25,434,776     $ 25,435     $ 40,281,375     $ (34,035,293 )   $ 6,271,517  
                                         
Stock-based compensation expense     182,710       182       157,660       -       157,842  
Net loss     -       -       -       (1,731,272 )     (1,731,272 )
                                         
Balance – September 30, 2020     25,617,486     $ 25,617     $ 40,439,035     $ (35,766,565 )   $ 4,698,087  

 

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

 

5

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

    2021     2020  
    For the Nine Months  
    Ended September 30,  
    2021     2020  
Cash Flows From Operating Activities                
Net loss   $ (1,174,785 )   $ (2,774,732 )
Adjustments to reconcile net loss to net cash from operating activities:                
Depreciation and amortization expense     1,680,804       2,134,398  
Stock-based compensation expense     530,595       369,843  
Impairment on asset held for sale     -       30,000  
(Gain) loss on disposition of assets, net     1,187       (142,234 )
Gain on forgiveness of loan     -       (41,403 )
Amortization of deferred loan costs     13,893       13,894  
Changes in operating assets and liabilities:                
Accounts receivable     (700,451 )     2,408,726  
Inventories     (551,189 )     (942,831 )
Prepaid expenses and other noncurrent assets     (161,564 )     327,968  
Accounts payable and accrued expenses     1,168,317       (18,728 )
Income tax payable     71,376       (34,692 )
Other long-term liabilities     -       (61,421 )
Net Cash From Operating Activities     878,183       1,268,788  
Cash Flows From Investing Activities                
Purchases of property, plant and equipment     (75,541 )     (154,475 )
Proceeds from sale of fixed assets     50,000       117,833  
Net Cash From Investing Activities     (25,541 )     (36,642 )
Cash Flows From Financing Activities                
Principal payments on debt     (1,146,309 )     (2,167,539 )
Proceeds received from debt borrowings     -       964,120  
Payments on revolving loan     (540,078 )     (1,018,690 )
Proceeds received on revolving loan     1,341,702       1,185,319  
Net Cash From Financing Activities     (344,685 )     (1,036,790 )
Net Change in Cash     507,957       195,356  
Cash at Beginning of Period     1,961,441       1,217,014  
Cash at End of Period   $ 2,469,398     $ 1,412,370  
Supplemental information:                
Cash paid for Interest   $ 410,598     $ 460,640  
Inventory converted to property, plant and equipment   $ 513,558     $ 922,993  
Reduction of debt with sale of asset   $ -     $ 211,667  

 

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

 

6

 

 

Superior Drilling Products, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2021

 

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 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 and other tools for a leading oil field services company and other customers including other oil field service companies and operators. 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 for other applications.

 

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

 

Basis of Presentation

 

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

 

Unaudited Interim Financial Presentation

 

These interim consolidated condensed financial statements for the three and nine months ended September 30, 2021 and 2020, and the related footnote disclosures included herein, are unaudited. However, in the opinion of management, these unaudited interim financial statements have been prepared on the same basis as the audited financial statements, and reflect all adjustments necessary to fairly state the results for such periods. The results of operations for the three and nine months ended September 30, 2021 are not necessarily indicative of the results of operations expected for the year ended December 31, 2021. These interim consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the years ended December 31, 2020 and 2019 and the notes thereto, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission (the “SEC”).

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant items subject to estimates and assumptions include the carrying amount and useful lives of property and equipment and intangible assets, impairment assessments, share-based compensation expense, and valuation allowances for accounts receivable, inventories, and deferred tax assets.

 

7

 

 

Concentrations of Credit Risk

 

The Company has two significant customers that represented 86% and 81% of its revenue for the nine months ended September 30, 2021 and 2020, respectively. These customers had approximately $1,081,000 and $432,000 in accounts receivable at September 30, 2021 and 2020, respectively.

 

The Company had two vendors that represented 12% of its purchases for the nine months ended September 30, 2021. These vendors had approximately $176,000 in accounts payable at September 30, 2021 and purchases in the nine months of 2021 from these vendors totaled approximately $546,000. The Company had one vendor that represented 14% of its purchases for the nine months ended September 30, 2020. This vendor had approximately $218,000 in accounts payable at September 30, 2020 and purchases in the nine months ended September 30, 2020 from this vendor totaled approximately $772,000.

