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Superior Drilling Products, Inc. - Quarter Report: 2022 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended September 30, 2022

 

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

 

Commission File Number: 001-36453

 

Superior Drilling Products, Inc.

(Exact name of registrant as specified in its charter)

 

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

 

1583 South 1700 East

Vernal, Utah 84078

(Address of principal executive offices)

 

435-789-0594

(Issuer’s telephone number)

 

 

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

 

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

 

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

 

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

 

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

Yes ☒ No ☐

 

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

Yes ☒ No ☐

 

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

 

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

 

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

 

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

 

There were 29,245,080 shares of common stock, $0.001 par value, issued and outstanding as of November 14, 2022.

 

 

 

 

 

 

Superior Drilling Products, Inc.

FORM 10-Q

 

QUARTER ENDED September 30, 2022

 

TABLE OF CONTENTS

 

  Page
   
PART I-FINANCIAL INFORMATION  
   
Item 1. Financial Statements 3
   
Condensed Consolidated Balance Sheets (Unaudited) at September 30, 2022 and December 31, 2021 3
   
Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2022 and 2021 4
   
Condensed Consolidated Statements of Shareholders’ Equity (Unaudited) for the three and nine months ended September 30, 2022 and 2021 5
   
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2022 and 2021 6
   
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 14
   
Item 4. Controls and Procedures 20
   
PART II - OTHER INFORMATION  
   
Item 1. Legal Proceedings 21
   
Item 1A. Risk Factors 21
   
Item 6. Exhibits 21
   
Signatures 22

 

2

 

 

PART I - FINANCIAL INFORMATION.

 

Item 1. Financial Statements

 

Superior Drilling Products, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

 

           
   September 30, 2022   December 31, 2021 
ASSETS          
Current assets          
Cash  $2,046,754   $2,822,100 
Accounts receivable, net   4,083,645    2,871,932 
Prepaid expenses   447,773    435,595 
Inventories   1,623,051    1,174,635 
Other current assets   774,799    55,159 
Total current assets   8,976,022    7,359,421 
Property, plant and equipment, net   8,427,003    6,930,329 
Intangible assets, net   111,111    236,111 
Right of use assets, net   688,673    20,518 
Other noncurrent assets   111,519    65,880 
Total assets  $18,314,328   $14,612,259 
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities          
Accounts payable  $1,264,952   $1,139,091 
Accrued expenses   883,572    467,462 
Income tax payable   264,081    206,490 
Current portion of operating lease liability   45,259    13,716 
Current portion of financial obligation   72,344    65,678 
Current portion of long-term debt, net of discounts   2,319,727    2,195,759 
Current portion of deferred income   63,281    - 
Total current liabilities   4,913,216    4,088,196 
Long-term operating lease liability   527,011    6,802 
Long-term financial obligation, less current portion   4,057,537    4,112,658 
Long-term debt, less current portion, net of discounts   684,038    256,675 
Deferred income   611,719    - 
Total liabilities   10,793,521    8,464,331 
Commitments and contingencies (Note 10)   -      
Shareholders’ equity          
Common stock - $0.001 par value; 100,000,000 shares authorized; 29,245,080 and 28,235,001 shares issued and outstanding, respectively   29,245    28,235 
Additional paid-in-capital   43,711,009    43,071,201 
Accumulated deficit   (36,219,447)   (36,951,508)
Total shareholders’ equity   7,520,807    6,147,928 
Total liabilities and shareholders’ equity  $18,314,328   $14,612,259 

 

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

 

3

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

                     
   For the Three Months   For the Nine Months 
   Ended September 30,   Ended September 30, 
   2022   2021   2022   2021 
                 
Revenue                    
Tool revenue  $3,343,227   $2,346,234   $9,004,055   $6,283,461 
Contract services   1,829,318    1,215,685    4,839,497    3,102,219 
                     
Total Revenue   5,172,545    3,561,919    13,843,552    9,385,680 
                     
Operating costs and expenses                    
Cost of revenue   2,230,705    1,441,943    6,114,705    3,841,713 
Selling, general and administrative expenses   1,723,221    1,551,462    5,264,270    4,540,134 
Depreciation and amortization expense   362,773    405,225    1,176,151    1,680,804 
                     
