UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the Quarterly Period Ended September 30, 20172020

 

[  ] 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 valueSDPINYSE 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 [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, 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 and post such files).

Yes [X] 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 [X] Emerging growth company [X][  ]

 

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 [X]

 

There were 24,313,31225,617,486 shares of common stock, $0.001 par value, issued and outstanding as of November 9, 2017.

6, 2020.

 

 

 

 
 

 

Superior Drilling Products, Inc.

FORM 10-Q

 

QUARTER ENDED SEPTEMBERSeptember 30, 20172020

 

TABLE OF CONTENTS

 

 Page
  
PART I - FINANCIALI-FINANCIAL INFORMATION 
  
Item 1. Financial Statements3
  
Condensed Consolidated Balance Sheet (Unaudited) at September 30, 20172020 and December 31, 201620193
  
Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 20172020 and 201620194
  
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 20172020 and 201620195
  
Notes to Condensed Consolidated Financial Statements (Unaudited)6
  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations1113
  
Item 4. Controls and Procedures1819
  
PART II - OTHER INFORMATION 
  
Item 1. Legal Proceedings1920
  
Item 1A. Risk Factors1920
  
Item 6. Exhibits22
  
Signatures23

PART I - FINANCIAL INFORMATION.

 

Item 1. Financial Statements

 

Superior Drilling Products, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

 

 September 30, 2017 December 31, 2016  September 30, 2020  December 31, 2019 
ASSETS             
Current assets             
Cash $2,705,837  $2,241,902  $1,412,370  $1,217,014 
Accounts receivable, net 2,532,659 1,038,664   1,441,783   3,850,509 
Prepaid expenses 154,018 76,175   73,785   139,070 
Inventories 1,176,912 1,167,692   943,870   924,032 
Asset held for sale - 2,490,000   40,000   252,704 
Other current assets  251,600  13,598   -   252,178 
Total current assets 6,821,026 7,028,031   3,911,808   6,635,507 
Property, plant and equipment, net 9,039,031 9,068,359   7,859,200   8,045,692 
Intangible assets, net 6,744,444 8,579,444   1,111,111   1,986,111 
Related party note receivable 7,746,717 8,296,717 
Right of use assets  146,450   - 
Deferred tax asset  34,692   - 
Other noncurrent assets  15,954  15,954   83,114   93,619 
Total assets $30,367,172 $32,988,505  $13,146,375  $16,760,929 
LIABILITIES AND SHAREHOLDERS’ EQUITY             
Current liabilities             
Accounts payable $658,390 $1,066,514  $663,090  $945,414 
Accrued expenses 1,125,359 449,004   843,197   683,832 
Capital lease obligation - 217,302 
Related party debt obligation 197,922 272,215 
Customer deposits  -   61,421 
Income tax payable  

98,028

   

15,880

 
Current portion of operating lease liability  108,104   - 
Current portion of long-term debt, net of discounts  6,647,944  2,905,682   4,760,252   4,102,543 
Total current liabilities 8,629,615 4,910,717   6,472,671   5,809,090 
Other long term liability - 820,657 
Operating lease liability  38,346   - 
Long-term debt, less current portion, net of discounts  6,763,880  13,288,701   1,937,271   3,848,863 
Total liabilities 15,393,495 19,020,075   8,448,288   9,657,953 
Commitments and contingencies (Note 7)     
Commitments and contingencies (Note 12)        
Shareholders’ equity             
Common stock - $0.001 par value; 100,000,000 shares authorized; 24,313,312 and 24,120,695 shares issued and outstanding, respectively 24,313 24,120 
Common stock - $0.001 par value; 100,000,000 shares authorized; 25,434,776 and 25,418,126 shares issued and outstanding  25,617   25,418 
Additional paid-in-capital 38,793,619 38,295,428   40,439,035   40,069,391 
Accumulated deficit  (23,844,255)  (24,351,118)  (35,766,565)  (32,991,833)
Total shareholders’ equity  14,973,677  13,968,430   4,698,087   7,102,976 
Total liabilities and shareholders’ equity $30,367,172 $32,988,505  $13,146,375  $16,760,929 

 

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

Superior Drilling Products, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

 

 For the Three Months For the Nine Months  For the Three Months For the Nine Months 
 Ended September 30, Ended September 30,  Ended September 30,  Ended September 30, 
 2017 2016 2017 2016  2020  2019  2020  2019 
                  
Revenue $4,446,540  $2,261,310  $11,865,648  $4,820,405                 
Tool revenue $1,190,929  $3,194,999  $6,147,280  $9,212,420 
Contract services  356,513   1,881,216   2,782,313   5,443,583 
                
Total Revenue  1,547,442   5,076,215   8,929,593   14,656,003 
                         
Operating costs and expenses                         
Cost of revenue 1,716,740 972,400 4,388,860 3,324,975   870,655   2,062,803   4,284,716   6,119,429 
Selling, general and administrative expenses 1,102,373 1,319,686 3,837,218 4,149,136   1,529,887   2,501,970   4,887,999   6,387,205 
Depreciation and amortization expense  907,837  932,250  2,745,232  3,379,215   693,259   738,555   2,134,398   2,680,070 
                         
Total operating costs and expenses  3,726,950  3,224,336  10,971,310  10,853,326   3,093,801   5,303,328   11,307,113   15,186,704 
                         
Operating income (loss) 719,590 (963,026) 894,338 (6,032,921)
Operating loss  (1,546,359)  (227,113)  (2,377,520)  (530,701)
                         
Other income (expense)                         
Interest income 90,959 78,650 255,327 234,969   145   12,080   5,775   52,444 
Interest expense (224,510) (373,335) (698,638) (1,101,412)  (126,482)  (196,582)  (450,210)  (590,805)
Other income - 49,975 43,669 158,926 
Gain on sale of assets  -  4,003  12,167  195,453 
Unrealized gain on warrant derivative  -  28,301  -  28,301 
Impairment on asset held for sale  -   (6,143)  (30,000)  (6,143)
Loan forgiveness  41,403   -   41,403   - 
Gain on disposition of assets  -   -   142,234   14,147 
Total other expense  (133,551)  (212,406)  (387,475)  (483,763)  (84,934)  (190,645)  (290,798)  (530,357)
                         
Income (loss) before income taxes 586,039 (1,175,432) 506,863 (6,516,684)
Loss before income taxes  (1,631,293)  (417,758)  (2,668,318)  (1,061,058)
Income tax expense  -  (2,000)  -  (2,000)  (99,979)  -   (106,414)  - 
Net income (loss)  586,039 $(1,173,432) $506,863 $(6,514,684)
                         
Basic income (loss) earnings per common share $0.02 $(0.07) $0.02 $(0.37)
Net loss $(1,731,272) $(417,758) $(2,774,732) $(1,061,058)
                
Basic loss earnings per common share $(0.07) $(0.02) $(0.11) $(0.04)
Basic weighted average common shares outstanding  24,261,272  17,891,786  24,218,477  17,606,324   25,555,167   25,074,466   25,469,609   25,042,577 
Diluted income (loss) per common share $0.02 $(0.07) $0.02 $(0.37)
Diluted loss per common share $(0.07) $(0.02) $(0.11) $(0.04)
Diluted weighted average common shares outstanding  24,261,272  17,891,786  24,218,477  17,606,324   25,555,167   25,074,466   25,469,609   25,042,577 

 

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

4

Superior Drilling Products, Inc.

Condensed Consolidated Statements Ofof Cash Flows

(Unaudited)

 

  For the Nine Months Ended 
  September 30, 
  2017  2016 
Cash Flows From Operating Activities        
Net income (loss) $506,863  $(6,514,684)
Adjustments to reconcile net loss to net cash used in operating activities:        
Depreciation and amortization expense  2,745,232   3,379,215 
Amortization of debt discount  59,766   93,172 
Deferred tax benefit  -   (2,000)
Share based compensation expense  498,384   534,051 
Unrealized gain on warrant derivative  -   (28,301)
Write-off of Strider asset  -   361,903 
Gain on sale of assets  (12,167)  (195,453)
Changes in operating assets and liabilities:        
Accounts receivable  (1,493,995)  648,546 
Inventories  (9,220)  (73,733)
Prepaid expenses and other noncurrent assets  (315,845)  (169,981)
Other assets  -   (10,936)
Accounts payable and accrued expenses  (610,936)   496,629 
Other long term liabilities  (17,490)  - 
Net Cash Provided by (Used in) Operating Activities  1,350,592   (1,481,572)
Cash Flows From Investing Activities        
Purchases of property, plant and equipment  (220,101)  (315,101)
Proceeds from sale of fixed assets  2,483,921   483,217 
Net Cash Provided by Investing Activities  2,263,820   168,116 
Cash Flows From Financing Activities        
Principal payments on debt  (2,858,882)  (1,226,339)
Principal payments on related party debt  (74,293)  (44,662)
Principal payments on capital lease obligations  (217,302)  (244,461)
Proceeds received from debt borrowings  -   1,500,000 
Net proceeds received from line of credit  -   637,992 
Proceeds from sale of subsidiary  -   50,700 
Proceeds from payments on related party note receivable  -   22,533 
Stock offering expenses  -   (193,418)
Debt issuance costs  -   (153,643)
Net Cash (Used in) Provided by Financing Activities  (3,150,477)  348,702 
Net increase (decrease) in Cash  463,935   (964,754)
Cash at Beginning of Period  2,241,902   1,297,002 
Cash at End of Period $2,705,837  $332,248 
Supplemental information:        
Cash paid for Interest $617,565  $1,194,498 
Non-cash payment of other long term liability by offsetting related party note receivable $550,000  $- 
Acquisition of equipment by issuance of note payable $16,557  $- 
Purchases of property, plant and equipment included in accrued expenses $626,000   - 
Long term debt paid with stock $-  $1,000,000 
Accounts receivable - stock subscription $-  $5,297,500 
  For the Nine Months 
  Ended September 30, 
  2020  2019 
Cash Flows From Operating Activities        
Net loss $(2,774,732) $(1,061,058)
Adjustments to reconcile net income (loss) to net cash used in operating activities:        
Depreciation and amortization expense  2,134,398   2,680,070 
Share based compensation expense  369,843   473,717 
Impairment on asset held for sale  30,000   6,143 
Gain on disposition of assets  (142,234)  (14,147)
Gain on forgiveness of loan  (41,403)  - 
Amortization of deferred loan costs  13,894   10,561 
Changes in operating assets and liabilities:        
Accounts receivable  2,408,726   (1,825,347)
Inventories  (942,831)  (539,586)
Prepaid expenses and other noncurrent assets  327,968   (39,998)
Accounts payable, accrued expenses and income tax payable  (18,728)  1,531,085 
Other noncurrent assets  