 

Impact of COVID-19

 

The COVID-19 pandemic has impacted and may further impact the Company’s operations, and the operations of the Company’s suppliers and vendors, as a result of quarantines, facility closures, and travel and logistics restrictions. The extent to which the COVID-19 pandemic will continue to impact the Company’s business, financial condition and results of operations will depend on future developments, which are highly uncertain and depend on, among other things, the duration, spread, severity, and impact of the COVID-19 pandemic and the success and speed of vaccination efforts both in the United States and globally, the effects of the COVID-19 pandemic on the Company’s customers, suppliers, and vendors and the remedial actions and stimulus measures adopted by local and federal governments, and to what extent normal economic and operating conditions can resume. Therefore, the Company cannot reasonably estimate future impacts of the COVID-19 pandemic at this time.

 

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.

 

Reclassifications

 

Certain prior year amounts have been reclassified to the balance sheet to conform to the current year presentation. The reclassifications were within accounts payable and income tax payable and did not impact net income.

 

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 $39,327 with income before income taxes of only $33,117. The reason The Company has income tax expense greater than income before income taxes is due to the Company having taxable income in a foreign tax jurisdiction. In the U.S. the Company is not subject to U.S. taxes due to having a taxable loss.

 

8

 

 

NOTE 2. LIQUIDITY

 

We believe that our cash on hand, cash generated from operations and our borrowing capacity under our current credit facility will be sufficient to fund our operations for the next 12 months. To enhance liquidity, our operational and financial strategies include managing our operating costs, accelerating collections of international receivables, and reducing working capital requirements. If we are unable to do this, we may not be able to, among other things, (i) maintain our revised general and administrative spending levels; (ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital requirements. We cannot provide any assurance that financing will be available to us in the future on acceptable terms, if at all.

 

In 2020, the Company filed a Form S-3 Shelf Registration that will allow the Company to offer and sell, from time to time, up to $20,000,000 of securities. We believe maintaining an active Shelf Registration provides additional financial flexibility to access the capital markets. In October 2021, the Company completed an equity offering of 1,739,131 shares of common stock at a price of $1.15 per share. Net proceeds from the equity offering were $1,739,103 (See Note 13 – Subsequent Events).

 

Also in 2020, the Company received notification from the NYSE American to the Company indicating that, as a result of the Company’s stockholders’ equity of $4.7 million as of September 30, 2020, and reported losses for each of the last five fiscal years, the Company was not in compliance with the stockholders’ equity standards for continued listing on the NYSE American. On January 28, 2021, the Company received notice that the NYSE American had accepted the Company’s plan that was submitted on December 18, 2020, to regain compliance with the continued listing standards of the NYSE American.

 

NYSE American Regulations staff will review the Company periodically for compliance with the initiatives outlined in the plan. If the Company does not make progress consistent with the plan during the plan period, NYSE Regulation staff may initiate delisting proceedings as appropriate. The Company’s first quarterly plan update was submitted to the NYSE American in April 2021 and was subsequently approved by the NYSE compliance committee on May 21, 2021. On August 16, 2021, the Company submitted its second quarterly plan update which was approved by the NYSE on September 10, 2021.

 

NOTE 3. REVENUE

 

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

 

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

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer under Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our contracts with customers contain a single performance obligation to provide agreed-upon products or services. For contracts with multiple performance obligations, we allocate revenue to each performance obligation based on its relative standalone selling price. In accordance with Topic 606, we do not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer.

 

9

 

 

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 85% of our revenue is from North America and approximately 15% is from the Middle East for the three months ended September 30, 2021. For the nine months ended September 30, 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:

   

Three months ended

September 30,

   

Nine months ended

September 30,

 
    2021     2020     2021     2020  
                         
Tool Revenue:                                
Tool and product sales     315,000       294,464     $ 1,470,000     $ 971,520  
Tool rental     521,228       254,574       1,318,135       1,716,210  
Other related revenue     1,510,006       641,891       3,495,326       3,459,550  
Total Tool Revenue     2,346,234       1,190,929       6,283,461       6,147,280  
                                 
Contract Services     1,215,685       356,513       3,102,219       2,782,313  
                                 
Total Revenue   $ 3,561,919     $ 1,547,442     $ 9,385,680     $ 8,929,593  

 

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.

