NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013
NOTE 1 - BUSINESS OVERVIEW AND SUMMARY OF ACCOUNTING POLICIES
Organization and
Business.
Coil Tubing Technology, Inc. (“
we
” or the “
Company
”) was formed in 2005
to specialize in the design and production of proprietary tools for the coil tubing industry. The Company concentrates on three
categories of coil tubing applications: tubing fishing, tubing work over and coil tubing drilling. The Company supplies a full
line of tools to oil companies, coiled tubing operators and well servicing companies. The Company focuses on the development, marketing,
sales and rental of advanced tools and related technical solutions for use with coil tubing and jointed pipe in the bottom hole
assembly for the exploration and production of hydrocarbons.
Basis of Presentation.
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Coil
Tubing Technology Holdings, Inc., a Nevada corporation and its subsidiaries, Total Downhole Solutions, Inc. (“
TDS
”)
and Coil Tubing Technology, Inc. (“
CTT Texas
”) Texas corporations and Coil Tubing Technology Canada Inc., an
Alberta, Canada corporation (“
CTT Canada
”). The Company’s consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the United States of America (“
GAAP
”).
The Company’s consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications.
Certain amounts in the consolidated financial statements of prior periods have been reclassified to conform to the current presentation
for comparative purposes. These reclassifications have no impact on net income.
Use of Estimates
in Financial Statement Preparation.
The preparation of financial statements in conformity with generally accepted accounting
principles (“
GAAP
”) requires management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as certain financial statement disclosures. While management believes that
the estimates and assumptions used in the preparation of the financial statements are appropriate, actual results could differ
from these estimates.
Cash Equivalents.
The Company considers all highly liquid investments with original purchased maturities of three months or less to be cash equivalents.
Revenue Recognition.
The Company's revenue is generated primarily from the rental and sales of its tools used for oilfield services primarily in Texas,
Louisiana and Pennsylvania in the U.S. and Alberta, Canada. The Rental income is recognized over the rental periods, which are
generally from one to thirty days. The estimated amounts of sales discounts, returns and allowances are accounted for as reductions
of sales when the sale occurs and the realization of collectability is reasonably assured. These estimates are based on historical
amounts and adjusted periodically based on changes in facts and circumstances when the changes become known to the Company. The
Company also recognizes rental revenue for the full sales price of any tools which are lost and/or damaged in use (and billed to
the customer) and recognizes the net carrying cost of such tool (“
manufacturers cost
” less depreciation) as
cost of product of rental revenue.
Sales of coil tubing
related products are primarily derived from instances where a customer has a specific need for a particular coil tubing related
product and desires to have the Company obtain and/or manufacture the particular product. These sales may include replacement parts,
as well as proprietary tools which are manufactured to the customer’s specification, but which are not part of the Company’s
tool line. The Company generally recognizes product revenue at the time the product is shipped. Concurrent with the recognition
of revenue, the Company provides for the estimated cost of product returns. Sales incentives are generally classified as a reduction
of revenue and are recognized at the later of when revenue is recognized or when the incentive is offered. Shipping and handling
costs are included in cost of goods sold.
Rental Tools.
Approximately
98% of the Company’s revenues are generated from rental equipment. Rental tools are recorded on the Company’s books
as rental equipment at “
manufacturers cost
” as they are purchased from a contract manufacturer. Depreciation
is calculated using the straight line method over the useful lives of the assets of five years. Lost or destroyed tools are not
a significant source of rental revenue for the Company (approximately 2.7% in 2013). The Company bills customers for the sales
price of any tools which are lost and/or damaged in use and the cost and related accumulated depreciation are removed from the
accounts and any resulting revenue or expense is recognized. Lost tools are recognized as product rental revenue and cost of products
of rental revenue, respectively.
Intangible Assets.
The Company’s intangible assets, which are recorded at cost, consist primarily of the unamortized cost basis of issued
and pending patents. These assets are being amortized on a straight line basis over their estimated useful lives of 15 years. The
Company continually evaluates the amortization period and carrying basis of intangible assets to determine whether subsequent events
and circumstances warrant a revised estimated useful life or impairment in value. To date, no such impairment has occurred. To
the extent such events or circumstances occur that could affect the recoverability of our Intangibles assets, we may incur charges
for impairment in the future.
Earnings Per Share
.
Basic earnings per common share equals net earnings attributable to common shareholders divided by the weighted average shares
outstanding during the period. Diluted earnings per share include the impact on dilution from all contingently issuable shares,
including options, warrants and convertible securities. The common stock equivalents from contingent shares are determined by the
treasury stock method. Diluted earnings per share for 2012 reflect the potential dilution of securities that could share in the
earnings of an entity, such as stock options and warrants. The calculation of diluted earnings per share for the year ended December
31, 2012 includes stock options and warrants to purchase 2,879,565 shares. The calculation of diluted earnings per share for the
year ended December 31, 2012 excludes stock options to purchase 3,334 shares due to their anti-dilutive effect. For the years ended
December 31, 2013 potential dilutive securities had an anti-dilutive effect and were not included in the calculation of fully diluted
net loss per common share.
Stock Based Compensation.
The Company accounts for stock-based employee compensation arrangements using the fair value method that requires that the
fair value of employee awards issued, modified, repurchased or cancelled after implementation, under share-based payment arrangements,
be measured as of the date the award is issued, modified, repurchased or cancelled. The resulting cost is then recognized as general
and administrative expense in the statement of operations over the service period.
The Company periodically
issues common stock for acquisitions and services rendered. Common stock issued is valued at the estimated fair market value, as
determined by management and the board of directors. Management and the board of directors consider market price quotations, recent
stock offering prices and other factors in determining fair market value for purposes of valuing the common stock. The fair value
of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the various weighted
average assumptions, including dividend yield, expected volatility, average risk-free interest rate and expected lives.
Income Taxes.
The Company uses the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities
are determined based upon differences between the financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are
reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in the consolidated statements of operations in the period that includes the enactment date.