(34,692

)  - 
Other long term liabilities  (61,421)  - 
Net Cash From Operating Activities  1,268,788   1,221,440 
Cash Flows From Investing Activities        
Purchases of property, plant and equipment  (154,475)  (392,691)
Proceeds from sale of fixed assets  117,833   - 
Net Cash From Investing Activities  (36,642)  (392,691)
Cash Flows From Financing Activities        
Principal payments on debt  (2,167,539)  (3,813,443)
Proceeds received from debt borrowings  964,120   800,000 
Payments on revolving loan  (1,018,690)  (735,019)
Proceeds received on revolving loan  1,185,319   1,517,005 
Debt issuance costs  -   (70,103)
Net Cash From Financing Activities  (1,036,790)  (2,301,560)
Net Change in Cash  195,356   (1,472,811)
Cash at Beginning of Period  1,217,014   4,264,767 
Cash at End of Period $1,412,370  $2,791,956 
Supplemental information:        
Cash paid for Interest $460,640  $673,251 
Acquisition of equipment by issuance of note payable $-  $183,378 
Inventory converted to property, plant and equipment $922,993  $582,879 
Reduction of debt with sale of asset $211,667  $- 

 

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

Superior Drilling Products, Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 20172020

 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Nature of Operations

 

Superior Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”) is aan innovative drilling and completion tool technology company providing cost saving solutions that drive production efficiencies for the oil and natural gas drilling industry. TheOur headquarters and manufacturing operations are located in Vernal, Utah. Our drilling solutions include the patented Drill-N-Ream® well bore conditioning tool (“Drill-N-Ream tool”) and the patented Strider™ Drill String Oscillation System technology (“Strider technology” or “Strider”). In addition, the Company designs, engineers, manufactures, sells,is a manufacturer and repairsrefurbisher 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 and completion tools.industry, as well as customers’ custom products.

 

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) HR.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.

 

In April 2012, the JOBS Act was enacted. Section 107 of the JOBS Act provides that an emerging growth company can utilize the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for implementing new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to nonissuers. We have elected to delay such adoption of new or revised accounting standards, and as a result, we may not implement new or revised accounting standards on the relevant dates on which adoption of such standards is required for other issuer companies.

Subject to certain conditions set forth in the JOBS Act, as an emerging growth company, we intend to rely on certain of these exemptions, including without limitation, providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404 and implementing any requirement that may be adopted regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis). These exemptions will apply for a period of five years following the completion of our IPO, which occurred in May 2014, although if the market value of our common stock that is held by nonaffiliates exceeds $700 million as of any June 30 before that time, we would cease to be an emerging growth company as of the following December 31.

Revenue Recognition

We are a drilling and completion tool technology company and we generate revenue from the manufacturing, repair, and sale of drilling and completion tools. Our manufactured products are produced in a standard manufacturing operation, even when produced to our customer’s specifications. We earn royalty commission revenue when our customer invoices their customer for the use of the tools. The Company may act as an agent by billing and collecting its customers’ tool rental revenue. When we are an agent for our customer, revenue is presented in the statement of operations on a net basis. At September 30, 2017, there was approximately $80,850 of accounts receivable and approximately $94,000 of accounts payable related to transactions we performed as an agent for our customer. At September 30, 2016, there was approximately $270,000 of accounts receivable and approximately $321,000 of accounts payable related to transactions we performed as an agent for our customer.

Unaudited Interim Financial Presentation

 

These interim consolidated condensed financial statements for the three and nine months ended September 30, 20172020 and 2016,2019, and the related footnote disclosures included herein, are unaudited. However, in the opinion of management, these unaudited interim financial statements have been prepared on the same basis as the audited financial statements, and reflect all adjustments necessary to fairly state the results for such periods. The results of operations for the three and nine months ended September 30, 20172020 are not necessarily indicative of the results of operations expected for the year ended December 31, 2017.2020. These interim consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the years ended December 31, 20162019 and 20152018 and the notes thereto, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016,2019, filed with the Securities and Exchange Commission (the “SEC”).

 

Use of Estimates

 

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

 

6

Accounting StandardsCOVID-19

 

In May 2014,The COVID-19 pandemic-related reduction in energy demand and the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,Revenue from Contractsdramatic decline in commodity prices that began in the first quarter of 2020 continued to cause disruptions and volatility in the second and third quarters of 2020. Sharp declines in crude oil and natural gas production along with Customers (“ASU 2014-09”), which requires an entityreduced demand for refined products due to recognize the amount of revenue to which it expects to be entitled foreconomic shutdown in the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In August 2015, the FASB issued ASU No. 2015-14,Revenue from Contracts with Customers (“ASU 2015-14”), which deferred the effective date of ASU 2014-09 for all entities by one year.The Company will adopt this guidance on January 1, 2019.ASU 2015-14 permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method nor has the effectwake of the standardpandemic affected our business in the second quarter, and we expect will continue to do so in the near term. Further, significant uncertainty remains regarding the duration and extent of the impact of the pandemic on ongoing financial reporting been determined.the energy industry. See Note 2 – Liquidity.

Leases

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which introducesrequires assets and liabilities that arise from all leases to be recognized on the balance sheet for lessees and expanded financial statement disclosures for both lessees and lessors. We adopted the new standard effective January 1, 2020 and elected the modified retrospective transition method and as such, the comparative financial information will not be restated and will continue to be reported under the lease standard in effect during those periods. The adoption of this standard resulted in approximately $270,000 of additional assets and liabilities on our consolidated balance sheet representing the recognition of operating lease right-of-use assets and operating lease liabilities by lesseesliabilities. Right-of-use assets represent the Company’s right to use an underlying asset for all leasesthe lease term and 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. Leases with a lease term of 12 months or less at inception are not short-termrecorded on the condensed consolidated balance sheet and are expensed on a straight-line basis over the lease term in nature.the condensed consolidated statement of operations. 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 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. See Note 8 – Leases.

Significant Customers

For the nine months ended September 30, 2020, two customers represented 81% of our total revenue during the period. For the nine months ended September 30, 2019, two customers represented 94% of our total revenue during the period.

Significant Vendors

We had one vendor that represented 13.9% of our purchases for the nine months ended September 30, 2020. The vendor had approximately $72,000 in accounts payable at September 30, 2020 and purchases in the nine months of 2020 from this vendor totaled approximately $554,000. We had one vendor that represented 12% of our purchases for the nine months ended September 30, 2019. This vendor had approximately $218,000 in accounts payable at September 30, 2019 and purchases during the nine months of 2019 from this vendor totaled approximately $772,000.

Reclassifications

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

Recently Issued Accounting Standards

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, and requires the use of a new standard requiresforward-looking expected loss model that will result in the earlier recognition of allowances for losses. Early adoption is permitted and entities must adopt the amendment using a modified retrospective transitionapproach to the first reporting period in which the guidance is effective. For smaller reporting companies, as provided by Accounting Standards Update 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), ASU 2016-13 is effective for capital or operating leases existing at or entered intoannual periods, including interim periods within those annual periods, beginning after the beginningDecember 15, 2022. The adoption of the earliest comparative period presented in the financial statements. The Company will adopt this guidance on January 1, 2019. The CompanyASU 2016-13 is currently evaluating the impact the pronouncement willnot expected to have a material effect on theour consolidated financial statementsstatements.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (“Topic 740”) - Simplifying the Accounting for Income Taxes. ASU 2019-12 is intended to simplify accounting for income taxes. It removes certain exceptions to the general principles in Topic 740 and related disclosure.amends existing guidance to improve consistent application. ASU 2019-12 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2020. The adoption of ASU 2019-12 is currently not expected to have a material effect on our consolidated financial statements.

 

NOTE 2. LIQUIDITY

 

At September 30, 2017,The significant decline in oil demand due to COVID-19, the instability of oil prices caused by geopolitical issues and production levels, and the limited availability of storage capacity, have together resulted in our customers announcing significant reductions to their capital expenditure budgets for 2020. Demand for our products and services has been severely impacted as a result, and management expects this to continue for the duration of 2020 and potentially beyond; however, we hadare currently unable to estimate the full impact to our business, how long this significant drop in demand will last or the depth of the decline.

In an effort to offset the reduction in revenue resulting from the weakened macroeconomic environment, we have implemented certain cost reduction measures during 2020. These measures included, but were not limited to, the following:

20% reduction of the base salary beginning in April 2020 and a 40% salary deferral beginning in October 2020 for the Company’s Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer;
20% reduction in the base salaries beginning in April 2020 and a 20% deferral of base salaries  beginning in October 2020 of certain non-executive officers of the Company;
20% reduction in fees to be paid beginning in April 2020 and a 40% deferral of fees beginning in October 2020 to the independent directors on the Board for their service as directors;
5% to 10% reduction in salaries beginning in April 2020 and a 10% deferral of salaries beginning in October 2020 of other members of the management team and salaried workforce;

43% reduction of the Company’s workforce; and 

Closure of our West Texas repair facility in July 2020. 

We have also entered into amended agreements with certain of our customers, reduced our planned capital expenditures for 2020 and decided to defer further investment in new technology development, including our Strider technology, for the foreseeable future. Management is working capital deficitdiligently with vendors to achieve amended price concessions and terms of approximately $1,800,000. The Company’s manufacturing facility is financedour payables. We believe the U.S. onshore activity for the remainder of 2020 will remain at depressed levels and continue to be constrained.

We are working to minimize the decline in revenue by a commercial bankadding additional revenue streams and maintaining cost containment measures in order to be cash flow positive. We believe that our borrowing capacity, cash generated from operations and the proceeds of the Paycheck Protection Program (“PPP”) loan with principal of $4,200,000 due August 15, 2018 (see Note 79 – Long-Term Debt). The classification of this debt from long-term will be sufficient to short-term resulted in a working capital deficit at September 30, 2017. The Company plans to work with its lender to refinance its commercial bank loan infund our operations for the first half of 2018. Additionally, approximately $626,000 is included in accrued liabilities related to the exercise of the option to purchase machinery undernext 12 months. To enhance liquidity, our expired capital lease agreement (see Note 7 – Long-Term Debt). 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, accelerating collections of international receivables, and reducing working capital requirements and debt to enhance liquidity. We will continue to work to grow revenue and review additional cost containment measures and be cash flow positive in 2017.restructuring our debt. If we are unable to do this, and successfully refinance our commercial bank loan that is collateralized by our property, we may not be able to, among other things, (i) maintain our currentrevised general and administrative spending levels; (ii) fund certain obligations as they become due; and (iii) respond to competitive pressures or unanticipated capital requirements. COVID-19 has also led to a significant disruption in the equity and debt capital markets, which could hinder our ability to raise new capital or obtain financing on acceptable terms. We cannot provide any assurance that financing will be available to us in the future on acceptable terms.terms, if at all.