 

10

 

 

NOTE 4. INVENTORIES

 

Inventories are comprised of the following:

 

    September 30, 2021     December 31, 2020  
Raw material   $ 568,904     $ 733,734  
Work in progress     208,369       50,631  
Finished goods     290,465       235,643  
Inventories, net   $ 1,067,738     $ 1,020,008  

 

NOTE 5. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are comprised of the following:

 

    September 30, 2021     December 31, 2020  
Land   $ 880,416     $ 880,416  
Buildings     4,764,441       4,764,441  
Building improvements     755,039       755,039  
Machinery and equipment     11,859,879       11,298,642  
Office equipment, fixtures and software     628,358       628,358  
Transportation assets     265,760       265,760  
Property, plant and equipment, gross     19,153,893       18,592,656  
Accumulated depreciation     (12,190,116 )     (11,057,558 )
Property, plant and equipment, net   $ 6,963,777     $ 7,535,098  

 

The Company sold its airplane for a gain of approximately $142,000 in February 2020 and the Company sold its hangar for a gain of $10,000 in March 2021, both of which were in assets held for sale at the end of 2019. The increase in machinery and equipment was mostly the result of the Company’s increased rental tool fleet for the Middle East operations.

 

Depreciation expense related to property, plant and equipment for the three and nine months ended September 30, 2021 was $363,558 and $1,139,137, respectively and for the three and nine months ended September 30, 2020 was $401,592 and $1,259,398, respectively.

 

NOTE 6. INTANGIBLE ASSETS

 

Intangible assets are comprised of the following:

 

    September 30, 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  
Intangible assets, gross     14,900,000       14,900,000  
Accumulated amortization     (14,622,222 )     (14,080,556 )
Intangible assets, net   $ 277,778     $ 819,444  

 

Amortization expense related to intangible assets for the three and nine months ended September 30, 2021 was $41,667 and $541,667, respectively, and for the three and nine months ended September 30, 2020 was $291,667 and $875,000, respectively. Full amortization was realized for the Company’s patent at the end of April 2021. This decreases the 2021 expense compared to 2020.

 

NOTE 7. RELATED PARTY NOTE RECEIVABLE

 

In January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy Corporation (“Tronco”), a party related to us through common control, in order to take over the legal position as Tronco’ s senior secured lender. 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 if and when consideration or payments of the loan are made in the future. 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. Interest only is due December 31, 2021, with a balloon payment of all unpaid interest and principal due upon maturity on December 31, 2022.

 

11

 

 

NOTE 8. LONG-TERM DEBT

 

Long-term debt is comprised of the following:

 

    September 30, 2021     December 31, 2020  
Hard Rock Note   $ 750,000     $ 1,500,000  
Credit Agreement     1,390,881       825,366  
Machinery loans     386,144       466,448  
Transportation loans     37,158       56,572  
      2,564,183       2,848,386  
Less:                
Current portion     (1,445,230 )     (1,397,337 )
Long-term debt, net   $ 1,118,953     $ 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 September 30, 2021, accrues interest at 8.00% per annum and is due in full by October 5, 2022. In October 2021, the Company made a payment of $15,123 related to accrued interest. Under the amended terms of the Hard Rock Note, we are required to make the following additional payments: accrued interest on January 5, April 5, July 5 and October 5 in 2022; with the remaining balance of principal and accrued interest on the Hard Rock Note due on October 5, 2022. For the nine months ended September 30, 2021, the Company has made a total of $89,754 in interest payments related to the Hard Rock Note.

 

12

 

 

Credit Agreement

 

In February 2019, the Company entered into a Loan and Security Agreement (the “Credit Agreement”) with Austin Financial Services, Inc. (“AFS”). The Credit Agreement provides a $4,500,000 credit facility, which includes a $1,000,000 term loan (the “Term Loan”) and a $3,500,000 revolver (the “Revolving Loan”). As of September 30, 2021, we had $416,662 outstanding on the Term Loan and $1,000,462 outstanding on the Revolving Loan. Amounts outstanding under the Revolving Loan at any time may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect (less a dilution reserve as determined by AFS in its sole good faith discretion), plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c) the borrowing base reserve as may be determined from time to time by AFS. Amounts outstanding on the Revolving Loan as of September 30, 2021, may not exceed $1,000,000, which is based on a calculation applying 85% of accounts receivable and 50% of inventory.