Financial Instruments.
Financial instruments consist of cash, accounts receivable, accounts payable, accrued expenses, notes payable, and debt. The Company
carries cash, accounts receivable, accounts payable and accrued expenses at historical costs; their respective estimated fair values
approximate carrying values due to their current nature. The Company also periodically carries convertible debt. The
fair values of the convertible debt instruments approximate carrying values based on the comparable market interest rates applicable
to similar instruments.
Customer Deposits.
The Company receives deposits from customers under certain agreements. Deposits are usually liquidated over the period of product
deliveries.
Allowance for Doubtful
Accounts.
Accounts receivable consists of amounts billed and currently due from customers. The Company monitors the aging of
its accounts receivable and related facts and circumstances to determine if an allowance should be established for doubtful accounts.
The Company recorded an allowance of $104,607 and $13,404 as of December 31, 2013 and 2012, respectively. Bad debt expense was
$91,204 and $30,540 for the years ended December 31, 2013 and 2012, respectively.
Property and Equipment.
Property and Equipment is stated at cost less accumulated depreciation. Depreciation is calculated using the straight line
method over the useful lives of the assets of five to thirty-nine years. Maintenance, repairs, and minor renewals and betterments
are charged to expense as incurred. When assets are sold or otherwise disposed of, the cost and the related accumulated depreciation
are removed from the accounts and any resulting gain or loss is recognized.
Fair Value Estimates
.
Pursuant to the Accounting Standards Codification (“ASC”) No. 820, “
Disclosures About Fair Value of Financial
Instruments
”, the Company records its financial assets and liabilities at fair value. ASC No. 820 provides a framework
for measuring fair value, clarifies the definition of fair value and expands disclosures regarding fair value measurements. Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants at the reporting date. ASC No. 820 establishes a three-tier hierarchy, which prioritizes
the inputs used in the valuation methodologies in measuring fair value:
Level 1—Inputs
are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2—Inputs
(other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through
correlation with market data at the measurement date and for the duration of the asset/liability’s anticipated life.
Level 3—Inputs
reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement
date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
The carrying values for cash and cash equivalents,
accounts receivable, prepaid assets, accounts payable and accrued liabilities approximate their fair value due to their short maturities.
Recently Issued
Accounting Pronouncements.
We have adopted recently issued accounting pronouncements and have determined that they have
no material effect on our financial position, results of operations, or cash flow. We do not expect any recently issued
but not yet adopted accounting pronouncements to have a material effect on our financial position, results of operations or cash
flow.
NOTE 2 – RENTAL TOOLS, NET
Rental tools are purchased
from contract manufacturers engaged to produce the Company’s patented or licensed products. These tools are rented or leased
to a variety of well-servicing companies over the life of the tool. Rental tools are depreciated over their estimated useful life
of 5 years and are presented in the accompanying financial statements, net of accumulated depreciation of $3,171,693 and $2,100,808
as of December 31, 2013 and 2012, respectively. For the years ended December 31, 2013 and 2012, depreciation expense
of $1,099,968 and $988,378, respectively, was included in the cost of revenue.
NOTE 3 – PROPERTY AND EQUIPMENT,
NET
Property and equipment
consisted of the following:
|
|
|
|
December 31,
|
|
Description
|
|
Life
|
|
2013
|
|
|
2012
|
|
Office equipment
|
|
5 years
|
|
$
|
35,870
|
|
|
$
|
29,359
|
|
Shop equipment
|
|
5 years
|
|
|
297,174
|
|
|
|
187,806
|
|
Vehicles
|
|
4 years
|
|
|
575,519
|
|
|
|
505,827
|
|
Leasehold improvements
|
|
10 years
|
|
|
180,562
|
|
|
|
116,893
|
|
Building
|
|
39 years
|
|
|
689,770
|
|
|
|
–
|
|
Land
|
|
N/A
|
|
|
194,000
|
|
|
|
–
|
|
|
|
|
|
|
1,972,895
|
|
|
|
839,885
|
|
Less: accumulated depreciation
|
|
|
|
|
(473,329
|
)
|
|
|
(306,171
|
)
|
|
|
|
|
$
|
1,499,566
|
|
|
$
|
533,714
|
|
For the years ended
December 31, 2013 and 2012, depreciation expense was $208,565 and $162,813, respectively. During the years ended December
31, 2013 and 2012, the Company sold equipment, traded in vehicles and disposed of obsolete equipment resulting in a loss of $14,533
and $5,884, respectively.
NOTE 4 - INTANGIBLE ASSETS, NET
In November 2010, the
Company entered into an Intellectual Property Purchase Agreement (the “
IP Agreement
”) with Jerry Swinford, the
Company’s then Chief Executive Officer and current Executive Vice President. Pursuant to the IP Agreement, the Company agreed
to purchase the patents and pending patents owned and held by Mr. Swinford for $25,000 cash and $1,175,000 in the form of two promissory
notes payable to Mr. Swinford (the “
Swinford Notes
”). Mr. Swinford reserved a first priority security
interest over these patents until such time as the Swinford Notes are paid in full (the first note, in the amount of $475,000,
was paid in full in January 2011).
Intangible assets consisted of the following:
|
|
|
|
December 31,
|
|
Description
|
|
Life
|
|
2013
|
|
|
2012
|
|
Issued patents
|
|
15 years
|
|
$
|
550,000
|
|
|
$
|
550,000
|
|
Pending patents
|
|
15 years
|
|
|
650,000
|
|
|
|
650,000
|
|
Total intangible assets
|
|
|
|
|
1,200,000
|
|
|
|
1,200,000
|
|
Less: accumulated amortization
|
|
|
|
|
(246,670
|
)
|
|
|
(166,667
|
)
|
Intangible assets, net
|
|
|
|
$
|
953,330
|
|
|
$
|
1,033,333
|
|
Amortization expense
was $80,000 during each of the years ended December 31, 2013 and 2012, respectively and is reflected as a component of operating
expenses in the accompanying consolidated financial statements.
