Notes
to Condensed Consolidated Financial Statements (Unaudited)
June
30, 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 consolidated condensed financial statements for the three and six months ended June 30, 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 and six months ended June 30, 2022 are not necessarily
indicative of the results of operations expected for the year ended December 31, 2022. These unaudited 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, 2021 and 2020 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 for more on our geographical operational information.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported
amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant items subject
to estimates and assumptions include the carrying amount and useful lives of property and equipment and intangible assets, impairment
assessments, share-based compensation expense, and valuation allowances for accounts receivable, inventories, and deferred tax assets.
Concentrations
of Credit Risk
The
Company has two significant customers that represented 89% and 87% of its revenue for the six months ended June 30, 2022 and 2021, respectively.
These customers had approximately $1,808,000 and $1,229,000 in accounts receivable at June 30, 2022 and 2021, respectively.
The
Company had two vendors that represented 14% of its purchases for the six months ended June 30, 2022. These vendors had approximately
$77,000 in accounts payable at June 30, 2022 and purchases in the six months of 2022 from these vendors totaled approximately $694,000.
The Company had two vendors that represented 12% of its purchases for the six months ended June 30, 2021. This vendor had approximately
$88,000 in accounts payable at June 30, 2021 and purchases in the six months ended June 30, 2021 from this vendor totaled approximately
$377,000.
Restatement
of the Unaudited Condensed Consolidated Financial Statements
The
purpose of this restatement is to correct an error in the Company’s previously issued financial statements for the six months ended
June 30, 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.
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 condensed consolidated statement of cash flows for the six months ended June 30, 2021
are as follows:
SCHEDULE OF RESTATEMENT OF CONSOLIDATED STATEMENT OF CASH FLOWS
|
| |
June 30, 2021 | |
|
| |
As Reported | | |
As Restated | |
- |
Net cash from operating activities | |
$ | 400,250 | | |
$ | 334,530 | |
- |
Net cash from investing activities | |
$ | 39,060 | | |
$ | 104,780 | |
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. There was no effect from the restatement on the Company’s condensed consolidated
balance sheet, condensed consolidated statement of operations and condensed consolidated statement of shareholders’ equity for
the six months ended June 30, 2021.
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 six months ended June 30, 2022 and 2021 of $63,683 and $43,649, respectively with income
before income taxes of $ and a loss before income taxes of $, respectively. The reason that 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.
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.
Disaggregation
of Revenue
Approximately 89%
of our revenue is from North America and approximately 11%
is from the Middle East for the three months ended June 30, 2022. For
the six months ended June 30, 2022, approximately 90% of our revenue was from North America and approximately 10%
was from the Middle East.
Revenue
disaggregated by revenue source are as follows:
SCHEDULE OF REVENUE DISAGGREGATED BY REVENUE
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
| |
Three months ended June 30, | | |
Six months ended June 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
| |
| | |
| | |
| | |
| |
Tool Revenue: | |
| | | |
| | | |
| | | |
| | |
Tool and product sales | |
$ | 627,200 | | |
$ | 660,000 | | |
$ | 1,291,500 | | |
$ | 1,155,000 | |
Tool rental | |
| 519,724 | | |
| 460,453 | | |
| 904,874 | | |
| 796,906 | |
Other related revenue | |
| 1,744,656 | | |
| 1,153,011 | | |
| 3,464,453 | | |
| 1,985,321 | |
Total Tool Revenue | |
| 2,891,580 | | |
| 2,273,464 | | |
| 5,660,827 | | |
| 3,937,227 | |
| |
| | | |
| | | |
| | | |
| | |
Contract Services | |
| 1,649,262 | | |
| 1,125,645 | | |
| 3,010,180 | | |
| 1,886,534 | |
| |
| | | |
| | | |
| | | |
| | |
Total Revenue | |
$ | 4,540,842 | | |
$ | 3,399,109 | | |
$ | 8,671,007 | | |
$ | 5,823,761 | |
Contract
Costs
We
do not incur any material costs of obtaining contracts.
Contract
Balances
Under
our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional.
Accordingly, our contracts do not give rise to contract assets or liabilities under Topic 606.
NOTE
3. INVENTORIES
Inventories
are comprised of the following:
SCHEDULE OF INVENTORIES
| |
June 30, 2022 | | |
December 31, 2021 | |
Raw material | |
$ | 1,017,672 | | |
$ | 769,547 | |
Work in progress | |
| 136,650 | | |
| 65,945 | |
Finished goods | |
| 170,402 | | |
| 339,143 | |
Inventories,
net | |
$ | 1,324,724 | | |
$ | 1,174,635 | |
NOTE
4. PROPERTY, PLANT AND EQUIPMENT
Property,
plant and equipment are comprised of the following:
SCHEDULE OF PROPERTY, PLANT AND EQUIPMENT
| |
June 30, 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 | |
| 12,946,080 | | |
| 12,207,497 | |
Office equipment, fixtures and software | |
| 628,358 | | |
| 628,358 | |
Transportation assets | |
| 265,760 | | |
| 265,760 | |
Property, plant and equipment,
gross | |
| 20,240,094 | | |
| 19,501,511 | |
Accumulated depreciation | |
| (12,813,404 | ) | |
| (12,571,182 | ) |
Property,
plant and equipment, net | |
$ | 7,426,690 | | |
$ | 6,930,329 | |
Middle
East tools, no longer in service, were written down on June 30, 2022. The asset value of the tools was $510,836 and the accumulated depreciation
totaled $487,825. The net gain (loss) was $(23,012).