 

The Credit Agreement contains various restrictive covenants that, among other things, limit or restrict the ability of the Company to incur additional indebtedness; incur additional liens; make dividends and other restricted payments; make investments; engage in mergers, acquisitions and dispositions; make optional prepayments of other indebtedness; engage in transactions with affiliates; and enter into restrictive agreements. The Credit Agreement does not include any financial covenants. If an event of default occurs, the lenders are entitled to accelerate the advances made thereunder and exercise rights against the collateral. Borrowing under the Revolving Loan is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration clause. At September 30, 2021, we were in compliance with the covenants in the Credit Agreement.

 

The interest rate for the Term Loan and the Revolving Loan is prime plus 2%. At September 30, 2021, the interest rate for the Term Loan was 8.85%, which includes a 3.6% management fee rate. The effective interest rate for the Revolving Loan for the quarter ending September 30, 2021 was 9.78%. Even if our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. At September 30, 2021, we had approximately $12,000 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, intellectual property, or aircraft. A collateral management fee is payable monthly on the used portion of the Revolving Loan 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.

 

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 the repurchase option, the Company accounted for the transaction as a financing transaction and not as a sale under ASC Topic 842, Leases.

 

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 $2,160,242, which will correspond to the carrying value of the property. The Company paid $25,950 of principal in 2020 that was prorated for the month of December.

 

The financing obligation is summarized below:

 

    September 30, 2021     December 31, 2020  
Finance obligations for sale-leaseback transactions   $ 4,193,363     $ 4,239,952  
Current principal portion of finance obligation     (63,561 )     (61,691 )
Non-current portion of finance obligation   $ 4,129,802     $ 4,178,261  

 

13

 

 

NOTE 10. GEOGRAPHICAL OPERATIONS INFORMATION

 

The following summarizes revenue by geographic location:

 

   

Three months ended

September 30,

   

Nine months ended

September 30,

 
    2021     2020     2021     2020  
                         
Revenue:                                
North America   $ 3,040,691     $ 1,118,404     $ 8,073,945     $ 7,387,847  
Middle East   $ 521,228     $ 429,038     $ 1,311,735     $ 1,541,746  
    $ 3,561,919     $ 1,547,442     $ 9,385,680     $ 8,929,593  

 

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

 

    September 30, 2021     December 31, 2020  
Property, plant and equipment, net:                
North America   $ 5,590,486     $ 6,008,431  
Middle East     1,373,291       1,526,667  
    $ 6,963,777     $ 7,535,098  

 

NOTE 11. COMMITMENTS AND CONTINGENCIES

 

We are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana Lafayette Division asserting Stabil Drill Specialties, LLC (“Stabil Drill”) infringed on our patent that covers the Company’s well bore conditioning tool, the Drill-N-Ream. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. 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. Extreme sued for patent infringement based on the same patents discussed in the Stabil Drill litigation. On December 23, 2019, the Court stayed Extreme’s patent infringement claim against Defendants pending resolution of the Southern District of Texas Stabil Drill case. The court ordered the Company to serve discovery requests upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit product inspection. Stabil Drill filed a motion for summary judgement for non-infringement. 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. On March 9, 2021, the Court lifted the automatic bankruptcy stay. On May 12, 2021, the Court denied Stabil Drill’s non-infringement summary judgment motion. The parties are preparing this case for trial and expect a jury trial setting in 2022. We are not currently involved in any other litigation which management believes could have a material effect on our financial position or results of operations.

 

NOTE 12. SHAREHOLDERS’ EQUITY

 

On August 9, 2021, the Board of Directors granted 434,641 restricted stock units to Troy Meier, Chairman and Chief Executive Officer, granted 333,333 restricted stock units to Annette Meier, President and Chief Operating Officer, granted 156,863 restricted stock units to Chris Cashion, Chief Financial Officer, and 98,039 restricted stock units to each of the three independent members of the Board of Directors. Stock price is based on the average price of the common stock on the date of the grant. In addition, the Board of Directors authorized 250,000 restricted stock units and 75,000 stock options to be granted to employees of the Company other than Mr. and Mrs. Meier and Mr. Cashion. The 250,000 restricted stock units were to be granted to employees subject to a Board approved performance based bonus plan. The plan was never developed and implemented nor communicated to the employees. These restricted stock units will vest over three years.