NOTE 5 – NOTES PAYABLE
As of December 31,
2013 and 2012, the following promissory notes were outstanding:
|
|
December 31,
|
|
|
|
2013
|
|
|
2012
|
|
Notes payable – vehicle loans
|
|
$
|
244,137
|
|
|
$
|
204,759
|
|
Notes payable – building loan
|
|
|
645,874
|
|
|
|
–
|
|
Related party note payable - Jerry Swinford
|
|
|
246,295
|
|
|
|
401,851
|
|
Total debt
|
|
|
1,136,306
|
|
|
|
606,610
|
|
Less current portion – current portion – notes payable – vehicle loans
|
|
|
(71,425
|
)
|
|
|
(47,365
|
)
|
Less current portion – current portion – notes payable – building loan
|
|
|
(19,415
|
)
|
|
|
–
|
|
Less current portion – related party note payable
|
|
|
(155,556
|
)
|
|
|
(155,556
|
)
|
Long-term debt
|
|
$
|
889,910
|
|
|
$
|
403,689
|
|
Building Loan
Effective October 25,
2013, the Company purchased a 6,000 square foot office/warehouse building and associated land located at 22305 Gosling Road, Spring,
Texas 77389. The purchase price was $884,508. The Company obtained $649,000 of the purchase price by way of a loan from Bank of
Houston, evidenced by a promissory note, which loan bears interest at 5% per annum for three years and the prime rate plus 1% thereafter
(not to be less than 5%), and has a maturity date of October 25, 2018. Upon an event of default, the loan bears interest at the
lesser of the rate of 5% above the then applicable interest rate of the note, and the greatest amount provided by law. Amortization
payments based on a 20-year amortization schedule (initially $4,309 per month) are due on the loan until maturity (recalculated
based on the then interest rate after the first three years of the loan). The amount due under the loan is secured by a Deed of
Trust, Security Agreement and Financing Statement on the property purchased.
Vehicle Loans
The Company has entered
into a number of loans for the purchase of vehicles used in its business. These vehicles are primarily used by sales and delivery
personnel. These installment loans are generally two to six year loans at interest rates varying for 4.99% to 8.79% and are secured
by the vehicle, and mature from one to four years.
Related Party Notes Payable
In November 2010, the
Company entered into the IP Agreement with Jerry Swinford, the Company’s then Chief Executive Officer and current Executive
Vice President. Pursuant to the IP Agreement, the Company agreed to purchase the patents and pending patents owned and held by
Mr. Swinford for $25,000 cash and $1,175,000 in the form of two promissory notes payable to Mr. Swinford (the “
Swinford
Notes
”). The first note, in the amount of $475,000 was paid in full in January 2011. The second note in the amount of
$700,000 is due September 15, 2015, and is payable in equal monthly installments of $12,963. The notes are non-interest bearing. The
Company also agreed to grant Mr. Swinford a security interest in all of the Company’s assets in connection with and to secure
the repayment of the Swinford Notes and Coil Tubing Technology Holding, Inc., the Company’s wholly-owned subsidiary (“
Holdings
”)
also agreed, pursuant to a Guaranty Agreement, to guaranty the repayment of the Swinford Notes.
In connection with
the IP Agreement, Mr. Swinford agreed to cancel 1,000,000 shares of the Company’s Series A Preferred Stock. As a result of
this cancellation, there was a change of control whereby Mr. Pohlmann obtained voting control over the Company. Mr. Swinford has
a first priority security interest over the patents until such time as the promissory notes he was provided in connection with
the IP Purchase Agreement (described above) are satisfied in full.
Future maturities under the above mentioned
notes payable at December 31, 2013 were as follows:
Year Ending
December 31,
|
|
Amount
|
|
2014
|
|
|
246,396
|
|
2015
|
|
|
172,462
|
|
2016
|
|
|
74,192
|
|
2017
|
|
|
68,867
|
|
2018
|
|
|
574,389
|
|
Thereafter
|
|
|
–
|
|
Total
|
|
$
|
1,136,306
|
|
NOTE 6 – STOCKHOLDERS’ EQUITY
The total number of
shares of stock of all classes which the Company has authority to issue as a result of the amendment in September 2011 and described
below is two hundred and five million (205,000,000), of which five million (5,000,000) are shares of Preferred Stock with a par
value of $0.001 per share ("
Preferred Stock
"), and two hundred million (200,000,000) are shares of Common Stock
with a par value of $0.001 per share ("
Common Stock
").
In January 2011, the
Company’s majority shareholder, Mr. Herbert C. Pohlmann, and the Company’s then sole director, Jerry Swinford, entered
into a Voting Agreement, pursuant to which Mr. Herbert C. Pohlmann agreed to vote the shares of the Company which he owns as directed
by Mr. Swinford from time to time, to appoint at least 40% of the Company’s Board of Directors, rounded up to the nearest
whole number of directors. The Voting Agreement remains in effect until December 31, 2015.
In May 2011, the Company’s
sole director and its majority shareholder approved the filing of a Certificate of Amendment to our Articles of Incorporation with
the Secretary of State of Nevada, pursuant to which our authorized shares of Common Stock were increased to 4,990,000,000 shares
of Common Stock $0.001 par value per share and we re-authorized 5,000,000 shares of Preferred Stock $0.001 par value per share,
which was filed and effective with the Secretary of State of Nevada in May 2011.
In September 2011,
the Company’s sole director and majority shareholder approved an amendment to the Company’s Articles of Incorporation
to affect a 1:300 reverse stock split of the Company’s outstanding shares of Common Stock and to authorize 205,000,000 shares
of capital stock, including 200,000,000 shares of Common Stock, $0.001 par value per share, and 5,000,000 shares of Preferred Stock,
$0.001 par value per share, which amendment was effective with the Secretary of State of Nevada on October 21, 2011. All
share amounts presented herein reflect retroactive recognition of the 1:300 reverse stock split.