Additionally, in July 2020, the Company filed a Form S-3 Shelf Registration that will allow the Company to offer and sell, from time to time, up to $20,000,000 of securities.

 

NOTE 33. REVENUE

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

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

.Performance Obligations

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

All of our contracts are less than one year in duration. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

Disaggregation of Revenue

Approximately 83% of our revenue was from the United States and approximately 17% was from the Middle East for the nine months ended September 30, 2020. For the nine months ended September 30, 2019, approximately 95% of our revenue was from the United States and approximately 5% was from the Middle East.

Tool Revenue

Tool and Product Sales: Revenue for tool and product sales is recognized upon shipment of tools or products to the customer. Shipping and handling costs related to tool and product sales are recorded gross as a component of both the sales price and cost of the product sold.

Tool Rental: Tool rental revenue is recognized upon completion of the customer’s job for which the tool was rented. While the duration of the rents vary by job and number of runs, these rents are generally less than one month. The rental agreements are typically based on the price per run or footage drilled and do not have any minimum rental payments or term.

Other Related Revenue: We receive revenue from the repair of tools upon delivery of the repaired tool to the customer. We earn royalty commission revenue when our customer invoices their customer for the use of our tools.

Contract Services

Drill Bit Manufacturing and Refurbishment: We recognize revenue for our PDC drill bit services upon transfer of control, which we have determined to be upon shipment. Shipping and handling costs related to refurbishing services are paid directly by the customer at the time of shipment.

Revenue disaggregated by revenue source are as follows:

  

Nine months ended September 30,

 
  2020  2019 
       
Tool Revenue:        
Tool and product sales $971,520  $3,358,119 
Tool rental  1,716,210   755,720 
Other related revenue  3,459,550   5,098,581 
Total Tool Revenue  6,147,280   9,212,420 
         
Contract Services  2,782,313   5,443,583 
         
Total Revenue $8,929,593  $14,656,003 

Contract Costs

We do not incur any material costs of obtaining contracts.

Contract Balances

Under our sales contracts, we invoice customers after our performance obligations have been satisfied, at which point payment is unconditional. Accordingly, our contracts do not give rise to contract assets or liabilities under ASC 606.

8

NOTE 4. INVENTORIES

 

Inventories isare comprised of the following:

 

 

September 30, 2017

  

December 31, 2016

  

September 30, 2020

  

December 31, 2019

 
Raw material $1,000,895  $952,419  $809,958  $800,662 
Work in progress  67,679   90,017   36,229   75,235 
Finished goods  108,338   125,256   97,683   48,135 
 $1,176,912  $1,167,692  $943,870  $924,032 

 

NOTE 4.5. PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are comprised of the following:

 

  September 30, 2017  December 31, 2016 
Land $880,416  $880,416 
Buildings  4,847,778   4,847,778 
Leasehold improvements  717,232   717,232 
Machinery and equipment  8,141,746   5,060,281 
Machinery under capital lease  -   2,322,340 
Furniture and fixtures  507,554   507,554 
Transportation assets  811,381   882,163 
   15,906,107   15,217,764 
Accumulated depreciation  (6,867,076)  (6,149,405)
  $9,039,031  $9,068,359 

  September 30, 2020  December 31, 2019 
Land $880,416  $880,416 
Buildings  4,764,441   4,758,832 
Building improvements  755,039   755,039 
Machinery and equipment  11,232,415   10,343,486 
Office equipment, fixtures and software  628,358   615,357 
Transportation assets  350,871   350,871 
   18,611,540   17,704,001 
Accumulated depreciation  (10,752,340)  (9,658,309)
  $7,859,200  $8,045,692 

 

In 2019, the Company decided to sell the Company airplane and related hangar. Accordingly, these assets were reported as assets held for sale on our balance sheet as of December 31, 2019 at their carrying value, which was lower than the expected fair value less costs to sell. In February 2020, the Company sold the airplane for a gain of approximately $142,000. The Company recorded a $30,000 impairment related to the hangar in March 2020 and expects a sale of the hangar to be completed in the next 12 months.

Depreciation expense related to property, plant and equipment for the three and nine months ended September 30, 20172020 was $296,170$401,592 and $910,232,$1,259,398, respectively and for the three and nine months ended September 30, 20162019 was $320,583$446,888 and $1,544,215,$1,271,737, respectively.

 

NOTE 5.6. INTANGIBLE ASSETS

 

Intangible assets are comprised of the following:

 

 

September 30, 2017

  

December 31, 2016

  September 30, 2020  December 31, 2019 
Developed technology $7,000,000  $7,000,000  $7,000,000  $7,000,000 
Customer contracts  6,400,000   6,400,000   6,400,000   6,400,000 
Trademarks  1,500,000   1,500,000   1,500,000   1,500,000 
  14,900,000   14,900,000   14,900,000   14,900,000 
Accumulated amortization  (8,155,556)  (6,320,556)  (13,788,889)  (12,913,889)
 $6,744,444  $8,579,444  $1,111,111  $1,986,111 

 

Amortization expense related to intangible assets for the three and nine months ended September 30, 20172020 was $291,667 and $875,000, respectively and for the three and nine months ended September 30, 20162019 was $611,667$291,667 and $1,835,000,$1,408,333, respectively.

 

Annually, and more often as necessary, we will perform an evaluation of our intangible assets for indications of impairment. If indications exist, we will perform an evaluation of the fair value of the intangible assets and, if necessary, record an impairment charge. As of September 30, 2017,2020, the Company reviewed the net balance of the intangible assets and determined no impairment was needed.

 

NOTE 6.7. RELATED PARTY NOTE RECEIVABLE

 

In January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy Corporation (“Tronco”), a party related to us through common control, in order to take over the legal position as Tronco’sTronco’ s senior secured lender. That agreement provided that,Effective August 2017, the Company fully reserved the related party note receivable of $6,979,043, which reduced the related party note receivable balance to $0. The Company continues to hold the 8,267,860 shares of the Company’s common stock as collateral. The Company will record a recovery of the loan upon our fullreceiving 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 loan fromchanging the proceeds ofpayment terms on the Offering,note. As amended, the lender would assign to us all of its rights under the Tronco loan, including all of the collateral documents. On May 30, 2014, we closed our purchase of the Tronco loan for a total payoff of $8.3 million, including principal, interest, and early termination fees. As a result of that purchase, we became Tronco’s senior secured lender, and as a result are entitled to receive all proceeds from sales of the Tronco-owned collateral, as discussed below.

The interest rate on the note is 4.5%. We earned interest of $87,867 and $251,600 for the three and nine months ended September 30, 2017, respectively, and interest of $78,421 and $233,558 for the three and nine months ended September 30, 2016, respectively.

On March 28, 2017, the Company and Tronco finalized an agreement with a third party and pursuant to this agreement, the third party acquired all of the Ohio assets of Tronco for $550,000. As Tronco’s senior secured lender, we agreed to release our lien and security interest on these assets in accordance with the agreement. The Company agreed to a non-cash receipt of the $550,000 from Tronco by reducing our bonus accrual liabilities, which was earned by the Meiers in 2014 but not paid, and was recorded in other long-term liability. As a result of this agreement, we reduced both the other long-term liability and the Tronco related party note receivable during the first quarter of 2017.

On August 8, 2017, the Board of Directors agreed to extend the terms of the Tronco loan to interestfixed at 2% per annum. Interest only paymentsis due December 31, 2017, 2018, 2019, 2020,2021 and 2021,2022, with a balloon payment of all unpaid interest and principal due upon full maturity on December 31, 2022.

 

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We have the direct legal right to enforce the collateral and guaranty agreements entered into in connection with the Tronco loan and to collect Tronco’ s collateral sales proceeds, in order to recover the loan purchase amount.

NOTE 8. LEASES

The Tronco loan continues to be secured by the first position liens on all of Tronco assets, as well as by the guarantees of Troy and Annette Meier (the “Meier Guaranties”), which are directly payable to and legally enforceable by us. In addition, the Meiers have provided us with stock pledges in which they pledge all of their shares of our common stock held by their family entities (the “Meier Stock Pledge”), as collateral for the Meiers guaranties until full repayment of Tronco loan. The pledged shares, which are subject to insider timing requirements and volume limitations under Rule 144Company determines whether a contract is a lease, or contains a lease, at inception of the Securities Actcontract and required periodic black-out periods, are being held in third-party escrow until full repaymentwhether that lease meets the classification criteria of the Tronco loan.a finance or operating lease. The Company holds 8,267,860 sharesdiscounts lease payments based on an estimate of its incremental borrowing rate as the Company’s leases do not provide a readily determinable implicit rate.

The Company leases certain facilities in Texas, Utah and 530,725 restricted stock units as collateral forDubai under long-term operating leases with lease terms of one year to two years. Effective January 1, 2020, the Tronco noteCompany adopted the provision of ASC 842 Leases.

The table below presents the lease related assets and liabilities recorded on the Company’s consolidated balance sheet as of September 30, 2017.2020:

  Classification on Balance Sheet 

September 30, 2020

 
Assets      
Operating lease assets Operating lease right of use assets $146,450 
Total lease assets   $146,450 
       
Liabilities      
Current liabilities      
Operating lease liability Current operating lease liability $108,104 
Noncurrrent liabilities      
Operating lease liability Long-term operating lease liability  38,346 
Total lease liability   $146,450 

The lease expense and the cash paid under operating leases for the three and nine months ended September 30, 2020 was $26,827 and $141,817, respectively. At September 30, 2020, the weighted average remaining lease terms were 1.84 years and the weighted average discount rate was 7.25%.