 

NOTE 13. SUBSEQUENT EVENTS

 

On October 19, 2021, the Company completed an equity offering of 1,739,131 shares of our common stock to certain institutional investors, at a purchase price of $1.15 per share. The Company paid approximately $261,000 in total offering costs. Net proceeds from the equity offering were approximately $1,700,000.

 

14

 

 

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 September 30, 2021, and our results of operations for the three and nine months ended September 30, 2021 and 2020. 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, 2020 and 2019, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, 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. These forward-looking statements include the following types of information and statements as they relate to the Company:

 

  future operations, financial results, business plans, cash flow and cash requirements;
     
  scheduled, budgeted and other future capital expenditures;
     
  working capital requirements;
     
  the availability of expected sources of liquidity;
     
  the introduction into the market of the Company’s future products;
     
  the market for the Company’s existing and future products;
     
  the opportunity to diversify the markets served by the Company or products provided within the existing oil and gas industry as a result of receiving the ISO-9001 certification;
     
  the Company’s ability to develop new applications for its technologies;
     
  the exploration, development and production activities of the Company’s customers;
     
  compliance with present and future environmental regulations and costs associated with environmentally related penalties, capital expenditures, remedial actions and proceedings;
     
  effects of potential legal proceedings; and
     
  changes in customers’ future product and service requirements that may not be cost effective or within the Company’s capabilities.

 

15

 

 

These statements are based on assumptions and analyses in consideration of the Company’s experience and perception of historical trends, current conditions, expected future developments and other factors the Company believes were appropriate in the circumstances when the statements were made. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly impact expected results, and actual future results could differ materially from those described in such statements.

 

While it is not possible to identify all factors, the Company continues to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially are the risks and uncertainties discussed under “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and the following:

 

  the volatility of oil and natural gas prices;
     
  the cyclical nature of the oil and gas industry;
     
  availability of financing, flexibility in restructuring existing debt and access to capital markets;
     
  our reliance on significant customers;
     
  consolidation within our customers’ industries;
     
  competitive products and pricing pressures;
     
  our ability to develop and commercialize new and/or innovative drilling and completion tool technologies;
     
  our ability to diversify products/services provided to customers and markets in which we operate;
     
  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;
     
  fluctuations in our operating results;
     
  our dependence on key personnel;
     
  costs 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;
     
  the potential impact of major health crises on our business and results of operations;
     
  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.

 

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Many of such factors are beyond the Company’s ability to control or predict. Any of the factors, or a combination of these factors, could materially affect the Company’s future results of operations and the ultimate accuracy of the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. Every forward-looking statement speaks only as of the date of the particular statement, and the Company undertakes no obligation to publicly update or revise any forward-looking statement.

 

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 PDC drill bit and other tool refurbishing and manufacturing service,
     
  Our 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

 

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. Currently we are experiencing raw material delays and difficulties in hiring and retaining direct laborers. These current conditions are a result of COVID-19.

 

The total U.S. rig count as reported by Baker Hughes as of October 29, 2021 was 544 rigs, an increase of 248 rigs from a year ago, as well as an increase of 150 rigs from the rig count as of December 31, 2020. We expect North American onshore activity to continue to improve in 2021 and into 2022 compared with the fourth quarter of 2020.

 

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 to the Company’s domestic market.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Three and Nine Months Ended September 30, 2021Compared with the Three and Nine Months Ended September 30, 2020

 

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

 

    Three-Months Ended September 30,     Nine-Months Ended September 30,  
(in thousands)   2021     2020     2021     2020  
Tool revenue     2,346       66 %     1,191       77 %     6,284       67 %     6,147       69 %
Contract services     1,216       34 %     356       23 %     3,102       33 %     2,782       31 %
Revenue   $ 3,562       100 %   $ 1,547       100 %     9,386       100 %     8,929       100 %
Operating costs and expenses     3,399       95 %     3,094       200 %     10,063       107 %     11,307       127 %
Operating income (loss)     163       5 %     (1,546 )     (100 )%     (677 )     (7 )%     (2,378 )     (27 )%
Other expense     (130 )     (4 )%     (85 )     (5 )%     (415 )     (4 )%     (291 )     (3 )%
Income tax expense     (39 )     (1 )%     (100 )     (6 )%     (83 )     (1 )%     (106 )     (1 )%
Net income (loss)   $ (6 )     0 %   $ (1,731 )     (111 )%     (1,175 )     (12 )%     (2,775 )     (31 )%