Preferred Stock
The shares of preferred
stock of the Company may be issued from time to time in one or more series, each of which shall have a distinctive designation
or title as shall be determined by the Board of Directors of the Company ("
Board of Directors
") prior to the issuance
of any shares thereof. The preferred stock shall have such voting powers, full or limited, or no voting powers, and such preferences
and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof as adopted
by the Board of Directors.
The total number of
designated shares of the Company’s Series A Preferred Stock is one million (1,000,000). As of December 31, 2013 and 2012,
the Company had -0- shares of its Series A Preferred Stock, $0.001 par value issued and outstanding. The Series A Preferred Stock
has no dividend rights, no liquidation preference, no redemption rights and no conversion rights and has 51% voting rights or voting
rights equal to 51% of the Company’s outstanding common stock.
The total number of
designated shares of the Company’s Series B Preferred Stock is one million (1,000,000). As of December 31, 2013 and 2012,
the Company had 1,000,000 shares of its Series B Preferred Stock, $0.001 par value issued and outstanding. The Series B Preferred
Stock has no dividend rights, no liquidation preference, no redemption rights, no voting rights and conversion rights of 0.0667
shares of common stock for each one preferred share during the Option Period (the “
Option
”). The
“
Option Period
”, beginning in November 2010 and terminated in November 2012, allowed the holder of such Series
B Preferred Stock to purchase shares of Series A Preferred Stock of the Company for aggregate consideration of one hundred dollars
and lasted for two years from the date that the holder of the Series A Preferred Stock no longer desired to hold the Series A Preferred
Stock.
Series A Preferred
Stock – Coil Tubing Technology Holdings, Inc.
The Series A Preferred Stock of our wholly-owned subsidiary Coil Tubing
Technology Holdings, Inc., has no dividend rights, no liquidation preference, no redemption rights and no conversion rights and
has 51% voting rights or voting rights equal to 51% of Holdings’ outstanding common stock. On December 5, 2012, and effective
November 30, 2010, the Company, Jerry Swinford and Holdings entered into a Series A Preferred Stock Cancellation Agreement pursuant
to which Mr. Swinford cancelled the 1,000,000 shares of Series A Preferred Stock of Holdings which he held and the Company agreed
to pay Mr. Swinford $1,000 ($0.001 per share of Series A Preferred Stock) in connection with such cancellation. As a result of
the cancellation, the Company has sole voting control over and holds 100% of the outstanding securities of Holdings.
Common Stock
As of December 31,
2013 and 2012, the Company had 15,651,827 shares of its $0.001 par value common stock issued and outstanding.
In January 2012, the
Company sold 52,500 Units to a third party in consideration for $52,500 or $1.00 per unit.
As of December 31,
2013, Mr. Herbert C. Pohlmann held 12,440,648 shares (12,242,397 directly and 198,251 through a trust) (or approximately 79.5%)
of the Company’s issued and outstanding shares of common stock.
NOTE 7 - STOCK OPTIONS AND WARRANTS
Stock Options
In January 2011, the
Company’s then sole director and its majority shareholder, approved the Company’s 2010 Stock Incentive Plan, which
allows the Board of Directors to grant up to an aggregate of eighty-three thousand three hundred and thirty-three (83,333) qualified
and non-qualified stock options, restricted stock and performance based awards of securities to the Company’s officers, directors
and consultants to help attract and retain qualified Company personnel (the “2010 Stock Plan”).
On
and effective January 12, 2012, the Company’s Board of Directors and its majority shareholder, Herbert C. Pohlmann, approved
the Company’s 2012 Stock Incentive Plan, which allows the Board of Directors to grant up to an aggregate of 750,000 qualified
and non-qualified stock options, restricted stock and performance based awards of securities to the Company’s officers, directors
and consultants to help attract and retain qualified Company personnel (the “2012 Stock Plan” and together with the
2010 Stock Plan, the “Stock Plans”).
|
|
Stock Plans
|
|
Options initially reserved
|
|
|
833,333
|
|
Options issued during 2012 under the 2012 plan
|
|
|
(600,000
|
)
|
Securities available to be granted/issued at December 31, 2013
|
|
|
233,333
|
|
Options issued and outstanding under the plans as of December 31, 2013
|
|
|
600,000
|
|
The Company recognized
total option expense of $459,865 and $215,706 for the years ended December 31, 2013 and 2012, respectively. The remaining
amount of unamortized options expense at December 31, 2013 and 2012 was $324,429 and $784,294, respectively. The intrinsic value
of outstanding as well as exercisable options at December 31, 2013 and 2012 was $-0-and $1,560,000, respectively.
In August 2012, options
to purchase an aggregate of 100,000 shares of common stock were granted to Jerry Swinford, at an exercise price of $1.00 per share.
The options have a term of 10 years and vest on December 31, 2014. Fair value of $100,000 was calculated using the Black-Scholes
option-pricing model. Variables used in the Black-
Scholes option-pricing model for the options granted include: (1) discount
rate of 1.64%, (2) term of 10 years, (3) expected volatility of 362%, and (4) zero expected dividends.
In August 2012, pursuant
to a Second Amendment to Employment Agreement entered into with Jerry Swinford, 301,667 options were modified to extend the term
from 5 to 10 years and to set the exercise price of certain of the options at $1.00 per share, resulting in an additional expense
of $37,881. In March 2013, and effective as of October 2012, pursuant to an amendment to the Employment Agreement entered into
with Jerry Swinford, the parties modified the vesting of certain of the options previously granted. The options granted to Jerry
Swinford are as follows:
|
·
|
1,667 options vested on November 30, 2011;
|
|
·
|
100,000 options vested on December 14, 2011;
|
|
·
|
200,000 options vest on December 31, 2013; and
|
|
·
|
100,000 options vest on December 31, 2014.
|
In August 2012, options
to purchase an aggregate of 100,000 shares of common stock were granted to Jason Swinford, at an exercise price of $1.00 per share.