Total operating costs and expenses   4,316,699    3,398,630    12,555,126    10,062,651 
                     
Operating income (loss)   855,846    163,289    1,288,426    (676,971)
                     
Other income (expense)                    
Interest income   10,544    49    13,720    147 
Interest expense   (154,108)   (130,221)   (410,707)   (413,798)
Loss on disposition of assets, net   (29,381)   -    (51,527)   (1,187)
Total other expense   (172,945)   (130,172)   (448,514)   (414,838)
                     
Income (loss) before income taxes   682,901    33,117    839,912    (1,091,809)
Income tax expense   (44,169)   (39,327)   (107,852)   (82,976)
                     
Net income (loss)  $638,732   $(6,210)  $732,060   $(1,174,785)
                     
Basic earnings (loss) per common share  $0.02   $(0.00)  $0.03   $(0.05)
Basic weighted average common shares outstanding   28,845,456    26,154,202    28,440,722    25,894,397 
Diluted earnings (loss) per common share  $0.02   $(0.00)  $0.03   $(0.05)
Diluted weighted average common shares outstanding   28,855,456    26,154,202    28,450,722    25,894,397 

 

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

 

4

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Shareholders’ Equity

(Unaudited)

 

                          
   Common Stock   Additional
Paid-in
   Accumulated   Total
Shareholders’
 
   Shares   Par Value   Capital   Deficit   Equity 
Balance - December 31, 2021   28,235,001   $28,235   $43,071,201   $(36,951,508)  $6,147,928 
                          
Stock-based compensation expense   -    -    210,133    -    210,133 

Stock-based compensation expense, shares 

                         
Net income   -    -    -    149,837    149,837 
                          
Balance – March 31, 2022   28,235,001   $28,235   $43,281,334   $(36,801,671)  $6,507,898 
                          
Stock-based compensation expense   -    -    212,468    -    212,468 
Net loss   -    -    -    (56,508)   (56,508)
                          
Balance – June 30, 2022   28,235,001   $28,235   $43,493,802   $(36,858,179)  $6,663,858 
                          
Stock-based compensation expense   1,010,079    1,010    217,207    -    218,217 
Net income   -    -    -    638,732    638,732 
                          
Balance – September 30, 2022   29,245,080   $29,245   $43,711,009   $(36,219,447)  $7,520,807 
                          
Balance - December 31, 2020   25,762,342   $25,762   $40,619,620   $(36,421,707)  $4,223,675 
                          
Stock-based compensation expense   -    -    167,472    -    167,472 
Net loss   -    -    -    (1,101,793)   (1,101,793)
                          
Balance – March 31, 2021   25,762,342   $25,762   $40,787,092   $(37,523,500)  $3,289,354 
                          
Stock-based compensation expense   -    -    167,033    -    167,033 
Net loss   -    -    -    (66,781)   (66,781)
                          
Balance – June 30, 2021   25,762,342   $25,763   $40,954,125   $(37,590,281)  $3,389,606 
                          
Stock-based compensation expense   667,613    667    195,426    -    196,093 
Net loss   -    -    -    (6,210)   (6,210)
                          
Balance – September 30, 2021   26,429,955   $26,430   $41,149,551   $(37,596,492)  $3,579,489 

 

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

 

5

 

 