 

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 September 30, 2021 Compared with the Three Months Ended September 30, 2020

 

Revenue. Our revenue increased approximately $2,014,000 or 130%. Tool revenue increased $1,155,000 or 97% from the prior-year period while contract services increased $859,000 or 241%. The increase in revenue was due to increased demand from continued growth in the number of end users and percentage of rigs using our Drill-N-Ream tool combined with an improvement in market conditions and increased drilling activity.

 

Operating Costs and Expenses. Total operating costs and expenses increased approximately $272,000 for the September 30, 2021 three-month period.

 

  Cost of revenue increased approximately $571,000 due to higher volume. As a percentage of revenue, cost of revenue was 40% and 56% of revenue for the three months ended September 30, 2021 and 2020, 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 $21,000 due to an increase in long-term equity compensation expense.
     
  Depreciation and amortization expense decreased approximately $288,000, or 41%, to $405,000. 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 September 30, 2021 and 2020 was approximately $130,000 and $126,000, respectively.

 

Income Tax Expense. The decrease in income tax expense from the prior year is due to a year-to-date foreign income tax adjustment in 2020.

 

Nine Months Ended September 30, 2021 Compared with the Nine Months Ended September 30, 2020

 

Revenue. Our revenue increased approximately $457,000 or 5% to $9,386,000. Tool revenue was $6,283,000, an increase of 2% or $137,000, from the prior-year period. Contract services increased approximately $320,000, or 12%, to $3,102,000.

 

Operating Costs and Expenses. Total operating costs and expenses decreased approximately $1,277,000 for the September 30, 2021 nine-month period.

 

  Cost of revenue decreased approximately $444,000 due to reduced costs resulting from the Company’s reduction in force implemented throughout 2020. As a percentage of revenue, cost of revenue was 41% and 48% of revenue for the nine months ended September 30, 2021 and 2020, respectively.
     
  Selling, general and administrative expenses decreased approximately $380,000 to $4,508,000 and was 48% of revenue compared with 55% in the prior-year period. The decline in expenses was due to cost reduction measures implemented in 2020 in response to the impact on demand resulting from the rapid decline in the oil & gas industry due to the global COVID-19 pandemic.
     
  Depreciation and amortization expense decreased approximately $454,000, or 21%, to $1,681,000. 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, interest income, and gain/loss on sale of assets.

 

  Interest expense for the nine months ended September 30, 2021 and 2020 was approximately $414,000 and $450,000, respectively.
     
  The Company recorded a loss of approximately $1,000 on assets disposed during the nine months ended September 30, 2021. The Company sold its airplane in February 2020 for a gain of approximately $142,000.

 

Income Tax Expense. The decrease in income tax expense from the prior year is due to a foreign income tax adjustments in 2020.

 

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Liquidity and Capital Resources

 

At September 30, 2021, we had working capital of approximately $1,500,000. 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 match revenue trends, accelerating collections of international receivables, and managing our working capital and debt to enhance liquidity. If we are unable to continue generating positive cash flow, 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. However, on October 19, 2021, the Company completed an equity offering of 1,739,131 shares of our common stock to certain institutional investors, at a purchase price of $1.15 per share. The Company paid approximately $261,000 in total offering costs. Net proceeds from the equity offering were approximately $1,700,000.

 

In addition, the significant decline in demand for oil due to the impacts of COVID-19 on the global economy, the instability of oil prices caused by geopolitical issues and over supply have resulted in the announcements by our customers and end users of our tools and technology of significant reductions to their capital expenditure budgets. Our expectation is that demand for our products and services may continue to be impacted in 2021 and potentially beyond; however, we are currently unable to estimate the full impact to our business, how long this significant drop in demand will last or the depth of the decline. We have minimal planned capital expenditures for the remainder of 2021 of $600,000.