The options have a term of 10 years and vest on December 31, 2014. Fair value of $100,000 was calculated using the Black-Scholes
option-pricing model. Variables used in the Black-Scholes option-pricing model for the options granted include: (1) discount rate
of 1.64%, (2) term of 10 years, (3) expected volatility of 362%, and (4) zero expected dividends.
In August 2012, pursuant
to a Second Amendment to Employment Agreement entered into with Jason Swinford, 301,667 options were modified to extend the term
from 5 to 10 years and to set the exercise price of certain of the options at $1.00 per share, resulting in an additional expense
of $37,881. In March 2013, and effective as of October 2012, pursuant to an amendment to the Employment Agreement entered into
with Jason Swinford, the parties modified the vesting of certain of the options previously granted. The options granted to Jason
Swinford are as follows:
|
·
|
1,667 options vested on November 30, 2011;
|
|
·
|
100,000 options vested on December 14, 2011;
|
|
·
|
200,000 options vest on December 31, 2013; and
|
|
·
|
100,000 options vest on December 31, 2014.
|
In August 2012, options
to purchase an aggregate of 400,000 shares of common stock were granted to Herbert C. Pohlmann, at an exercise price of $1.00 per
share. The options have terms of 10 years, with 25% of the options vesting on December 31, 2012 and 25% vesting annually thereafter
over the next three years. Fair value of $400,000 was calculated using the Black-Scholes option-pricing model. Variables used in
the Black-Scholes option-pricing model for the options issued include: (1) discount rate of 1.64%, (2) term of 10 years, (3)
expected volatility of 362%, and (4) zero expected dividends.
Activity in options during the year ended
December 31, 2013 and related balances outstanding as of that date are reflected below:
|
|
Number of Shares Outstanding
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Contract Term
|
|
|
|
|
|
|
(in dollars)
|
|
|
(in years)
|
|
Balance at December 31, 2013
|
|
|
1,203,334
|
|
|
$
|
1.02
|
|
|
|
6.92
|
|
Exercisable at December 31, 2013
|
|
|
803,334
|
|
|
$
|
1.03
|
|
|
|
6.92
|
|
Summary of options
outstanding and exercisable as of December 31, 2013 is as follows:
Exercise Price
|
|
|
Weighted Average Remaining Life (years)
|
|
|
Number of Options Outstanding
|
|
|
Number of Options Exercisable
|
|
$
|
7.50
|
|
|
|
6.9
|
|
|
|
3,334
|
|
|
|
3,334
|
|
$
|
1.00
|
|
|
|
6.9
|
|
|
|
1,200,000
|
|
|
|
800,000
|
|
$
|
1.00 to 7.50
|
|
|
|
6.9
|
|
|
|
1,203,334
|
|
|
|
803,334
|
|
Activity in options during the year ended
December 31, 2012 and related balances outstanding as of that date are reflected below:
|
|
Number of Shares Outstanding
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Contract Term
|
|
|
|
|
|
|
|
|
(in dollars)
|
|
|
|
(in years)
|
|
Balance at December 31, 2012
|
|
|
1,203,334
|
|
|
$
|
1.04
|
|
|
|
8.50
|
|
Exercisable at December 31, 2012
|
|
|
303,334
|
|
|
$
|
1.07
|
|
|
|
8.50
|
|
Summary of options
outstanding and exercisable as of December 31, 2012 is as follows:
Exercise Price
|
|
|
Weighted Average Remaining Life (years)
|
|
|
Number of Options Outstanding
|
|
|
Number of Options Exercisable
|
|
$
|
7.50
|
|
|
|
7.9
|
|
|
|
3,334
|
|
|
|
3,334
|
|
$
|
1.00
|
|
|
|
8.5
|
|
|
|
1,200,000
|
|
|
|
300,000
|
|
$
|
1.00 to 7.50
|
|
|
|
8.5
|
|
|
|
1,203,334
|
|
|
|
303,334
|
|
Investor Warrants
In December 2011, the
Company completed a private placement of 1,600,000 Units to Mr. Herbert C. Pohlmann. Each Unit consisted of one share of common
stock, and a warrant. Each warrant entitles the holder to purchase one additional share of common stock at a price of $1.00 per
share at any time until December 14, 2016. The Company sold each Unit at a price of $1.00 per Unit, which represents total proceeds
of $1,600,000.
In January, 2012, the
Company completed a private placement of 52,500 Units to a former director as described in Note 6 above. Each Unit consisted of
one share of common stock, and a warrant. Each warrant entitles the holder to purchase one additional share of common stock at
a price of $1.00 per share at any time until January 5, 2017. The Company sold each Unit at a price of $1.00 per Unit, which represents
total proceeds of $52,500. The relative fair value of the warrants issued was approximately 50% of the proceeds. The warrants vest
upon issuance. Variables used in the Black-Scholes option-pricing model for the warrants issued include: (1) discount rate of 0.86%,
(2) term of 5 years, (3) expected volatility of 437%, and (4) zero expected dividends.
In August, 2012, the
Company granted John Callis, a former director of the Company (a) warrants to purchase 220,000 shares of common stock of the Company
with a term of one (1) year and an exercise price of $1.00 per share, which warrants expired on August 8, 2013; and (b) warrants
to purchase 52,500 shares of common stock of the Company with a term expiring on January 5, 2017 and an exercise price of $1.00
per share in consideration for funding previously provided to the Company. The relative fair value of the warrants issued was approximately
33% of the proceeds. In October 2011, John Callis purchased 166,667 shares of the Company’s common stock for consideration
of $200,000 or $1.20 per share. The warrants vest upon issuance. Variables used in the Black-
Scholes option-pricing model
for the warrants issued include: (1) discount rate ranging from 0.18% to 0.69%, (2) term ranging from 1 to 4.4 years, (3)
expected volatility ranging from 469% to 782%, and (4) zero expected dividends.
The intrinsic value
of outstanding as well as exercisable options at December 31, 2013 and 2012 was $-0-.