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

           
   For the Nine Months 
   Ended September 30, 
   2022   2021 
Cash Flows From Operating Activities          
Net income (loss)  $732,060   $(1,174,785)
Adjustments to reconcile income (loss) to net cash from operating activities:          
Depreciation and amortization expense   1,176,151    1,680,804 
Stock-based compensation expense   640,816    530,595 
Loss on disposition of assets, net   51,527    1,187 
Amortization of deferred loan costs   13,893    13,893 
Changes in operating assets and liabilities:          
Accounts receivable   (1,211,713)   (700,451)
Inventories   (446,866)   (37,631)
Prepaid expenses and other assets   (777,457)   (161,564)
Accounts payable, accrued expenses, and other liabilities   1,100,571    1,168,317 
Income tax payable   57,591    71,376 
Net Cash From Operating Activities   1,336,573    1,391,741 
Cash Flows From Investing Activities          
Purchases of property, plant and equipment   (2,600,902)   (589,099)
Proceeds from sale of fixed assets   -    50,000 
Net Cash From Investing Activities   (2,600,902)   (539,099)
Cash Flows From Financing Activities          
Principal payments on debt   (508,146)   (1,146,309)
Proceeds received from debt borrowings   997,134    - 
Payments on revolving loan   (633,440)   (540,078)
Proceeds received on revolving loan   633,435    1,341,702 
Net Cash From Financing Activities   488,983    (344,685)
Net Change in Cash   (775,346)   507,957 
Cash at Beginning of Period   2,822,100    1,961,441 
Cash at End of Period  $2,046,754   $2,469,398 
Supplemental information:          
Cash paid for Interest  $394,548   $410,492 
Non-Cash item related to deferred income  $675,000   $- 
Right of use assets obtained in exchange for lease obligations  $749,718   $- 

 

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

 

6

 

 

Superior Drilling Products, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 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 nine months ended September 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 nine months ended September 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.

 

7

 

 

Concentrations of Credit Risk

 

The Company has two significant customers that represented 89% and 86% of its revenue for the nine months ended September 30, 2022 and 2021, respectively. These customers had approximately $2,741,000 and $1,081,000 in accounts receivable at September 30, 2022 and 2021, respectively.

 

The Company had two vendors that represented 12% of its purchases for the nine months ended September 30, 2022. These vendors had approximately $0 in accounts payable at September 30, 2022 and purchases in the nine months of 2022 from these vendors totaled approximately $966,000. The Company had two vendors that represented 12% of its purchases for the nine months ended September 30, 2021. These vendors had approximately $176,000 in accounts payable at September 30, 2021 and purchases in the nine months ended September 30, 2021 from these vendors totaled approximately $546,000.

 

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 nine months ended September 30, 2021 in connection with the classification of $513,558 of inventory converted to property, plant and equipment reported within the Supplemental Information section of the Statement of Cash Flows. The $513,558 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 nine months ended September 30, 2021 are as follows:

SCHEDULE OF RESTATEMENT OF CONSOLIDATED STATEMENT OF CASH FLOWS

   September 30, 2021 
   As Reported   As Restated 
-Net cash from operating activities  $878,183   $1,391,741 
-Net cash from investing activities  $(25,541)  $(539,099)

 

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 nine months ended September 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 nine months ended September 30, 2022 and 2021 of $107,852 and $82,976, respectively with income before income taxes of $839,912 and a loss before income taxes of $1,091,809, respectively. For the nine months ended September 30, 2021, the Company had income tax expense greater than income before income taxes due to 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.

 

Accounting for Grant Received

 

The Company applied for and received grant award of up to $750,000 from the State of Utah’s Manufacturing Modernization Grant Program. The program helps develop manufacturing industry in the state. Current GAAP has no specific authoritative guidance on the accounting for government assistance received by business entities. However, Accounting Standard Codification (“ASC”) 105 describes the decision-making framework for determining the guidance to apply when guidance is not specified by GAAP. ASC 105 points to IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, and ASC 958-605, Not-for-Profit Entities - Revenue Recognition, that require conditions of the grant to be met in order to recognize the income.

 

During 2022, the Company met the conditions of the grant by purchasing additional manufacturing equipment. The Company recorded the initial grant funding totaling $675,000 as deferred income on the balance sheet as portions of the grant are approved by the State of Utah. Once all project requirements such as employee training and installation of the equipment have been completed, the recognition of the income will be based on a straight-line amortization schedule over the life of the asset.

 

8

 

 

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 and nine months ended September 30, 2022.