 

The Hard Rock Note had a remaining balance of $750,000 as of September 30, 2021. It accrues interest at 8.00% per annum and is due in full by October 5, 2022. In October 2021, the Company made a payment of $15,123 related to accrued interest. Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued interest on January 5, April 5, July 5 and October 5 in 2022; with the remaining balance of principal and accrued interest on the Hard Rock Note due on October 5, 2022. For the nine months ended September 30, 2021, the Company has made a total of $839,754 in principal and interest payments related to the Hard Rock Note.

 

Our Credit Agreement is comprised of $1,000,000 Term Loan and $3,500,000 Revolving Loan. As of September 30, 2021, we had $416,662 outstanding on the Term Loan and $1,000,462 outstanding on the Revolving Loan. Amounts outstanding under the Revolving Loan at any time may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect (less a dilution reserve as determined by AFS in its sole good faith discretion), plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c) the borrowing base reserve as may be determined from time to time by AFS. Amounts outstanding on the Revolving Loan as of September 30, 2021, may not exceed $1,000,000, which is based on a calculation applying 85% of accounts receivable and 50% of inventory. A collateral management fee is payable monthly on the used portion of the Revolving Loan and Term Loan. If our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. At September 30, 2021, we had approximately $12,000 of accrued interest.

 

The interest rate for the Term Loan and the Revolving Loan is prime plus 2%. At September 30, 2021, the interest rate for the Term Loan was 8.85%, which includes a 3.6% management fee rate. The effective interest rate for the Revolving Loan for the quarter ending September 30, 2021 was 9.78%. 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.

 

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Cash Flows

 

Nine Months Ended September 30, 2021 Compared with the Nine Months Ended September 30, 2020

 

Net cash provided by operating activities was approximately $878,000 and $1,269,000 for the nine months ended September 30, 2021 and 2020, respectively. For the nine months ended September 30, 2021, the Company had approximately $1,175,000 of net loss, approximately $1,168,000 increase in accounts payable and accrued expenses, depreciation and amortization expense of approximately $1,681,000, which were offset by an approximately $700,000 decrease in accounts receivable. For the nine months ended September 30, 2020, the Company had approximately $2,775,000 of net loss, an approximately $2,409,000 increase in accounts receivable, and depreciation and amortization expense of approximately $2,134,000.

 

Net cash used in investing activities was approximately $26,000 for the nine months ended September 30, 2021 and $37,000 for the nine months ended September 30, 2020.

 

Net cash used in financing activities was approximately $345,000 for the nine months ended September 30, 2021. Net cash used in financing activities was approximately $1,037,000 for the nine months ended September 30, 2020.

 

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 September 30, 2021.

 

Changes in Internal Controls over Financial Reporting

 

None

 

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 Stabil Drill Specialties, LLC (“Stabil Drill”) infringed on our patent that covers the Company’s well bore conditioning tool, the Drill-N-Ream. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. 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. Extreme sued for patent infringement based on the same patents discussed in the Stabil Drill litigation. On December 23, 2019, the Court stayed Extreme’s patent infringement claim against Defendants pending resolution of the Southern District of Texas Stabil Drill case. The court ordered the Company to serve discovery requests upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit product inspection. Stabil Drill filed a motion for summary judgement for non-infringement. 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. On March 9, 2021, the Court lifted the automatic bankruptcy stay. On May 12, 2021, the Court denied Stabil Drill’s non-infringement summary judgment motion. The parties are preparing this case for trial and expect a jury trial setting in 2022. We are not currently involved in any other litigation which management believes could have a material effect on our financial position or results of operations.

 

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 2020 Annual Report on Form 10-K. The risk factors below updates or expands upon those risk factors.

 

We may be unable to maintain adequate liquidity and make payments on our debt.

 

At September 30, 2021, we had working capital of approximately $1,500,000. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments. Our operational and financial strategies include lowering our operating costs and capital spending to match revenue trends, managing our working capital and debt to enhance liquidity. Subsequent to the end of the quarter on October 19, 2021, the Company completed an equity offering of 1,739,131 shares of our common stock to certain institutional investors, at a purchase price of $1.15 per share. The Company paid approximately $261,000 in total offering costs. Net proceeds from the equity offering were approximately $1,700,000.