Depreciation
expense related to property, plant and equipment for the three months ended June 30, 2022 and 2021 was $360,981 and $377,171, respectively,
and for the six months ended June 30, 2022 and 2021 was $730,046 and $775,577, respectively.
NOTE
5. INTANGIBLE ASSETS
Intangible
assets are comprised of the following:
SCHEDULE OF INTANGIBLE ASSETS
| |
June 30, 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 | |
| (14,747,222 | ) | |
| (14,663,889 | ) |
Intangible
assets, net | |
$ | 152,778 | | |
$ | 236,111 | |
Amortization
expense related to intangible assets for the three months ended June 30, 2022 and 2021 was $41,667 and $208,333, respectively, and for
the six months ended June 30, 2022 and 2021 was $83,333 and $500,000, 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 June 30, 2022 was approximately $6,816,000
and as of 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 (check with Drew on this heading)
Total
debt is comprised of the following:
SCHEDULE OF LONG-TERM DEBT INSTRUMENTS
| |
June 30, 2022 | | |
December 31, 2021 | |
Hard Rock Note | |
$ | 750,000 | | |
$ | 750,000 | |
Credit Agreement | |
| 1,154,769 | | |
| 1,312,194 | |
Machinery loans | |
| 299,927 | | |
| 357,963 | |
Transportation loans | |
| 26,217 | | |
| 32,277 | |
Insurance financing | |
| 164,128 | | |
| - | |
Long term debt, Total | |
| 2,395,041 | | |
| 2,452,434 | |
Less: | |
| | | |
| | |
Current portion | |
| (2,204,508 | ) | |
| (2,195,759 | ) |
Long-term debt, net | |
$ | 190,533 | | |
$ | 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 June 30, 2022, accrues interest at 8.00% per annum and is fully payable and
will be paid on or before October 5, 2022.The Company paid an interest payment on the note on July 5, 2022 of $14,959.
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 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 June 30, 2022, we had approximately $167,000 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 June 30, 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 June 30, 2022, the interest rate for the Term Loan was 10.35%, 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 June 30, 2022, we had approximately $9,900 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/or to repurchase the Property. Due to the
repurchase option, the Company was unable to account for the transfer as a sale under ASC Topic 842, Leases, and as such is a
failed sale-leaseback that is accounted for as a financing transaction. The Company did not record the transaction as a failed
sale-leaseback.
As
a result of the agreement, 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 June 30, 2022
and December 31, 2021 was $4,145,803 and $4,178,336, respectively.
The
financing obligation is summarized below:
SCHEDULE OF FINANCING OBLIGATION
| |
June 30, 2022 | | |
December 31, 2021 | |
Finance obligations for sale-leaseback transactions | |
$ | 4,145,803 | | |
$ | 4,178,336 | |
Current principal portion of finance obligation | |
| (70,025 | ) | |
| (65,678 | ) |
Non-current portion of finance obligation | |
$ | 4,075,778 | | |
$ | 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 | | |
2022 | | |
2021 | |
| |
Three months ended June 30, | | |
Six months ended June 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
| |
| | |
| | |
| | |
| |
Revenue: | |
| | | |
| | | |
| | | |
| | |
North America | |
$ | 4,021,118 | | |
$ | 2,941,056 | | |
$ | 7,766,133 | | |
$ | 5,033,255 | |
Middle East | |
$ | 519,724 | | |
$ | 458,053 | | |
$ | 904,874 | | |
$ | 790,506 | |
Revenues | |
$ | 4,540,842 | | |
$ | 3,399,109 | | |
$ | 8,671,007 | | |
$ | 5,823,761 | |
The
following summarizes net property, plant and equipment by geographic location:
SCHEDULE OF NET PROPERTY, PLANT AND EQUIPMENT BY GEOGRAPHIC LOCATION
| |
June 30, 2022 | | |
December 31, 2021 | |
Property, plant and equipment, net: | |
| | | |
| | |
North America | |
$ | 5,369,729 | | |
$ | 5,762,066 | |
Middle East | |
| 2,056,961 | | |
| 1,168,263 | |
Property, plant and equipment,
net | |
$ | 7,426,690 | | |
$ | 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 mid-2023.
NOTE
11. SHAREHOLDERS’ EQUITY
The
Company is authorized to issue 100,000,000 shares of common stock, par value $0.001. As of June 30, 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 six months ended June 30, 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 April 14, 2022 and final acceptance was completed on July 1, 2022. The
Company financed the remaining balance of $669,200
with payments of $12,783
starting on August 1, 2022.
On August 9, 2022, the Board of Directors approved
restricted stock units to Troy Meier, Chairman and Chief Executive Officer, Annette Meier, President and Chief Operating Officer, Chris
Cashion, Chief Financial Officer, and to each of the three independent members of the Board of Directors. The grant date for these units
is effective the filing date of the Form S-8 registration statement. The registration effective date of the filing is August 12, 2022.
The restricted stock units awarded to Troy Meier is 332,500, the restricted stock units awarded to Annette Meier is 255,000, the restricted
stock units awarded to Chris Cashion is 120,000 and the restricted stock units awarded to each of the three independent members of the
Board of Directors is 75,000. In addition, the Board of Directors authorized 75,000 stock options and 250,000 restricted stock units to
be granted to employees of the Company other than Mr. and Mrs. Meier and Mr. Cashion. These stock options and restricted stock units will
vest over three years.