The following is the aggregate future lease payments for operating leases as of September 30, 2020:

2020 (remaining) $26,827 
2021  90,042 
2022  23,304 
2023  16,104 
Total undiscounted lease payments  156,277 
Less: effects of discounting  (9,827)
Present value of lease payments $146,450 

 

NOTE 7.9. LONG-TERM DEBT

 

Long-term debt is comprised of the following:

 

 

September 30, 2017

  

December 31, 2016

  September 30, 2020  December 31, 2019 
Real estate loans $4,583,000  $7,264,036  $2,681,373  $2,938,191 
Hard Rock Note, net of discount  7,903,808   7,846,497 
Hard Rock Note  1,500,000   3,000,000 
Credit Agreement  1,065,146   1,134,626 
Machinery loans  557,368   684,921   495,635   580,185 
PPP Loan  891,600   - 
Transportation loans  367,648   398,929   63,769   298,404 
  13,411,824   16,194,383   6,697,523   7,951,406 
Current portion of long-term debt  (6,647,944)  (2,905,682)
Long-term debt, less current portion $6,763,880  $13,288,701 
Less:        
Current portion  4,760,252   (4,102,542)
Long-term debt, net $1,937,271  $3,848,864 

Real Estate Loans

 

Our manufacturing facility is financed byOn February 1, 2019, we signed a loan agreement for $3,129,861 refinancing our commercial bank loan requiringwhich is secured by the land and buildings at our Vernal, Utah campus. We paid $1,000,000 towards the previous loan that was scheduled to mature on February 15, 2019, upon refinancing. The loan requires monthly payments of approximately $39,000,$43,000, including principal and interest at 5.25%.7.25%, and is secured by the land and buildings at our Vernal, Utah Campus. A lump sum principalballoon payment of approximately $4.2 million$2,500,000 is due at theupon maturity date of this loan on AugustFebruary 15, 2018.2021.

 

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On February 9, 2017, the Company sold real estate to Superior Auto Body (“SAB”), a related party, for the net proceeds of $2.5 million. The cash received from the sale was used to pay down the $2.5 million loan balance on the property. As part of the sale, the Company released 547,000 shares of the Meiers common stock from the collateral for the Tronco note (see Note 6 – Related Party Note Receivable).

Hard Rock Note

 

In 2014, the Company purchased all of the interests of Hard Rock Solutions, LLC (“Hard Rock”).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 in the closing of theto Hard Rock acquisition. At issuance, the fair value of the Hard Rock Note was determined to be $11,144,000, which is less than the face value due to a below-market interest rate. The resulting discount of $1,356,000 will be amortized to interest expense using the effective interest method, totaling approximately $19,657 and $59,766 for the three and nine months ended September 30, 2017, respectively.Rock.

 

On August 10, 2016, certainThe Company paid $803,630 of our subsidiaries entered into an amendedprincipal and restated note withaccrued interest on January 5, 2020, and $790,223 of principal and accrued interest on April 5, 2020. In April 2020, the seller in our acquisition of Hard Rock. AsCompany amended and restated the Hard Rock Note accrues interest at 5.75% per annum and matures and is fully payable on January 15, 2020.Note. Under the currentamended terms of the Hard Rock Note, we are required to make the following remaining payments: $2,000,000 in total principal plus accrued interest in 2018 through four $500,000 in principal plus accrued interest payments on each of January 15, March 15, May 15 and July 15, 2018, and $1,000,000 in principal$750,000 plus accrued interest on eachJuly 5, 2021 and October 5, 2022. Interest accrues at a rate of 8% per annum. The Company paid $29,759 of accrued interest on July 5, 2020 and $30,247 of accrued interest on October 5, 2020. Accrued interest only payments will also be due on the fifth day of January, 15, March 15, May 15April and October 2021 and January, April and July 15, 2019 for a total of $4,000,000 in principal and accrued interest.2022. The remaining principal balance of principal of $2,000,000 and accrued interest on the Hard Rock Note are due on January 15, 2020. During 2017, we made accrued interest payments related to the note on January 15, 2017, March 15, 2017, May 15, 2017, and July 15, 2017 of $129,808, $74,356, $76,877, and $76,877, respectively.is $1,500,000.

 

Capital LeaseCredit Agreement

 

In 2012, weFebruary 2019, the Company entered into a lease for machineryLoan and Security Agreement (the “Credit Agreement”) with Austin Financial Services, Inc. (“AFS”). The Credit Agreement provides a $4,500,000 credit facility, which was capitalized by the Companyincludes a $1,000,000 term loan (the “Term Loan”) and accordingly, the machinery and the related obligation under the lease were included on the Company’s balance sheet. The lease had a five-year term with an option to buy the asset or renew the lease. On August 31, 2017, the Company exercised the option to purchase the machinery for $690,000, which is due in November 2017.$3,500,000 revolver (the “Revolving Loan”). As of September 30, 2017,2020, $359,916 was outstanding on the Revolving Loan. Amounts outstanding under the Revolving Loan at any time may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect (less a dilution reserve as determined by AFS in its sole good faith discretion), plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c) the borrowing base reserve as may be determined from time to time by AFS. Amounts outstanding on the Revolving Loan as of September 30, 2020, may not exceed $511,791, which is based on a calculation applying 85% of accounts receivable and 50% of inventory. A collateral management fee is payable monthly on the used portion of the Revolving Loan and Term Loan. Even if our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. At September 30, 2020, we had approximately $9,456 of accrued interest.

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 Revolving Loan is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration clause. At September 30, 2020, we were in compliance with the covenants in the Credit Agreement.

The interest rate for the Term Loan and the Revolving Loan is prime plus 2%. At September 30, 2020, the interest rate was 8.85%, which includes a 3.6% management fee rate. The obligations of the Company owed $626,000under the agreement are secured by a security interest in substantially all of the tangible and intangible assets of the borrowers, 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, subject to early termination pursuant to the original lessor which was includedterms of the agreement or extension as may be agreed by the parties.

Paycheck Protection Program

On April 21, 2020, the Company received loan proceeds of $891,600 under a promissory note from its existing commercial bank (the “PPP Loan”). The PPP, established as part of the CARES Act, provides for loans to qualifying businesses for amounts up to 2.5 times the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after eight weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels.

The application for these funds required the Company to, in accrued expenses.good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. Some of the uncertainties related to the Company’s operations that are directly related to COVID-19 include, but are not limited to, the severity of the virus, the duration of the outbreak, governmental, business or other actions (which could include limitations on operations or mandates to provide products or services), impacts on the supply chain, and the effect on customer demand or changes to operations. In addition, the health of the Company’s workforce, and its ability to meet staffing needs to continue to build, repair and distribute drilling tools, and other critical functions, are uncertain and is vital to its operations.

The PPP Loan certification further requires the Company to take into account our current business activity and our ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The Company had approximately $341,000 of available credit under the Credit Agreement as of April 21, 2020. Further, the Company has a limited market capitalization and the Company’s shares have limited trading volume and as a result, the Company believes it met and continues to meet the certification requirements.

The term of the Company’s PPP Loan is two years. The annual interest rate on the PPP Loan is 1% and no payments of principal or interest are due during the six-month period beginning on the date of the PPP Loan.

11

NOTE 10. TOTAL EQUITY

A summary of changes in total equity for the nine months ended September 30, 2020 and 2019 is presented below:

  Common Stock  Additional
Paid-in
  Accumulated  Total
Shareholders
 
  Shares  Par Value  Capital  Deficit  Equity 
Balance - December 31, 2019  25,418,126  $25,418  $40,069,391  $(32,991,833) $7,102,976 
Stock-based compensation expense  199,360   199   369,644   -   369,843 
Net loss  -   -   -   (2,774,732)  (2,774,732)
Balance - September 30, 2020  25,617,486  $25,617  $40,439,035  $(35,766,565) $4,698,087 

  Common Stock  Additional
Paid-in
  Accumulated  Total
Shareholders
 
  Shares  Par Value  Capital  Deficit  Equity 
Balance - December 31, 2018  25,018,098  $25,018  $39,440,611  $(32,055,410) $7,410,219 
Stock-based compensation expense  79,652   80   473,637   -   473,717 
Net loss  -   -   -   (1,061,058)  (1,061,058)
Balance - September 30, 2019  25,097,750  $25,098  $39,914,248  $(33,116,468) $6,822,878 

On August 7, 2020, the Board of Directors recommended and the Company’s shareholders approved an additional 2,543,448 shares of the Company’s common stock to be added to the 2015 Incentive Plan. Subject to adjustment as provided in the 2015 Incentive Plan, the maximum aggregate number of shares of the Company’ s common stock that may be issued with respect to awards under the 2015 Incentive Plan is 5,536,353.

Also on  August 7, 2020, the Board of Directors granted 259,765 restricted stock units to Troy Meier, Chairman and Chief Executive Officer, 199,219 restricted stock units to Annette Meier, President and Chief Operating Officer, 140,625 restricted stock units to Chris Cashion, Chief Financial Officer, and 87,891 restricted stock units to each of the three independent members of the Board of Directors. In addition, the Board of Directors authorized 675,000 restricted stock units to be granted to employees of the company other than Mr. and Mrs. Meier and Mr. Cashion.  These restricted stock units will vest over three years from the date of grant.

NOTE 11. GEOGRAPHICAL OPERATIONS INFORMATION

The following summarizes revenue by geographic location:

  Three months ending September 30,  Nine months ending September 30, 
  2020  2019  2020  2019 
             
Revenue:                
North America $1,118,404  $4,787,693  $7,387,847  $13,957,666 
Middle East $429,038  $288,522  $1,541,746  $698,337 
  $1,547,442  $5,076,215  $8,929,593  $14,956,003 

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

  September 30, 2020  December 31, 2019 
Property, plant and equipment, net:        
North America $6,600,808  $7,160,646 
Middle East  1,258,392   885,046 
  $7,859,200  $8,045,692 

 

NOTE 8.12. COMMITMENTS AND CONTINGENCIES

 

We are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana Lafayette Division asserting Stabil Drill Specialties, LLC (“Stabil Drill”) infringed on our patent that covers the Company’s well bore conditioning tool, the Drill-N-Ream. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. The court ordered the Company to serve discovery requests upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit product inspection. Stabil Drill filed a motion for summary judgement and the Company responded and cross-moved for patent infringement. The parties are awaiting the judge’s decision. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company, filed for bankruptcy, which may result in a delay in the resolution of this litigation. We cannot predict the outcome of this matter, but our legal costs could have a material effect on our financial position or results of operations in future periods. We are not currently involved in any other litigation which management believes could have a material effect on our financial position or results of operations, except as follows:operations.