 

While we believe that our cash generated from operations and our borrowing capacity under our current credit facility will be sufficient to fund our operations for the next twelve months, our operational and financial strategies include managing our operating costs, working capital and debt to enhance liquidity. We will continue to work to grow revenue and review additional cost containment measures in order to be cash flow positive in 2021. 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.

 

On May 6, 2020, certain subsidiaries of the Company amended and restated the outstanding note (the “Hard Rock Note”) with the seller in our acquisition of Hard Rock Solutions, LLC. As amended, the Hard Rock Note accrues interest at 8.00% per annum and matures and is now fully payable on October 5, 2022. Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued interest on each January 5, April 5, July 5, and October 5 in 2022; with the remaining principal balance of $750,000 plus accrued interest on the Hard Rock Note due on October 5, 2022. For the nine months ended September 30, 2021, the Company has made a total of $839,754 in principal and interest payments related to the Hard Rock Note. If we are unable to make the payments required, we could lose our rights to market the Drill-N-Ream.

 

Our Credit Agreement is comprised of $1,000,000 Term Loan and $3,500,000 Revolving Loan. As of September 30, 2021, we had $416,662 outstanding on the Term Loan and $1,000,462 outstanding on the Revolving Loan. If we are unable to make required payments under the Credit Agreement, we would be in default thereunder, which would permit the holders of the indebtedness to accelerate the maturity thereof, unless we are able to obtain, on a timely basis, a necessary waiver or amendment. Any waiver or amendment may require us to revise the terms of the Credit Agreement which could increase the cost of our borrowings, require the payment of additional fees, and adversely impact the results of our operations. Upon the occurrence of any event of default that is not waived, the lenders could elect to exercise any of their available remedies, which include the right to not lend any additional amounts or, in the event we have outstanding indebtedness under the Credit Agreement, to declare any outstanding indebtedness, together which any accrued interest and other fees, to be immediately due and payable. If we are unable to repay the outstanding indebtedness, if any, under the Credit Agreement when due, the lenders would be permitted to proceed against their collateral, and this could have a material adverse effect on our business and financial condition.

 

21

 

 

Our level of indebtedness could adversely affect our future ability to raise additional capital to fund growth, limit our ability to react to changes in our business or our industry and place us at a competitive disadvantage.

 

We are required to make a payment on the Hard Rock Note of $750,000 (plus accrued interest) in October 2022. In addition, we are required to make monthly payments of approximately $46,000 on our other indebtedness.

 

Our level of debt and debt service requirements could have important consequences. For example, it could (i) result in a foreclosure upon our key assets, (ii) increase our vulnerability to general adverse economic and industry conditions, (iii) limit our ability to fund future capital expenditures and working capital, to engage in future acquisitions or development activities, or to otherwise realize the value of our assets and opportunities fully because of the need to dedicate a substantial portion of our cash flow from operations to payments on our debt, (iv) increase our cost of borrowing, (v) restrict us from making strategic acquisitions or causing us to make non-strategic divestitures, (vi) limit our flexibility in planning for, or reacting to, changes in our business or industry in which we operate, placing us at a competitive disadvantage compared with our competitors who are less leveraged and (vii) impair our ability to obtain additional financing in the future.

 

Our customer base is concentrated and the loss of, or nonperformance by, one or more of our significant customers, or our failure to expand our channels to market and further commercialize could cause our revenue to decline substantially.

 

We have two large customers that currently comprise 86% of our total revenue. It is likely that we will continue to derive a portion of our revenue from a relatively small number of customers in the future. If a major customer decided not to continue to use our services or significantly reduces its drilling plans, or if we are unable to expand our channels to market or further commercialize, our revenue would decline and our operating results and financial condition could be harmed. In addition, we are subject to credit risk due to the concentration of our customer base. Any increase in the nonpayment of and nonperformance by our counterparties, either as a result of changes in financial and economic conditions or otherwise, could have a material effect on our business, results of operations and financial condition and could adversely affect our liquidity.

 

22

 

 

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.

 

23

 

 

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.
     
November 12, 2021 By:  /s/ G. TROY MEIER
    G. Troy Meier, Chief Executive Officer
    (Principal Executive Officer)
     
November 12, 2021 By: /s/ CHRISTOPHER CASHION
    Christopher Cashion, Chief Financial Officer
    (Principal Financial Officer and Principal Accounting Officer)

 

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