 

Revenue disaggregated by revenue source are as follows:

SCHEDULE OF REVENUE DISAGGREGATED BY REVENUE

                     
  

Three months ended

September 30,

  

Nine months ended

September 30,

 
   2022   2021   2022   2021 
                 
Tool Revenue:                    
Tool and product sales  $892,300   $315,000   $2,183,800   $1,470,000 
Tool rental   549,931    521,228    1,454,806    1,318,135 
Other related revenue   1,900,996    1,510,006    5,365,449    3,495,326 
Total Tool Revenue   3,343,227    2,346,234    9,004,055    6,283,461 
                     
Contract Services   1,829,318    1,215,685    4,839,497    3,102,219 
                     
Total Revenue  $5,172,545   $3,561,919   $13,843,552   $9,385,680 

 

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.

 

9

 

 

NOTE 3. INVENTORIES

 

Inventories are comprised of the following:

           
   September 30, 2022   December 31, 2021 
Raw material  $1,171,346   $769,547 
Work in progress   73,861    65,945 
Finished goods   377,844    339,143 
Inventories, net  $1,623,051   $1,174,635 

 

NOTE 4. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are comprised of the following:

           
   September 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   14,267,498    12,207,497 
Office equipment, fixtures and software   628,358    628,358 
Transportation assets   265,760    265,760 
Property, plant and equipment, gross   21,561,512    19,501,511 
Accumulated depreciation   (13,134,509)   (12,571,182)
Property, plant and equipment, net  $8,427,003   $6,930,329 

 

Depreciation expense related to property, plant and equipment for the three months ended September 30, 2022 and 2021 was $321,106 and $363,558, respectively, and for the nine months ended September 30, 2022 and 2021 was $1,051,151 and $1,139,137, respectively.

 

The Company purchased a Computerized Numerical Control (CNC) machining center in 2022. The value of the machine is approximately $1,100,000. The Company has also contracted and issued a deposit to purchase a second CNC machining center.

 

NOTE 5. INTANGIBLE ASSETS

 

Intangible assets are comprised of the following:

           
   September 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   (14,788,889)   (14,663,889)
Intangible assets, net  $111,111   $236,111 

 

Amortization expense related to intangible assets for the three months ended September 30, 2022 and 2021 was $41,667 and $41,667, respectively, and for the nine months ended September 30, 2022 and 2021 was $125,000 and $541,667, 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. All unpaid interest and principal is due on December 31, 2022, the maturity date, and the Company is actively negotiating new terms for the Tronco note with the Meiers. The Tronco note balance, including accrued interest, as of September 30, 2022 was approximately $6,850,000 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.

 

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NOTE 7. LONG-TERM DEBT

 

Debt obligations are comprised of the following:

 

   September 30, 2022   December 31, 2021 
Hard Rock Note  $750,000   $750,000 
Credit Agreement   1,076,081    1,312,194 
Machinery loans   919,835    357,963 
Transportation loans   23,149    32,277 
Insurance financing   234,700    - 
Long term debt, Total   3,003,765    2,452,434 
Less:          
Current portion, long-term debt   (2,319,727)   (2,195,759)
Long-term debt, net  $684,038   $256,675 

 

A new CNC machining center was purchased and a loan of $669,000 was received as partial funding. The term of the loan is 60 months with a fixed interest rate of 5.5%.

 

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 had a remaining balance of $750,000 as of September 30, 2022, which accrued interest at 8.00% per annum and was paid in full on October 17, 2022.

 

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Credit Agreement

 

In February 2019, the Company entered into a Loan and Security Agreement (the “Credit Agreement”) with Austin Financial Services, Inc. (“AFS”). The Credit Agreement provides a $4,500,000 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 September 30, 2022, we had approximately $83,000 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 September 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 September 30, 2022, the interest rate for the Term Loan was 11.85%, 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 September 30, 2022, we had approximately $7,000 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. FINANCIAL 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 September 30, 2022 and December 31, 2021 was $4,129,881 and $4,178,336, respectively.