 

Del Rio Suit

12

 

In October 2013, Del-Rio Resources, Inc. (“Del-Rio”) filed suit, on its own behalf and derivatively on behalf of Philco Exploration, LLC (“Philco”), against the following co-defendants (a) Tronco Ohio, LLC and Tronco, (b) the lender on the Tronco loan, ACF Property Management, Inc. (p.k.a. Fortuna Asset Management, LLC,) (“ACF”), (c) Troy and Annette Meier personally, and several of their family trusts, (d) Meier Family Holding Company, LLC and Meier Management Company, LLC, and (e) SDS and MPS in the Eighth Judicial District Court, Uintah County, Utah Cause #130800125 (the “Suit”). On May 11, 2017, pursuant to a mediation proceeding, all of the plaintiffs and remaining defendants in the Suit executed a Settlement Agreement whereby each of the parties have released all of their claims against the other parties to the Suit without liability, effective as of March 22, 2017. Such release includes the Company’s two subsidiaries that were a party to the Suit, SDS and MPS, as well as Troy and Annette Meier personally and all of their family trusts named as defendants in the Suit. As a result of the execution of the Settlement Agreement, a Stipulated Motion for Dismissal with Prejudice was filed with the Court which includes a form of Order of Dismissal with Prejudice (the “Court Order”). On May 15, 2017, the Court Order was executed by the judge and the Suit was formally dismissed with prejudice.

NOTE 9. RELATED PARTY TRANSACTIONS

In 2014, the Company issued notes payable to related parties in the amount of $2 million. The notes bear interest at 7.5% and were scheduled to mature on January 2, 2017. The Company made principal payments of $50,000 in January 2017 and $24,000 in May 2017. Based on an informal agreement, the Company will continue to reduce the balance on the note in 2017 against the interest due to the Company on the Tronco related party note receivable (see Note 6 – Related Party Note Receivable) instead of repaying the note.

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, 2017,2020, and our results of operations for the three and nine months ended September 30, 20172020 and 2016.2019. 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, 20162019 and 2015,2018, which were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016,2019, 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.

Jumpstart Our Business Startups Act of 2012

In April 2012, the JOBS Act was enacted. Section 107 of the JOBS Act provides that an emerging growth company can utilize the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for implementing new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to nonissuers. We have elected to delay such adoption of new or revised accounting standards, and as a result, we may not implement new or revised accounting standards on the relevant dates on which adoption of such standards is required for other issuer companies.

Subject to certain conditions set forth in the JOBS Act, as an emerging growth company, we intend to rely on certain of these exemptions, including without limitation, providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404 and implementing any requirement that may be adopted regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis). These exemptions will apply for a period of five years following the completion of our IPO, which occurred in May 2014, although if the market value of our common stock that is held by nonaffiliates exceeds $700 million as of any June 30 before that time, we would cease to be an emerging growth company as of the following December 31.

Forward - Looking Statements

This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control of the Company. You can identify the Company’s forward-looking statements by the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe” and similar expressions, or by the Company’s discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurances can be given that these expectations will prove to be correct. These forward-looking statements include the following types of information and statements as they relate to the Company:

 

 future operatingoperations, financial results, business plans, cash flow and cash flow;requirements;
   
 scheduled, budgeted and other future capital expenditures;
   
 working capital requirements;
   
 the availability of expected sources of liquidity;
the transition of our business to primarily selling tools;
   
 the introduction into the market of the Company’s future products;
   
 the market for the Company’s existing and future products;
   
 the Company’s ability to develop new applications for its technologies;
   
 the exploration, development and production activities of the Company’s customers;
   
 compliance with present and future environmental regulations and costs associated with
future operations, financial results, business plans and cash needs
environmentally related penalties, capital expenditures, remedial actions and proceedings;
   
 effects of pendingpotential legal proceedings; and
   
 changes in customers’ future product and service requirements that may not be cost effective or within the Company’s capabilities; and
future operations, financial results, business plans and cash needscapabilities.

13

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

 

While it is not possible to identify all factors, the Company continues to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially are the risks and uncertainties discussed under “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 20162019, our subsequent filings with the SEC, and the following:

 

the impact of COVID-19 on domestic and global economic conditions and the future impact of such conditions on the oil and gas industry and the demand for our services;
 the volatility of oil and natural gas prices;
   
 the cyclical nature of the oil and gas industry;
   
 availability of financing, flexibility in restructuring existing debt and access to capital markets;
   
 our reliance on significant customers;
consolidation within our customers’ industries;
   
 competitive products and pricing pressures;
   
 our reliance on significant customers;
our limited operating history;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 of raw materials;
   
 our dependence on third party suppliers;
   
 unforeseen risks in our manufacturing processes;
   
 the need for skilled workers;
   
 our ability to successfully manage our growth strategy;
   
 unanticipated risks associated with, and our ability to integrate, acquisitions;
   
 current and potential governmental regulatory actions in the United States and regulatory actions and political unrest in other countries;
   
 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;systems and other cybersecurity risks;
   
 related party transactions with our founders; and
   
 risks associated with our common stockstock.

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

 

OverviewExecutive Summary

 

Superior Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”) is an innovativeWe innovate, design, engineer, manufacture, sell, and repair drilling and completion tool technology company providing cost saving solutions that drive production efficiencies fortools in the oilUnited States, Canada, Middle East and natural gas drilling industry. The Company innovates, designs, engineers, manufactures, sells, and repairs drilling and completion tools. 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”). 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. The Company’s strategy for growth is to leverage its expertise in innovative drill tool technology and precision machining in order to broaden its product offerings and solutions for the oil and gas industry.Eastern Europe.

 

We currently have three basic operations:

 

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

 

FromOur strategy for growth is to expand our headquartersglobal market penetration of our current drill tool technology and to leverage our expertise in Vernal, Utah, we operate a technologically-advanced PDC drill bit refurbishing facility,tool technology and precision machining in order to broaden our product offerings and solutions for the oil and gas industry, as well as a state-of-the-art, high-techother 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 completion tool engineering designreduce production costs.

Recent Developments and manufacturing operation. We manufacture our drill string enhancement tools,Trends

Our business and operations have been adversely affected by and are expected to continue to be adversely affected by the COVID-19 pandemic. The COVID-19 pandemic greatly reduced global oil demand as social distancing and travel restrictions were implemented across the world. The timeline and potential magnitude of the COVID-19 outbreak and its consequences are currently unknown. The continuation or amplification of this virus could continue to more broadly affect the United States and global economy, including the patented Drill- N-Ream tooldemand for oil and the patented Strider technology, and conduct our new product research and development from this facility.gas.

 

Our co-founder, Troy Meier, developedFurther disrupting the first commercially-viable process for refurbishing PDC drill bits afteroil and gas industry was the lifting by the Organization of the Petroleum Exporting Countries (“OPEC”) of supply curtailments. This resulted in an increase in the global supply of oil in an environment of rapidly contracting demand. As a successful 13-year career with a predecessorresult, the price of Baker Hughes Inc. For the past 21 years, we have exclusively provided our PDC drill bit refurbishing services for the Rocky Mountain, California and Alaska regions of Baker Hughes’s oilfield operations. In addition, we have expanded our offerings and our customer base by demonstrating our engineering, design and manufacturing expertise to develop our own down-hole drilling tools. We continuously work with our customers to develop new products and enhancements to existing products, improve efficiency and safety, and solve complex drilling tool problems.

We employ a senior work force with specialized training and extensive experience related to drill bit refurbishing and tooling manufacturing. They produce our products and services using a suite of highly technical, purpose-built equipment, much of which we design and manufacture for our proprietary use. Our manufacturing equipment and products use advanced technologies that enable us to increase efficiency, enhance product integrity, improve efficiency and safety, and solve complex drilling tool problems.

Oil and Gas Drilling Industryoil declined significantly in April 2020 as storage capacity became limited.

 

Overview

Drilling and completionOverall, the significant decline in oil demand due to COVID-19 coupled with a global over supply of oil drove down oil prices. This has resulted in our customers announcing significant reductions to their capital expenditure budgets for 2020. This is evidenced by the significant decline in U.S. onshore rig counts from the beginning of the year. At the end of 2019, the U.S. onshore rig count as reported by Baker Hughes was 781 rigs. As of September 30, 2020, the U.S. onshore rig count was 266 rigs compared with 855 rigs as of September 30, 2019. We expect oil and gas wells are upstream operationsrelated markets to continue to experience significant weakness for the remainder of 2020 and into 2021. Despite these current challenges, the oil and gas industry is beginning to experience slight improvements including an increase in the oil & gas industry served bynumber of active rigs in the oilfield services group within the energy industry. The drilling industry is often segmentedU.S. from third quarter lows, and we expect additional rig count improvement to occur into the North American market and the International market. These markets share common exposure to the same macro environment, but also exhibit unique factors that drive the dynamics of each market.year-end.

 

Oilfield services companies drill the wells for hydrocarbon exploration and production (“E&P”) companies. Demand for onshore drilling is a functionThe reduction of the willingnessU.S. onshore rig count has negatively affected our results of E&P companies to make operating and capital expenditures to explore for, develop and produce hydrocarbons. When oil or natural gas prices increase, E&P companies generally increase their capital expenditures, resulting in greater revenue and profits for both drillers and equipment manufacturers. Likewise, significant decreases in the prices of those commodities may lead E&P companies to reduce their capital expenditures, which decreases the demand for drilling equipment.

Trends in the Industry

Recent Rig Count Improvement and Stabilization; Industry Volatility.Ouroperations as our business is highly dependent upon the vibrancy of the oil and gas drilling operations in the U.S. Worldwide military, political and economic eventsIn an effort to offset the reduction in revenue resulting from the weakened macroeconomic environment, we have contributedimplemented certain cost reduction measures during 2020. These measures included, but were not limited to, oil and natural gas price volatility and are likely to continue to do so in the future. Very soon after the completionfollowing:

20% reduction of the base salary beginning in April 2020 and a 40% salary deferral beginning in October 2020 for the Company’s Chief Executive Officer, Chief Operating Officer, and Chief Financial Officer;
20% reduction in the base salaries beginning in April 2020 and a 20% deferral of base salaries  beginning in October 2020 of certain non-executive officers of the Company;
20% reduction in fees to be paid beginning in April 2020 and a 40% deferral of fees beginning in October 2020 to the independent directors on the Board for their service as directors;
5% to 10% reduction in salaries beginning in April 2020 and a 10% deferral of salaries beginning in October 2020 of other members of the management team and salaried workforce;
43% reduction of the Company’s workforce; and 
Closure of  our West Texas repair facility in July 2020. 

We have also entered into amended agreements with certain of our initial public offeringcustomers as discussed below in late May 2014more detail, reduced our planned capital expenditures for 2020 and through early 2016, oil prices dramatically declineddecided to defer further investment in new technology development, including our Strider technology, for the United Statesforeseeable future. Management is working diligently with vendors to achieve amended price concessions and as a result, the numberterms of operating drill rigs was measurably reduced. The NYMEX-WTI oil price was as low as $26.19 in February 2016, while the NYMEX-Henry Hub natural gas price was as low as $1.49 per MMBtu in March 2016. The Baker Hughes weekly rotary rig count decreased over 70% from the high of 1,931 on September 13, 2014 to a historic low of 404 as of May 27, 2016.