Activity in warrants during the year ended
December 31, 2013 and related balances outstanding as of that date are reflected below:
|
|
Number of Shares Outstanding
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Contract Term
|
|
|
|
|
|
|
(in dollars)
|
|
|
(in years)
|
|
Balance at December 31, 2012
|
|
|
1,925,000
|
|
|
$
|
1.00
|
|
|
|
2.96
|
|
Forfeited and canceled
|
|
|
220,000
|
|
|
$
|
–
|
|
|
|
|
|
Balance at December 31, 2013
|
|
|
1,705,000
|
|
|
$
|
1.00
|
|
|
|
2.96
|
|
Exercisable at December 31, 2013
|
|
|
1,705,000
|
|
|
$
|
1.00
|
|
|
|
2.96
|
|
Summary of warrants
outstanding and exercisable as of December 31, 2013 is as follows:
Exercise Price
|
|
|
Weighted Average Remaining Life (years)
|
|
|
Number of Warrants Outstanding
|
|
|
Number of Warrants Exercisable
|
|
$
|
1.00
|
|
|
|
2.96
|
|
|
|
1,705,000
|
|
|
|
1,705,000
|
|
$
|
1.00
|
|
|
|
2.96
|
|
|
|
1,705,000
|
|
|
|
1,705,000
|
|
Activity in warrants during the year ended
December 31, 2012 and related balances outstanding as of that date are reflected below:
|
|
Number of Shares Outstanding
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Contract Term
|
|
|
|
|
|
|
(in dollars)
|
|
|
(in years)
|
|
Balance at December 31, 2011
|
|
|
1,600,000
|
|
|
$
|
1.00
|
|
|
|
3.96
|
|
Granted
|
|
|
325,000
|
|
|
$
|
1.00
|
|
|
|
1.74
|
|
Balance at December 31, 2012
|
|
|
1,925,000
|
|
|
$
|
1.00
|
|
|
|
3.59
|
|
Exercisable at December 31, 2012
|
|
|
1,925,000
|
|
|
$
|
1.00
|
|
|
|
3.59
|
|
Summary of warrants
outstanding and exercisable as of December 31, 2012 is as follows:
Exercise Price
|
|
|
Weighted Average Remaining Life (years)
|
|
|
Number of Warrants Outstanding
|
|
|
Number of Warrants Exercisable
|
|
$
|
1.00
|
|
|
|
3.59
|
|
|
|
1,925,000
|
|
|
|
1,925,000
|
|
$
|
1.00
|
|
|
|
3.59
|
|
|
|
1,925,000
|
|
|
|
1,925,000
|
|
NOTE 8 - INCOME TAXES
Income tax expense
(benefit) attributable to income from continuing operations differed from the amounts computed by applying the U.S. Federal income
tax of 34% to pretax income from continuing operations as a result of the following:
|
|
December 31, 2013
|
|
|
December 31, 2012
|
|
Provision (benefit) at statutory rate
|
|
$
|
(295,000
|
)
|
|
$
|
256,000
|
|
Net operating loss utilization
|
|
|
(55,000
|
)
|
|
|
(347,000
|
)
|
Prior period adjustment
|
|
|
140,000
|
|
|
|
–
|
|
Non-deductible expenses
|
|
|
156,000
|
|
|
|
–
|
|
Change in valuation allowance
|
|
|
54,000
|
|
|
|
91,000
|
|
|
|
$
|
–
|
|
|
$
|
–
|
|
The tax effects of
temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December
31, 2013 and 2012, are presented below:
|
|
December 31, 2013
|
|
|
December 31, 2012
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforward
|
|
$
|
1,362,000
|
|
|
$
|
1,532,000
|
|
Deferred tax assets
|
|
|
1,362,000
|
|
|
|
1,532,000
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(957,000
|
)
|
|
|
(1,126,000
|
)
|
Deferred tax liabilities
|
|
|
(957,000
|
)
|
|
|
(1,126,000
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
405,000
|
|
|
|
406,000
|
|
Valuation allowance
|
|
|
(405,000
|
)
|
|
|
(406,000
|
)
|
|
|
$
|
–
|
|
|
$
|
–
|
|
The Company has determined
that a valuation allowance of $405,000 at December 31, 2013, is necessary to reduce the net deferred tax assets to the amount that
will more than likely than not be realized. The change in valuation allowance, net of the reduction of the deferred tax asset for
the use of the net operating loss, for 2013 was approximately $405,000. As of December 31, 2013, the Company has an approximate
net operating loss carry-forward of $4,006,000, which is available to offset future federal taxable income, if any, with expiration
in starting in 2022.
The ability of the
Company to utilize net operating loss (“NOL”) carryforwards to reduce future federal taxable income and federal income
tax is subject to various limitations under the Internal Revenue Code of 1986, as amended. The utilization of such carryforwards
may be limited upon the occurrence of certain ownership changes, including the issuance or exercise of rights to acquire stock,
the purchase or sale of stock by 5% stockholders, as defined in the Treasury regulations, and the offering of stock during any
three-year period resulting in an aggregate change of more than 50% in the beneficial ownership of the Company.
In the event of an
ownership change (as defined for income tax purposes), Section 382 of the Code imposes an annual limitation on the amount of a
corporation's taxable income that can be offset by these carryforwards. The limitation is generally equal to the product of (i)
the fair market value of the equity of the company multiplied by (ii) a percentage approximately equivalent to the yield on long-term
tax exempt bonds during the month in which an ownership change occurs. In addition, the limitation is increased if there are recognized
built-in gains during any post-change year, but only to the extent of any net unrealized built-in gains (as defined in the Code)
inherent in the assets sold. Certain NOLs acquired through various acquisitions are also subject to limitations.
There are no significant differences between
the Company’s operating results for financial reporting purposes and for income tax purposes.
NOTE 9 – CONCENTRATION OF RISK
The Company had gross
sales of $6,143,093 and $7,764,984 for the years ended December 31, 2013 and 2012, respectively. The Company had two customers
representing approximately 17% and 18% of gross sales and 15% and 37% of total accounts receivable for the year ended December
31, 2013. The Company had two customers representing approximately 16% and 18% of gross sales and 32% and 20% of total accounts
receivable for the year ended December 31, 2012.
