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.
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:
SCHEDULE
OF RESTATEMENT OF CONSOLIDATED STATEMENT OF CASH FLOWS
|
|
|
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.
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 $.
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.
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:
SCHEDULE OF REVENUE DISAGGREGATED BY REVENUE
| |
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.
NOTE
3. INVENTORIES
Inventories
are comprised of the following:
SCHEDULE OF INVENTORIES
| |
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:
SCHEDULE OF PROPERTY, PLANT AND EQUIPMENT
| |
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:
SCHEDULE OF INTANGIBLE ASSETS
| |
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.
NOTE
7. LONG-TERM DEBT
Long-term
debt is comprised of the following:
SCHEDULE OF LONG-TERM DEBT INSTRUMENTS
| |
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.
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:
SCHEDULE OF FINANCING OBLIGATION
| |
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 | |
NOTE
9. GEOGRAPHICAL OPERATIONS INFORMATION
The
following summarizes revenue by geographic location:
SCHEDULE OF REVENUE AND PROPERTY, PLANT AND EQUIPMENT 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:
SCHEDULE
OF 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.