During the downturn in 2015 and 2016, our business with Baker Hughes decreased measurably as a result of the decline in drilling activity. This severely impacted both pricing and volume for drill bit refurbishment. We are contracted with Baker Hughes to serve the Rocky Mountain region that includes the Bakken shale formation in North Dakota. This region is higher cost production and as such, the drill rig count reduction was more dramatic than the overall U.S rig count decline. During the second half of calendar year 2016 and into 2017, the U.S. rig count began to increase from the historic low in May 2016 to 913 as of October 20, 2017. With this increase in market activity, we have seen an increase in demand for our product and services, however we have not seen an increase in pricing. The rate of growth in rig count stabilized in July 2017 and is expected to not increase at the same rate as it has over the last twelve months.

Lower oil and natural gas prices combined with the advent of horizontal drilling requires new technologies.payables. We believe the valueU.S. onshore activity for the remainder of 2020 will remain at depressed levels and continue to be constrained. We will continue to actively monitor the situation and may take further actions altering our business operations that we determine are in the best interests of our Drill-N- Ream toolemployees, customers, partners, suppliers, and Strider technology combined with our low market penetration provide us sales opportunities in softstakeholders, or as well as robust markets.

The oil and gas industry is increasingly using directional (e.g., horizontal) drilling in their exploration and production activities because of measurably improved recovery rates that can be achieved with these methods. With the rise of this type of drilling, traditional drill string tools used for vertical drilling do not necessarily provide the best performancerequired by federal, state, or are not well suited for directional drilling.

We believe that our Drill-N-Ream tool and Strider technology have proven to provide significant operational efficiencies and costs savings for horizontal drilling activity. In addition, we are developing additional technologies to take advantage of the oil and gas industry’s significant shift to horizontal/directional drilling and its resulting need for new drill string tools and technology.local authorities.

 

We expect thathave placed a priority on protecting our employees during this pandemic while continuing to provide essential services to our customers. We operate under an emergency response plan specific to the global pandemic. This plan is reviewed and revised quarterly based on the latest federal and state government information provided, best practice, and consultation with local health departments. This plan includes disinfecting on a regular basis, the elimination of overlap between shifts, and a strict procedure for handling potential cases within the processes outlined in the Families First Coronavirus Response Act. Employees are also required to perform self-health evaluations at the start of every shift. These measures continue to act as a barrier to the spread of the virus on company property and among its employees. To date, these precautions have had an immaterial impact on the normal costs associated with our extensive knowledge and experience in the oilfield industry, we can identify additional challenges with directional drilling, and then design and develop tools that will help our customers with their drilling challenges. Further development of additional drill string components, such as our Drill-N-Ream and Strider technology, will become increasingly important to our business as we continue to grow through both organic expansion and strategic acquisitions.operations.

 

GE Oil & Gas to merge with Baker Hughes. In October 2016, GE Oil and Gas and Baker Hughes announced an agreement to combine their businesses. Currently, Baker Hughes is our sole customer for our bit refurbishment business and we do not know how this merger may impact our business. Despite this, we intend to continue developing our long-time relationship with Baker Hughes. In January 2016,Effective April 1, 2020, the Company through its Hard Rock subsidiary entered into ana First Amendment to Amended and Restated Distribution Agreement (the “DTI Amendment”) with Drilling Tools International, Inc. (“DTI”), amending the agreement between Hard Rock and DTI dated August 30, 2016. Under the DTI Amendment, all charges for repair rates the Company provides to DTI are reduced by 10%. These rate changes are applicable through September 30, 2020, unless extended on, or prior to, the expiration date by mutual written agreement. The Company hopes to extend the DTI Agreement prior to year-end 2020.

Effective May 1, 2020, we entered into a First Amendment to Vendor Agreement (the “Baker Hughes Amendment”) with Baker Hughes Oilfield Operations LLC (“Baker Hughes”), amending their existing Vendor Agreement dated April 1, 2018. Under the Baker Hughes Amendment, we may engage in other activity not related to supply themor in competition with the Strider technology with our Open Hole Strider tool and related services. Tool shipments associated with the agreement are expected to begin in early 2018. The agreement has no set expiration date or minimum shipment requirement. It will remain in force until it is canceled by either us orbusiness of Baker Hughes as stipulated into the agreement. The Company’s current agreement withextent that such other activity shall not be considered a breach of the Vendor Agreement. Also, under the Baker Hughes regardingAmendment, charges for repair rates that we provide to Baker Hughes are reduced by 10%. Lastly, Baker Hughes agreed to remove the exclusivity restrictions that prevented us from providing drill bit refurbishment has been extended until January 28, 2018. The Company is currently negotiating an agreement renewal with Baker Hughes that is expected to replace the existing agreement.repair for other entities, which broadens our market opportunity.

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CONSOLIDATED RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONSThree and Nine Months Ended September 30, 2020 Compared with the Three and Nine Months Ended September 30, 2019

 

The following table represents our condensedsummary consolidated statement of operationsoperating results for the periods indicated:

 

  Three-Months Ended September 30,  Nine-Months Ended September 30, 
(in thousands) 2017  2016  2017  2016 
Revenue $4,447   100% $2,261   100% $11,866   100% $4,820   100%
Operating costs and expenses  3,727   84%  3,224   143%  10,971   92%  10,853   225%
Income (loss) from continuing operations  720   16%  (963)  (43)%  894   8%  (6,033)  (125)%
Other expense  (134)  (3)%  (212)  (9)%  (387)  (3)%  (484)  (10)%
Net income (loss) $586   13% $(1,173)  (52)% $507   4% $(6,515)  (136)%

  Three-Months Ended September 30,  Nine-Months Ended September 30, 
(in thousands) 2020  2019  2020  2019 
Tool revenue  1,191   77%  3,195   65%  6,147   69%  9,212   63%
Contract services  357   23%  1,881   37%  2,782   31%  5,444   37%
Total Revenue $1,547   100% $5,076   100%  8,929   100%  14,656   100%
Operating costs and expenses  3,094   200%  5,303   104%  11,307   127%  15,187   104%
Loss from operations  (1,546)  (100)%  (227)  (4)%  (2,378)  (27)%  (531)  (4)%
Other expense  (85)  (5)%  (191)  (4)%  (291)  (3)%  (530)  (4)%
Income tax expense  (100)  (6)%  -   -   (106)  (1)%  -   - 
Net loss $(1,731)  (111)% $(418)  (8)%  (2,775)  (31)%  (1,061)  (7)%

 

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.

 

16

During 2016, the Company changed its revenue model from primarily renting tools to primarily selling tools. In May 2016, the Company entered into a distribution agreement with Drilling Tools International, Inc., (“DTI”), under which they purchase our Drill-N-Ream tool for their rental tool business. As part of this agreement, DTI also hired much of our field sales team and purchased the related vehicles associated with our previous rental tool business in the second half of 2016. In order to maintain exclusivity of the Drill-N-Ream Tool in the U.S. and Canada, the agreement required DTI to achieve 10% market share, defined as 10% of the average horizontal rig count in the 30 days prior to June 30, 2017. As a result of DTI’s successful efforts to achieve this 10% market share, our sales grew measurably when compared with the prior-year period.

 

For the three months endedThree Months Ended September 30, 2017, as compared2020 Compared with the three months endedThree Months Ended September 30, 20162019

 

Revenue. Our revenue increaseddecreased approximately $2,186,000, during$3,529,000 or 70%. The revenue decline was driven primarily by a 73% decrease in the three months ended September 30, 2017 compared withU.S. land rig count resulting from the same period in 2016. Tool revenue for third quarter 2017 was $3,182,000global impact of the COVID-19 pandemic, which was comprised of approximately $2,012,000 ofpartially offset by a $141,000, or 49% increase, in International revenue to $429,000. The Company’s U.S. revenue declined 77%, from reduced drill bit repair and tool rental and sales revenue and approximately $1,170,000 of other related revenue. Other related revenue includes royalty fees, maintenance and repair of tools. Tool revenue for third quarter 2016 was approximately $1,845,000 which was comprised of approximately $1,726,000 of tool rental and sales revenue and approximately $119,000 of other related revenue. Tool revenue forreflecting the third quarter 2017 grew as a result ofdramatic slowdown in the continued increase in U.S. drilling activity from 2016 to 2017, and the Company’s channel partner’s efforts to retain its exclusivity in the U.S. and Canada by achieving its increasing market share targets.quarter. Contract services revenue increased 204%decreased approximately $1,525,000, or 81%, to approximately $1,264,000 for$357,000. Tool revenue was $1,191,000, down 65% or $2,004,000, from the three months ended September 30, 2017 compared with approximately $417,000 forprior-year period reflecting the same period in 2016 as a resultpositive impact of the increase in drilling activity in 2017, which drove demand for drill bit refurbishment, as well as the Company receiving overflow drill bit refurbishment work from outside its contracted territory.International activity.

 

Operating Costs and Expenses. Total operating costs and expenses increaseddecreased approximately $503,000 during$2,210,000 for the three months ended September 30, 2017 compared with the same period in 2016.2020 three-month period.

 

 Cost of revenue increaseddecreased approximately $744,000$1,192,000 reflecting lower volume and the impact of cost savings resulting from the Company’s reduction in the third quarter of 2017 compared with the prior-year period due to an increase in volume.force. As a percentage of revenue, cost of salesrevenue was 39%, compared with 43% in56% and 41% of revenue for the prior year period.three months ended September 30, 2020 and 2019, respectively.
   
 Selling, general and administrative expenses decreased approximately $217,000 for the three months ended September 30, 2017$972,000 to $1,530,000 and was 99% of revenue compared with 49% in the same period in 2016.prior-year period. The decrease was due to acost reduction measures implemented by us in 2020 given the significant reduction in professional fees and research and development expense.our revenue related to market conditions, including COVID-19.
   
 

Depreciation and amortization expense decreased approximately $24,000.

$45,000, or 6%, to $693,000.

Other Income (Expense)(Expenses). Other income and expense primarily consists of rent income, interest income, interest expense, loan forgiveness and gain or gain/loss on disposition of assets.

 

 Other Income. ThereInterest expense for the three months ended September 30, 2020 and 2019 was no other income inapproximately $126,000 and $197,000, respectively. The decrease was the third quarter of 2017 due to the sale of SAB facilities in February 2017. As result of an approximate $2.2 million reduction of principal owed under the sale, we will no longer receive this rental income.Hard Rock Note.  
   