The Company supplies
a full line of tools to oil companies, coiled tubing operators and well servicing companies. A significant amount of the Company’s
customers are in the oil and gas industry. Volatility or decline in oil and natural gas prices may result in reduced demand for
our products and services which may adversely affect our business, financial condition and results of operation.
At various times during
the year, the Company maintained cash balances in excess of FDIC insurable limits. Management feels this risk is mitigated due
to the longstanding reputation of these banks.
NOTE 10 – LITIGATION
From time to time,
we may become party to litigation or other legal proceedings that we consider to be a part of the ordinary course of our business.
We are not currently involved in legal proceedings that could reasonably be expected to have a material adverse effect on our business,
prospects, financial condition or results of operations other than the proceeding described below. We may become involved in other
material legal proceedings in the future.
On July 25, 2013, Eric
Cohen (a shareholder of the Company) filed a lawsuit against the Company, Jerry Swinford (the Executive Vice President and director
of the Company), Jason Swinford (the Chief Executive Officer and director of the Company) and Herbert C. Pohlmann (the Company’s
majority shareholder and former director)(collectively, the “Defendants”) in the 61st Judicial District Court for Harris
County, Texas (Cause No. 2013-43593). The suit seeks monetary damages in excess of $1 million in connection with compensatory damages
alleged suffered by Mr. Cohen or seeks a buyout of Mr. Cohen’s interest in the Company. The suit also seeks legal fees and
pre-and-post judgment interest. The suit alleges “minority shareholder oppression” and “breach of fiduciary duty”
in connection with the actions of Defendants, i.e., that Defendants have engaged in burdensome, harsh or wrongful conduct which
has diluted Mr. Cohen’s shares; granted more power to Defendants (for little or no consideration); and granted rights to
insiders for less than reasonably equivalent value. The Company disputes Mr. Cohen’s claims and the Company has engaged legal
counsel in the matter and filed an answer to the complaint denying Cohen’s allegations. The Company intends to vigorously
defend the case against Cohen’s claims. At this stage of the litigation, the Company believes the likelihood of
material loss is remote. On January 27, 2014, the Company filed a counterclaim against Eric Cohen (plaintiff) requesting damages
and attorneys’ fees incurred in this case.
NOTE 11 – COMMITMENTS AND CONTINGENCIES
The Company has a twelve
month residential sub-lease agreement in effect from December 1, 2013 to December 1, 2014, pursuant to which the Company agreed
to rent a residence located in Blairsville, Pennsylvania. The lease has a monthly rental cost of $850 per month. The
Company plans to use the leased residence as a district office for sales in Ohio, Pennsylvania, and West Virginia and repair of
equipment for that area.
The Company leases
space serving as a sales office, warehouse and machine shop in Haynesville, Louisiana. The Company paid the landowner (a former
employee of the Company) an aggregate of $77,632 in connection with the construction of the warehouse and machine shop (which is
owned by the former employee). In consideration for paying for the cost to construct the warehouse and machine shop,
the landowner agreed to allow the Company to use the warehouse and machine shop and sales office free of charge until August 2012. The
Company currently pays recurring operating costs for the rental of the space only. The Company and the former employee
have entered into a two year extension of the lease (through August 2014) at $500 per month.
The Company also leases
approximately 1,560 square feet of warehouse and office space in Red Deer, Alberta, Canada, which lease arrangement is in effect
from November 3, 2013 through November 3, 2014. Rent due under the lease is $1,300 per month plus the Company’s portion of
common expenses associated with the rental property which total approximately $487 per month and goods and service tax of approximately
$94 per month, for a total monthly rental expense of approximately $1,970 Canadian dollars (approximately $1,789 U.S. dollars)
per month during the term of the lease.
All leases are expiring
in 2014 and the related total lease expense is $31,240.
NOTE 12 - RELATED PARTY TRANSACTIONS
Executive Bonuses
In September, 2012,
the Board of Directors, along with the Company’s majority shareholder agreed to pay the Company’s executive management
discretionary bonuses totaling $311,500. As of December 31, 2012, the Company had paid the bonuses in full.
In December 2011, the
Board of Directors, along with the Company’s majority shareholder, agreed to pay the Company’s executive management
discretionary bonuses totaling $252,000. The bonuses, which had been accrued in 2011, were paid on July 15, 2012.
In 2013, the Company
paid bonuses totaling $142,510 to executive management.
Employment Agreements
Jerry Swinford
In November 2010, the
Company entered into an executive employment agreement with Jerry Swinford that expires in November 2015 (automatically renewable
for additional one year terms unless terminated by either party as provided in the agreement). This agreement was amended in November
2011 (First Amendment), August 2012 (Second Amendment) and October 2012 (Third Amendment, effective August 2012). Pursuant
to the First Amendment, Mr. Swinford will receive (i) a base salary of $108,000 per year, (ii) standard benefits that are available
to other executive officers, (iii) a one-time option to purchase up to 301,667 shares, (iv) and an annual bonus ranging from 20%
to 100% of the prior year salary if certain earnings before income taxes, depreciation and amortization (EBITDA) are met.
Pursuant to the Second
Amendment, (i) Mr. Jerry Swinford’s base salary increased to $120,000 effective July 1, 2012, (ii) Mr. Jerry Swinford received
an option to purchase an additional 100,000 shares of the Company’s common stock at $1.00 per share, vesting on December
31, 2014, (iii) the option to purchase shares (401,667 in aggregate) was extended from five years to ten years, (iv) and Mr. Swinford
was provided a profit bonus equal to 2.5% of the Company’s gross profit for fiscal 2013, in lieu of the EBITDA bonus discussed
above. The Third Amendment clarified the terms of the gross profit bonus described in the Second Amendment and corrected the expiration
date of the options (November 30, 2020) as previously set forth in the option agreements evidencing such options. In March 2013,
and effective as of October 10, 2012, Mr. Jerry Swinford entered into a fourth amendment to his employment agreement with the Company,
pursuant to which the parties agreed to modify the vesting date of stock options to purchase 100,000 shares of the Company’s
common stock from December 31, 2012 to December 31, 2013.