 

The financing obligation is summarized below:

 

 

   September 30, 2022   December 31, 2021 
Finance obligations for sale-leaseback transactions  $4,129,881   $4,178,336 
Current principal portion of finance obligation   (72,344)   (65,678)
Non-current portion of finance obligation  $4,057,537   $4,112,658 

 

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NOTE 9. GEOGRAPHICAL OPERATIONS INFORMATION

 

The following summarizes revenue by geographic location:

                     
  

Three months ended

September 30,

  

Nine months ended

September 30,

 
   2022   2021   2022   2021 
                 
Revenue:                    
North America  $4,622,614   $3,040,691   $12,388,746   $8,073,945 
Middle East  $549,931   $521,228   $1,454,806   $1,311,735 
Revenues  $5,172,545   $3,561,919   $13,843,552   $9,385,680 

 

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

 

   September 30, 2022   December 31, 2021 
Property, plant and equipment, net:          
North America  $6,435,672   $5,762,066 
Middle East   1,991,331    1,168,263 
Property, plant and equipment, net  $8,427,003   $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. On May 23, 2022, the Court issued its Order on Claim Construction of the patents, adopting Extreme Technologies’ proffered interpretation on the disputed claim terms. The parties are preparing this case for trial and expect a jury trial setting in mid-2023.

 

NOTE 11. SHAREHOLDERS’ EQUITY

 

On August 12, 2022, the Board of Directors granted 475,000 restricted stock units to Troy Meier, Chairman and Chief Executive Officer, granted 425,000 restricted stock units to Annette Meier, President and Chief Operating Officer, granted 300,000 restricted stock units to Chris Cashion, Chief Financial Officer, and 75,000 restricted stock units to each of the three independent members of the Board of Directors. Stock price is based on the average price of the common stock on the date of the grant. The average price on the grant date was $1.00. These grants will vest at one-third each year for three years. In addition, the Board of Directors authorized 75,000 stock options to be granted to employees of the Company other than Mr. and Mrs. Meier and Mr. Cashion. The fair value of stock options issued to employees during 2022 will be estimated at the issuance date using the Black-Scholes option pricing model. These options have not been issued as of September 30, 2022.

 

NOTE 12. LEASES

 

During the nine months ended September 30, 2022, the Company entered into three operating leases and recorded the transactions in accordance with ASC 842 (Topic 842) – Leases, which requires assets and liabilities that arise from all leases to be recognized on the balance sheet for lessees. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and the lease liability represents the Company’s obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. The interest rate implicit in lease contracts is typically not readily determinable. As a result, the Company utilizes an estimate of its incremental borrowing rate to discount the lease payments, which reflects the fixed rate at which the Company believes it could borrow on a collateralized basis the amount of the lease payments in the same currency, for a similar term, in a similar economic environment.

 

The Company recorded right-of-use asset balance of $688,673 as of September 30, 2022. The current portion of the lease liability is $45,259 and the long-term portion of the lease liability is $527,011 as of September 30, 2022. The weighted average remaining lease term is 1.83 years, and the weighted average discount rate is 7.25%.

 

The aggregate future minimum lease payments by year:

 

       
2022   $

16,800

2023    

243,794

2024    

243,794

 
2025    

60,000

 
2026    

60,000

 
2027    

40,000

 
Total    

664,388

 
Less: discount    

(92,118

)
Present value of lease payments   $

572,270

 

 

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

 

Introduction

 

The following discussion and analysis was prepared to supplement information contained in the accompanying financial statements and is intended to provide certain details regarding our financial condition as of September 30, 2022, and our results of operations for the three and nine months ended September 30, 2022 and 2021. It should be read in conjunction with the unaudited financial statements and notes thereto contained in this Quarterly Report on Form 10-Q (this “Quarterly Report”) as well as our audited financial statements for the years ended December 31, 2021 and 2020, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission (the “SEC”).