 Interest Income. For the three months ended September 30, 2017 and 2016 interest income was approximately $91,000 and $79,000, respectively, and relates to interest received from the Tronco related party note receivable.
Interest Expense.The interest expenseCompany recognized $41,000 of loan forgiveness for the three months ended September 30, 2017 and 20162020 related to an SBA equipment loan that was approximately $225,000 and $373,000, respectively. The decline in interest expense was due primarily to principal payments associated withforgiven as part of the Hard Rock Note.CARES Act.

 

For the nine months endedNine Months Ended September 30, 2017 as compared2020 Compared with the nine months endedNine Months Ended September 30, 20162019

 

Revenue. Our revenue increaseddecreased approximately $7,046,000, during the nine months ended September 30, 2017 compared with the same period in 2016. Tool revenue for the nine months ended September 30, 2017 was approximately $7,938,000 which was comprised of approximately $5,257,000 of tool rental and sales revenue and approximately $2,681,000 of other related revenue. Other related revenue includes royalty fees, maintenance and repair of tools and agency fees. Tool revenue for the nine months ended September 30, 2016 was approximately $3,687,000 which was comprised of approximately $3,474,000 of tool rental and sales revenue and approximately $213,000 of other related revenue Tool revenue for the nine months of 2017 grew as$5,726,000 or 39% to $8,930,000. The decrease is a result of the Company’s shiftCOVID-19 pandemic induced decrease in business model in May 2016 from a rental tool businessthe demand of oil and gas leading to a tool sales business, the increase in U.S. drilling activity from 2016 to 2017 and the Company’s channel partner’s efforts to retain its exclusivity in the U.S. and Canada by achieving its increasing market share targets. Contract services revenue increased 247% to approximately $3,927,000 for the nine months ended September 30, 2017 compared with approximately $1,133,000 for the same period in 2016 as a result of the increasereduction in drilling activity in 2017 driving demand for its drill bit refurbishment capabilities.the United States. Partially offsetting this decline was an increase of $843,000, or more than double, in International revenue to $1,542,000.

Tool revenue was $6,147,000, down 33% or $3,065,000, from the prior-year period. Contract services revenue decreased approximately $2,661,000, or 49%, to $2,782,000.

 

Operating Costs and Expenses. Total operating costs and expenses increaseddecreased approximately $118,000 during$3,880,000 for the nine months ended September 30, 2017 compared with the same period in 2016.2020 nine-month period.

 Cost of revenue increaseddecreased approximately $1,064,000$1,835,000 and was driven by a decrease in sales and the impact of cost savings resulting from the Company’s reduction in force. As a percentage of revenue, cost of revenue was 48% for the nine months ended September 30, 2017 compared with2020, and 42% for the prior-year period due to an increase in volume. As a percentage of revenue, cost of sales was 37% compared with 69% in the prior year period.nine months ended September 30, 2019.
   
 Selling, general and administrative expenses decreased approximately $312,000 for the nine months ended September 30, 2017$1,499,000 to $4,888,000 and was 55% of revenue compared with 44% in the same period in 2016.prior-year period. The decrease was primarily due to restructuringcost reduction measures implemented by us in 2020 in an effort to offset the sales and marketing departments as a result of the business model change and a decreasereduction in research and development.revenue.
   
 Depreciation and amortization expenseexpenses decreased approximately $634,000 primarily as a result of the Drill-N-Ream tool being reclassified from property, plant, and equipment$546,000 to inventory in accordance with the Company’s shift from a rental tool business to a tool sales business,$2,134,000 for the nine months ended September 30, 2017 compared with the same period2020. Depreciation expense decreased due to lower amortization expense as a result of fully amortizing a portion of intangible assets in 2016.May 2019.

 

Other Income (Expenses). Other income and expense primarily consists of rent income, interest income, interest expense, loan forgiveness and gain/loss on disposition of assets.

 

 

Other Income. ForInterest income for the nine months ended September 30, 20172020 and 2016, other income was approximately $44,000 and $159,000, respectively. The decrease was the result of the sale of the SAB facilities in February 2017. As result of the sale, we will no longer receive this rental income. For the nine months ended September 30, 2016, we received $158,926 rental from two real property leases, our SAB facilities and our Vernal campus.

Interest Income. For the nine months ended September 30, 2017 and 2016,2019 interest income was approximately $255,000$5,800 and $235,000, respectively, and relates to interest received from the Tronco related party note receivable.$52,000, respectively.
   
 Interest Expense. The interest expense for the nine months ended September 30, 20172020 and 20162019 was approximately $699,000$450,000 and $1,101,000,$591,000, respectively. The declinedecrease in interest expense was due primarily to principal payments associated withthe reduction in the balance outstanding on the Hard Rock Note.
The Company recognized $41,000 of loan forgiveness for the nine months ended September 30, 2020 related to an SBA equipment loan that was forgiven as part of the CARES Act.

 

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Liquidity and Capital Resources

 

At September 30, 2017,2020, we had a working capital deficit of approximately $1,800,000. The Company’s manufacturing facility is financed by a commercial bank loan with principal of $4,200,000 due August 15, 2018 (see Note 7 – Long-Term Debt). The classification of this debt from long-term to short-term resulted in a working capital deficit at September 30, 2017. The Company plans to work with its lender to refinance its commercial bank loan in the first half of 2018. Additionally, approximately $626,000 is included in accrued liabilities related to the exercise of the option to purchase machinery under our expired capital lease agreement (see Note 7 – Long-Term Debt).$2,600,000. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments. In February 2017, the Company received approximately $2,483,000 related to the sale of the SAB facilities, and we used the proceeds to repay the mortgage related to the SAB property of approximately $2,500,000. Our operational and financial strategies include managinglowering our operating costs and capital spending to match revenue trends, accelerating collections of international receivables, and managing our working capital and debt to enhance liquidity. We will continue to work to grow revenue and review additional cost containment measures and bemanage costs to minimize negative net cash flow positive in 2017.2020. If we are unable to do this, and successfully refinance our commercial bank loan that is collateralized by our property, 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.

Public Offering: On

In addition, the significant decline in oil demand due to COVID-19, the instability of oil prices caused by geopolitical issues and over supply have resulted in the announcements by our customers and end users of our tools and technology of significant reductions to their capital expenditure budgets. Our expectation is that demand for our products and services will be severely impacted for the duration of 2020 and potentially beyond; however, we are currently unable to estimate the full impact to our business, how long this significant drop in demand will last or the depth of the decline. We have also reduced our planned capital expenditures for 2020 and we have decided to defer further investment in new technology development, including our Strider technology.

The Hard Rock Note has a remaining balance of $1,500,000 as of September 30, 2016, we priced a follow-on public offering of common stock2020, accrues interest at $1.008.00% per share. The transaction closedannum and is fully payable on October 5, 2016. Net of underwriting expenses of $452,500, stock offering expenses of $256,419, net proceeds were approximately $5.0 million. The Company used the proceeds to repay its $1 million bridge financing entered into the summer of 2016, Federal National Commercial Credit (“FNCC”) indebtedness of $868,000 and pay the remaining $500,000 plus accrued interest on the Hard Rock Note. We have used the remaining $2.6 million from the offering to service on going debt obligations, which include real property leases and equipment loans, as well as for general corporate purposes, including growth working capital. The Bridge Financing Agreement and the FNCC lending agreement were both terminated upon the repayment on October 5, 2016.

Hard Rock Note: On August 10, 2016, certain of our subsidiaries entered into an amended and restated note with the seller in our acquisition of Hard Rock Solutions, LLC (as so amended and restated, the “Hard Rock Note”). As amended and restated, the Hard Rock Note accrues interest at 5.75% per annum and matures on January 15, 2020.2022. Under the currentamended terms of the Hard Rock Note, we are required to make the following remaining payments: $500,000 in principal plus accrued interest on each of January 15, March 15, May 155, April 5, July 5 and July 15, 2018,October 5 in 2021 and $1,000,0002022; plus $750,000 in principal plus accrued interest on each of January 15, March 15, May 15 and July 15, 2019. The5, 2021 with the remaining principal balance of $2,000,000principal and accrued interest on the Hard Rock Note are due on JanuaryOctober 5, 2022.

Our commercial bank loan is secured by our Vernal, Utah campus. The loan requires monthly payments of approximately $43,000, including principal and interest at 7.25%, and a balloon payment of $2,500,000 is due upon maturity on February 15, 2020. During 2017,2021. We have been in active discussions regarding the extension of this loan.

Our Credit Agreement is comprised of $1,000,000 Term Loan and $3,500,000 Revolving Loan. As of September 30, 2020, we madehad $749,998 outstanding on the Term Loan and $359,916 outstanding on the Revolving Loan. Amounts outstanding under the Revolving Loan at any time may not exceed the sum of: (a) up to 85% of accounts receivable or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect (less a dilution reserve as determined by AFS in its sole good faith discretion), plus (b) the lesser of (i) up to 50% of inventory or such lesser percentage as AFS in its sole discretion may deem appropriate if it determines that there has been a material adverse effect, or (ii) the inventory sublimit, minus (c) the borrowing base reserve as may be determined from time to time by AFS. Amounts outstanding on the Revolving Loan as of September 30, 2020, may not exceed $511,791, which is based on a calculation applying 85% of accounts receivable and 50% of inventory. A collateral management fee is payable monthly on the used portion of the Revolving Loan and Term Loan. If our borrowings are less than $1,000,000, we still pay interest as if we had borrowed $1,000,000. At September 30, 2020, we had approximately $9,456 of accrued interest.

The interest payments relatedrate for the Term Loan and the Revolving Loan is prime plus 2%. At September 30, 2020, the interest rate was 8.85%, 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 the notesuch real property), certain excluded equipment, intellectual property, or aircraft. The Credit Agreement matures on January 15, 2017, March 15, 2017, May 15, 2017 and July 15, 2017 of $129,808, $74,356, $76,877 and $76,877, respectively.February 20, 2023.

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Cash FlowFlows

 

Operating Cash FlowsNine Months Ended September 30, 2020 Compared with the Nine Months Ended September 30, 2019

 

ForNet cash provided by operating activities was $1,268,788 and $1,221,440 for the nine months ended September 30, 2017, net cash provided by our operating activities2020 and 2019, respectively. The primary reason for the improvement was approximately $1,351,000. The Company had approximately $507,000 of net income, approximately $1,494,000 increase in accounts receivable,due to a $4,234,073 decrease in accounts payable and accrued expenses of approximately $611,000 and a decrease in depreciation and amortization expense of approximately $634,000.receivable.