In the event of termination,
for good reason, by Mr. Jerry Swinford, including but not limited to death or disability, the Company will continue to pay his
salary through the term of the agreement, plus a $100,000 lump-sum payment within ten (10) days of such termination. In the event
of termination, for cause, by the Company, the Company will pay his compensation and benefits, through the date of termination
within ten (10) days of such termination, and thereafter the Company shall have no further compensation, benefit or payment obligations
to him, and all unvested options will terminate and be forfeited by him.
In March 2013, and
effective as of October 10, 2012, Jerry and Jason Swinford each entered into fourth amendments to their employment agreements with
the Company, pursuant to which they agreed to modify the vesting date of stock options to purchase 100,000 shares of the Company’s
common stock from December 31, 2012 to December 31, 2013 resulting in an additional expense of $36,689 for the year ended December
31, 2012.
Jason Swinford
In November 2010, the
Company entered into an executive employment agreement with Jason Swinford that expires in November 2015 (automatically renewable
for additional one year terms unless terminated by either party as provided in the agreement). This agreement was amended in November
2011 (First Amendment), August 2012 (Second Amendment) and October 2012 (Third Amendment, effective in August 2012). Pursuant to
the First Amendment, Mr. Jason Swinford will receive (i) a base salary of $200,000 per year, (ii) standard benefits that are available
to other executive officers, (iii) a one-time stock grant of up to 301,667 shares, (iv) and an annual bonus ranging from 20% to
100% of the prior year salary if certain earnings before income taxes, depreciation and amortization (EBITDA) are met.
Pursuant to the Second
Amendment, (i) Mr. Jason Swinford received an option to purchase an additional 100,000 shares of the Company’s common stock
at $1.00 per share, vesting on December 31, 2014, (ii) the option to purchase shares (401,667 in aggregate) was extended from five
years to ten years, (iii) a profit bonus equal to 2.5% of the Company’s gross profit for the 2013 fiscal year (in lieu of
the EBITDA bonus), and (iv) a transaction bonus ranging from $3 million to $5 million based on certain corporate events. The
Third Amendment clarified the terms of the gross profit bonus described in the Second Amendment and corrected the expiration date
of the options (November 30, 2020) as previously set forth in the option agreements evidencing such options. In March 2013, and
effective as of October 10, 2012, Mr. Jason Swinford entered into a fourth amendment to his employment agreement with the Company,
pursuant to which they agreed to modify the vesting date of stock options to purchase 100,000 shares of the Company’s common
stock from December 31, 2012 to December 31, 2013.
In the event of termination,
for good reason, by Mr. Jason Swinford, including but not limited to death or disability, the Company will continue to pay his
salary through the term of the agreement, plus a $100,000 lump-sum payment within ten (10) days of such termination. In the event
of termination, for cause, by the Company, the Company will pay his compensation and benefits through the date of termination within
ten (10) days of such termination, and thereafter the Company shall have no further compensation, benefit or payment obligations
to him, and all unvested options will terminate and be forfeited by him.
In March 2013, and
effective as of October 10, 2012, Jerry and Jason Swinford each entered into fourth amendments to their employment agreements with
the Company, pursuant to which they agreed to modify the vesting date of stock options to purchase 100,000 shares of the Company’s
common stock from December 31, 2012 to December 31, 2013 resulting in an additional expense of $36,689 for the year ended December
31, 2012.
In July 2013, the Company
entered into a fifth amendment to the employment agreement originally entered into between the Company and Jason Swinford (the
“Fifth Amendment”). Pursuant to the Fifth Amendment, the employment agreement was modified to include a transaction
bonus payable to Mr. Swinford in the event (1) a Change of Control (as defined in the employment agreement) of the Company, its
wholly-owned subsidiary, Coil Tubing Technology Holdings, Inc., a Nevada corporation (“Holdings”) and/or Coil Tubing
Technology, Inc., a Texas corporation (the wholly-owned subsidiary of Holdings) occurs; or (2) the sale by the Company of a substantial
amount of the assets of the Company (or the Company’s subsidiaries), each in one or more related transactions (each a “Bonus
Transaction”); occurs while Mr. Swinford is employed under the terms of the employment agreement or within six (6) months
of the termination of such employment agreement (a) by the Company for any reason other than Cause (as defined in the employment
agreement), or (b) by Mr. Swinford for Good Reason (as defined in the employment agreement).
The bonus payable in
connection with the Bonus Transaction is payable based on the following schedule:
(1) If the total
consideration received by the Company and the Company’s shareholders in such Bonus Transaction, including the assumption
of any liabilities of the Company in such transaction and the value of any securities received by the Company or its shareholders
in connection with such Bonus Transaction (collectively the “Bonus Transaction Consideration”), exceeds $20 million,
but is less than $25,000,000.01, Mr. Swinford is to receive a bonus of 2% of the total Bonus Transaction Consideration;
(2) If the Bonus
Transaction Consideration is between $25,000,000.01 and $35,000,000.01, Mr. Swinford is to receive a Transaction Bonus of 3% of
the total Bonus Transaction Consideration; and
(3) If the Bonus
Transaction Consideration is above $35,000,000.01, Mr. Swinford is to receive a Transaction Bonus of 3.5% of the total Bonus Transaction
Consideration.
The Fifth Amendment
also extended the term of the employment agreement for an additional year such that the employment agreement now expires on November
1, 2014, subject to automatic renewals for successive one (1) year increments unless either party is given written notice of their
intent to not renew not less than 60 days prior to such automatic renewal date(s).
NOTE 13 – SUBSEQUENT EVENTS
On January 27, 2014,
the Company filed a counterclaim against Eric Cohen (plaintiff) requesting damages and attorneys’ fees incurred in this case.