 

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

 

Forward- Looking Statements

 

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

 

  the continued impact of COVID-19 or other public health concerns on domestic and global economic conditions and the future impact of such conditions on the oil and gas industry and the demand for our services;
     
  the volatility of oil and natural gas prices including inflationary factors;
     
  the cyclical nature of the oil and gas industry and the impact of economic conditions in the U.S. and globally on the demand for oil and gas;
     
  availability of financing and access to capital markets;
     
  our reliance on significant customers;
     
  consolidation within our customers’ industries;
     
  competitive products and pricing pressures;

 

  our ability to develop and commercialize new and/or innovative drilling and completion tool technologies;
     
  fluctuations in our operating results;
     
  our dependence on key personnel;
     
  costs and availability of raw materials;

 

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

 

15

 

 

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

 

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

 

Executive Summary

 

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

 

We currently have three basic operations:

 

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

 

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

 

Recent Developments and Trends

 

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

 

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

 

Inflationary and/or recessionary factors relating to the oil and gas industry may directly affect the Company’s operations. The increased demand for oil and gas production has benefited the Company’s operations. The Company is not immune to the effects of inflation on its labor requirements, supply chain and costs of revenues. The Company continues to monitor these economic trends as part of its strategic forward planning.

 

The total U.S. rig count as reported by Baker Hughes as of October 28, 2022 was 768 rigs, compared with 586 rigs as of December 31, 2021. We expect North American onshore activity to be relatively consistent through the remainder of 2022.

 

The Middle East market has been slower to recover due to the actions taken by governments in that region to address COVID-19. Although this segment of our business is rebounding, the improvements are at a slower rate compared with the Company’s domestic market.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Three and Nine Months Ended September 30, 2022 Compared with the Three and Nine Months Ended September 30, 2021

 

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

 

   Three Months Ended September 30,   Nine Months Ended September 30, 
(in thousands)  2022   2021   2022   2021 
Tool revenue   3,343    65%   2,346    66%   9,004    65%   6,284    67%
Contract services   1,829    35%   1,216    34%   4,839    35%   3,102    33%
Revenue  $5,172    100%  $3,562    100%   13,843    100%   9,386    100%
Operating costs and expenses   4,317    83%   3,399    95%   12,555    91%   10,063    107%
Operating income (loss)   856    17%   163    5%   1,288    9%   (677)   (7)%
Other income (expense)   (173)   (3)%   (130)   (4)%   (449)   (3)%   (415)   (4)%
Income tax expense   (44)   (1)%   (39)   (1)%   (107)   (1)%   (83)   (1)%
Net income (loss)  $639    12%  $(6)   (0)%   732    5%   (1,175)   (12)%

 

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

 

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Three Months Ended September 30, 2022 Compared with the Three Months Ended September 30, 2021

 

Revenue. Our revenue increased approximately 45% or $1,611,000. This was the result of growth in both tool revenue, which was up $997,000 or 42% from the prior-year period and contract services which increased $614,000 or 50%. Revenue growth was directly attributable to higher demand for the Drill-N-Ream from the increase in operating rigs and related drilling activity that was driven by the improvements in market conditions.

 

Operating Costs and Expenses. Total operating costs and expenses increased approximately $918,000 for the September 30, 2022 three-month period.

 

  Cost of revenue increased approximately $789,000 due to higher volume. As a percentage of revenue, cost of revenue was 43% and 40% of revenue for the three months ended September 30, 2022 and 2021, respectively. The increase in the cost of revenue as a percent of revenue was the result of increased payroll expenses and supplies.
     
  Selling, general and administrative expenses increased approximately $172,000 due to an increase in payroll (reflecting higher headcount, the impact of inflation on wages, and higher stock-based compensation expense of $58,000), legal fees and public company expenses of approximately $159,000 (in part due to the preparation and filing of the Company’s annual shareholder meeting and proxy statement) offset with a decrease in international payroll and travel expenses of approximately $45,000.
     
  Depreciation and amortization expense decreased approximately $42,000, or 10%, to $363,000. The decrease was primarily a result of fully amortizing a portion of the Company’s intangible assets and fully depreciating manufacturing center equipment.

 

Other Expense. Other expense primarily consists of interest expense, interest income, and loss on disposition of assets.

 

 

Interest expense for the three months ended September 30, 2022 and 2021 was approximately $154,000 and $130,000, respectively.

  In the three months ending with September 30, 2022, Tool HRS-DNR-213 was “lost in hole” and the cost of the tool was expensed.

 

Income Tax Expense. The increase in income tax expense from the prior year was due to higher foreign income tax as a result of the growth in international revenue.

 

Nine Months Ended September 30, 2022 Compared with the Nine Months Ended September 30, 2021

 

Revenue. Our revenue increased approximately $4,458,000 or 47% to $13,843,000. Tool revenue was $9,004,000, up 43% or $2,721,000, from the prior-year period. Contract services increased approximately $1,737,000, or 56%, to $4,839,000. The increase in revenue was due primarily to an improvement in market conditions and increased drilling activity.

 

Operating Costs and Expenses. Total operating costs and expenses increased approximately $2,492,000 for the September 30, 2022 nine month period.

 

  Cost of revenue increased approximately $2,273,000 or 59% due to increased revenue. As a percentage of revenue, the cost of revenue increased to 44% compared with 41% in the prior year reflecting higher payroll expenses and increased supplies.
     
  Selling, general and administrative expenses increased approximately $724,000 to $5,264,000 and was 38% of revenue compared with 48% in the prior-year period. The increase reflects higher payroll expenses, legal and public company expenses and stock-based compensation expense.
     
  Depreciation and amortization expense decreased approximately $505,000, or 30%, to $1,176,000. The decrease was primarily a result of fully amortizing a portion of the Company’s intangible assets and fully depreciating manufacturing center equipment.

 

Other Expense. Other expense primarily consists of interest expense, interest income, and loss on disposition of assets..

 

  Interest expense for the nine months ended September 30, 2022 and 2021 was approximately $411,000 and $414,000, respectively.
     
  The Company recorded a loss of approximately $52,000 on assets disposed during the nine months ended September 30, 2022 compared with $1,000 in the same period in 2021.

 

Income Tax Expense. Income tax expense increased by approximately $25,000 from the prior year due mainly to foreign income taxes resulting from increased foreign revenues earned in the nine months ended September 30, 2022.

 

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Liquidity and Capital Resources

 

As of September 30, 2022, we had working capital of approximately $4,065,000. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments. Our operational and financial strategies include managing our operating costs and capital spending to reflect revenue trends, accelerating collections of international receivables, and controlling our working capital and debt to enhance liquidity. We will continue to work to grow revenue and manage costs and expect to be cash flow positive by year end 2022. If we are unable to do this, we may not be able to, among other things, (i) maintain our current general and administrative spending levels; (ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital requirements. We cannot provide any assurance that financing will be available to us in the future on acceptable terms.

 

The Hard Rock Note had a remaining balance of $750,000 as of September 30, 2022 and accrued interest at 8.00% per annum and was paid in full on October 17, 2022. Accounts receivable as of September 30, 2022 has increased approximately $1,200,000 from December 31, 2021 due to delayed cash receipts from customers. Approximately $1,000,000 in cash was received in early October 2022. Inventory as of September 30, 2022 is higher than December 31, 2021 by approximately $448,000. Supply chain issues continue to extend lead-times thus increasing the need for higher inventory levels.

 

Our Credit Agreement facilitated by Austin Financial Services (“AFS”) is comprised of $1,000,000 Term Loan and $3,500,000 Line of Credit (“LOC”). As of September 30, 2022, we had approximately $83,000 outstanding on the Term Loan and approximately $1,000,000 outstanding on the LOC. Amounts outstanding under the LOC at any time may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect (less a dilution reserve as determined by AFS in its sole good faith discretion), plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c) the borrowing base reserve as may be determined from time to time by AFS. A collateral management fee is payable monthly on the used portion of the LOC and Term Loan. If our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. As of September 30, 2022, we had approximately $7,000 of accrued interest combined between the two loans.

 

The interest rate for both the Term Loan and the LOC is prime plus 2%, which as of September 30, 2022, was 11.85%, which includes a 3.6% management fee rate. The obligations of the Company under the agreement are secured by a security interest in substantially all of the tangible and intangible assets of the Company, other than any assets owned by the Company that constitute real property (and fixtures affixed to such real property), certain excluded equipment, intellectual property, or aircraft. The Credit Agreement matures on February 20, 2023, and the Company currently plans to refinance this credit facility.

 

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Cash Flows

 

Nine Months Ended September 30, 2022 Compared with the Nine Months Ended September 30, 2021

 

Net cash provided by operating activities was approximately $1,337,000 and $1,392,000 for the nine months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022, the Company had approximately $732,000 of net income, approximately $1,217,000 increase in accounts payable and accrued expenses, depreciation and amortization expense of approximately $1,176,000, stock-based compensation of $641,000 and a decrease in accounts receivable of $1,212,000. Offsets occurred with decreases in prepaid expenses and other assets of approximately $894,000 and a decrease in inventories of $447,000.

 

For the nine months ended September 30, 2021, the Company had approximately $1,175,000 of net loss, an approximately $700,000 decrease in accounts receivable, $38,000 decrease in inventories, and $162,000 decrease in prepaid expenses and other assets. Increases to cash provided by operating activities occurred with depreciation and amortization expense of approximately $1,681,000, stock-based compensation expense of $531,000, increase in accounts payable and accrued expenses of $1,168,000 and an increase in income tax payable of $71,000.

 

Net cash used in investing activities was approximately $2,601,000 for the nine months ended September 30, 2022. Net cash used in investing activities was approximately $539,000 for the nine months ended September 30, 2021. The major investing activities during 2022 includes the purchase of two CNC machining centers and an increase in the Company’s international tool fleet.

 

Net cash provided by financing activities was approximately $488,983 for the nine months ended September 30, 2022. Net cash used in financing activities was approximately $345,000 for the nine months ended September 30, 2021. SDPI entered into a financing contract with Mazak Corporation during 2022 for the purchase of one of the CNC machining center.

 

Critical Accounting Policies

 

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

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2022.

 

Changes in Internal Controls over Financial Reporting

 

There has been no change in our internal control over financial reporting that occurred during the three months ended September 30, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

 

Item 1. Legal Proceedings

 

We are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana, Lafayette Division, asserting that Stabil Drill Specialties, LLC’s (“Stabil Drill”) Smoothbore Eccentric Reamer infringes the patents of Extreme Technologies, LLC (one of our subsidiaries) on our patented Drill-N-Ream well bore conditioning tool. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. Additionally, on May 20, 2019, Extreme Technologies, LLC sued Short Bit & Tool Co. and Lot William Short, Jr. (“Defendants”) in the Northern District of Texas-Dallas Division for their work manufacturing the Smoothbore Eccentric Reamer for Stabil Drill. The Dallas lawsuit is stayed pending resolution of the first-filed, Houston suit. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company, filed for bankruptcy, which resulted in a brief, automatic stay of the litigation. Superior Energy Services announced on February 2, 2021, that it successfully completed its financial restructuring and emerged from Chapter 11 bankruptcy, but this bankruptcy did not affect Extreme Technologies, LLC’s claims against Superior’s subsidiary Stabil Drill. On March 9, 2021, the Court lifted the automatic bankruptcy stay, and on May 12, 2021, the Court denied Stabil Drill’s motion for summary judgment of non-infringement. On May 23, 2022, the Court issued its Order on Claim Construction of the patents, adopting Extreme Technologies’ proffered interpretation on the disputed claim terms. The parties are preparing this case for trial and expect a jury trial setting in mid-2023.

 

Item 1A. Risk Factors

 

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

 

Item 6. Exhibits

 

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

 

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

 

** Furnished herewith.

* Filed herewith.

 

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SIGNATURES

 

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

 

  SUPERIOR DRILLING PRODUCTS, INC.
     
November 14, 2022 By: /s/ G. TROY MEIER
    G. Troy Meier, Chief Executive Officer
    (Principal Executive Officer)
     
November 14, 2022 By: /s/ CHRISTOPHER CASHION
    Christopher Cashion, Chief Financial Officer
    (Principal Financial Officer and Principal Accounting Officer)

 

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