 

Investing Cash Flows

ForNet cash used in investing activities was $36,642 for the nine months ended September 30, 2017, net cash provided by our investing activities was approximately $2,264,000. The Company received approximately $2,484,0002020 and related to property, plant and equipment purchases for tools to support international expansion, which was offset by the sale of the SAB facilities. The Company airplane. Net cash used approximately $220,000 in investing activities was $392,691 for property, plant and equipment purchases.

Financing Cash Flows

For the nine months ended September 30, 2017, net2019, and related to property, plant and equipment purchases mostly for tools to support international expansion.

Net cash used in our financing activities was approximately $3,150,000 primarily attributable to a $2,500,000 loan repayment related to$1,036,790 and $2,301,560 for the SAB property that was soldnine months ended September 30, 2020 and 2019, respectively. Principal payments on debt were offset by proceeds of debt borrowings in February 2017.both periods.

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, revenues,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: revenue recognition, 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 not effective as of September 30, 2017 due to certain material weaknesses.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a possibility that a material misstatement in our interim financial statements will not be prevented or detected on a timely basis. During the course of our assessment, management identified that the Company has a lack of staffing and appropriate accounting expertise within its accounting department. Management believes the lack of accounting and financial personnel amounts to a material weakness in its internal control over financial reporting and their ability to adequately prepare financial statements and disclosures, and a lack of accounting expertise to appropriately apply GAAP for complex and non-routine transactions. As a result, at September 30, 2017 and on the date of this Report, its internal control over financial reporting is not effective.

To remediate these issues, management has retained the services of additional third party accounting personnel as well as to modify existing disclosure controls and procedures in a manner designed to ensure future compliance.2020.

 

Changes in Internal Controls over Financial Reporting

 

None

 

Internal Controls and Procedures

 

This quarterly report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’ s registered public accounting firm due to a transaction period established by the rules of the Securities and Exchange CommissionSEC for newly public companies. Under these rules, we will not be required to include an attestation report for so for as long as we are an “emerging growtha “smaller reporting company” pursuant to the provisionsas defined in Rule 12b-2 of the JOBSExchange Act.

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PART II

 

Item 1. Legal Proceedings

 

We are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana Lafayette Division asserting Stabil Drill Specialties, LLC (“Stabil Drill”) infringed on our patent that covers the Company’s well bore conditioning tool, the Drill-N-Ream. The lawsuit was subsequently moved from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. The court ordered the Company to serve discovery requests upon Stabil Drill and gave Stabil Drill deadlines to respond and produce documents and permit product inspection. Stabil Drill filed a motion for summary judgement and the Company responded and cross-moved for patent infringement. The parties are awaiting the judge’s decision. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company, filed for bankruptcy, which may result in a delay in the resolution of this litigation. We cannot predict the outcome of this matter, but our legal costs could have a material effect on our financial position or results of operations in future periods. We are not currently involved in any other litigation which management believes could have a material effect on our financial position or results of operations, except as follows:operations.

In October 2013, Del-Rio Resources, Inc. (“Del-Rio”) filed suit, on its own behalf and derivatively on behalf of Philco Exploration, LLC (“Philco”), against the following co-defendants (a) Tronco Ohio, LLC and Tronco, (b) the lender on the Tronco loan, ACF Property Management, Inc. (p.k.a. Fortuna Asset Management, LLC,) (“ACF”), (c) Troy and Annette Meier personally, and several of their family trusts, (d) Meier Family Holding Company, LLC and Meier Management Company, LLC, and (e) SDS and MPS in the Eighth Judicial District Court, Uintah County, Utah Cause #130800125 (the “Suit”). On May 11, 2017, pursuant to a mediation proceeding, all of the plaintiffs and remaining defendants in the Suit executed a Settlement Agreement whereby each of the parties have released all of their claims against the other parties to the Suit without liability effective as of March 22, 2017. Such release includes the Company’s two subsidiaries that were a party to the Suit, SDS and MPS, as well as Troy and Annette Meier personally and all of their family trusts named as defendants in the Suit. As a result of the execution of the Settlement Agreement, a Stipulated Motion for Dismissal with Prejudice was filed with the Court which includes a form of Order of Dismissal with Prejudice (the “Court Order”). On May 15, 2017, the Court Order was executed by the judge and the Suit was formally dismissed with prejudice.

 

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 2019 Annual Report on Form 10-K. The risk factors below updates or expands upon those risk factors.

The outbreak of the recent coronavirus (“COVID-19”) has had, and is expected to continue to have, depending on the duration of the pandemic, a significant impact on our business, financial condition and results of operations due to its effect on the oil and gas industry.

The impact of COVID-19 and measures to prevent its spread are expected to continue to impact our results, operations, cash flows and liquidity.

We expect the impact of these disruptions, including the extent of their adverse impact on our financial and operational results, will be dictated by the length of time that such disruptions continue.

Demand for our products and services is declining as our customers continue to revise their capital budgets downwards and swiftly adjust their operations in response to lower commodity prices. Our customers may not be unable to meet existing payment or other obligations to us. To address the situation, we have been forced to take several actions, including reductions in salaries for officers and fees for independent directors, a reduction in our total workforce and the indefinite postponement of the development of new technology by us and elimination of any activity not necessary to conduct our business. Such a further spread or outbreak could also negatively impact the business and operations of third party service providers who perform critical services for our business

Given the uncertainty around the extent and timing of the potential future spread or mitigation of COVID-19 and around the imposition or relaxation of protective measures, we cannot reasonably estimate the impact on our future results of operations, cash flows or financial condition.

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

 

At December 31, 2016,September 30, 2020, we had working capital of approximately $2.1 million. On September 30, 2016, we priced a public offering of common stock at $1.00 per share. The transaction closed on October 5, 2016. Net of underwriting and stock offering expenses of approximately $709,000, proceeds to the Company were approximately $5.0 million. The Company used the proceeds to pay off a $1 million Bridge Financing completed on August 5, 2016, and the $868,000 indebtedness on our $3 million credit facility with Federal National Commercial Credit (“FNCC”) as well as for general corporate purposes, including working capital. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments.

As amended and restated effective August 10, 2016, the Hard Rock Note accrues interest at 5.75% per annum and matures and is fully payable on January 15, 2020. Under the current terms of Hard Rock Note, and after the payment described below, we are required to make the following remaining payments: equal payments totaling $2,000,000 of principal plus accrued interest on each of January 15, March 15, May 15 and July 15, 2018, and equal principal payments totaling $4,000,000 (plus accrued interest) on each of January 15, March 15, May 15 and July 15, 2019, with the remaining $2,000,000 balance of principal and accrued interest on the Hard Rock Note due on January 15, 2020. During 2017, we made the accrued interest payments related to the note on January 15, 2017, March 15, 2017, May 15, 2017, and July 15, 2017 of $129,808, $74,356, $76,877 and $76,877, respectively.

The Company’s manufacturing facility is financed by a commercial bank loan with principal of $4,200,000 due August 15, 2018 (see Note 7 – Long-Term Debt). The classification of this debt from long-term to short-term resulted in a working capital deficit of approximately $1.8 million at September 30, 2017. The Company plans to work with its lender to refinance its commercial bank loan in the first half of 2018.

$2,600,000. Our principal uses of cash are operating expenses, working capital requirements, capital expenditures and debt service payments. Our operational and financial strategies include lowering our operating costs and capital spending to match revenue trends, accelerating collections of international receivables, and managing our working capital and debt to enhance liquidity. For example, to conserve cash, we implemented a salary for stock options program during the first quarter of 2016 for senior management and our board of directors. With the success we are having with our distributor agreement with DTI and the opportunity with our new CTS tool,

While we believe we should havethat our borrowing capacity and cash generated from operations will be sufficient to fund our operations for the next twelve months, our operational and financial strategies include managing our operating costs, working capital and debt to support our opportunities in 2017.

enhance liquidity. We expectwill continue to be cash flow positive in 2017.work to grow revenue and review additional cost containment measures. 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. In order to make our debt payments in 2018, we may need additional capital to support additional growth. We cannot provide any assurance that financing will be available to us in the future on acceptable terms.

 

Failure to generate sufficient revenueOn May 6, 2020, certain subsidiaries the Company amended and restated the Hard Rock Note with the seller in the acquisition of Hard Rock Solutions, LLC. As amended, the Hard Rock Note accrues interest at 8.00% per annum and matures and is now fully payable on October 5, 2022. Under the amended terms of the Hard Rock Note, we are required to make paymentsthe following payments: accrued interest on each July 5, October 5, January 5, and April 5 in 2021 and 2022; and $750,000 (plus accrued interest) on July 5, 2021 with the remaining balance of principal and accrued interest on the Hard Rock Note could result in our loss of the patents securing such note.

The Hard Rock Note is secured by all of the patents, patents pending, other patent rights, and the Drill-N-Ream trademark purchased in the Hard Rock acquisition (the “Drill-N-Ream Collateral”).due on October 5, 2022. If we do not have the funds necessaryare unable to make the futurepayments required, we could lose our rights to market the Drill-N-Ream.

Our Credit Agreement is comprised of $1,000,000 Term Loan and $3,500,000 Revolving Loan. As of September 30, 2020, we had $749,998 outstanding on the Term Loan and $359,916 outstanding on the Revolving Loan. If we are unable to make required payments under the Hard Rock Note and failCredit Agreement, we would be in default thereunder, which would permit the holders of the indebtedness to make any payments as required thereunder, andaccelerate the maturity thereof, unless we are unsuccessful in amendingable to obtain, on a timely basis, a necessary waiver or restructuringamendment. Any waiver or amendment may require us to revise the terms of the Credit Agreement which could increase the cost of our borrowings, require the payment terms,of additional fees, and adversely impact the holderresults of our operations. Upon the Hard Rock Noteoccurrence of any event of default that is not waived, the lenders could conduct a foreclosure sale onelect to exercise any of their available remedies, which include the Drill-N-Ream Collateralright to not lend any additional amounts or, in orderthe event we have outstanding indebtedness under the Credit Agreement, to applydeclare any outstanding indebtedness, together which any accrued interest and other fees, to be immediately due and payable. If we are unable to repay the proceeds thereof toward repayment ofoutstanding indebtedness, if any, under the Hard Rock Note and all foreclosure costs, and our subsidiary Superior Drilling Solutions, LLCCredit Agreement when due, the lenders would be liable for any shortfall or receive any excess from the sales proceeds. The failurepermitted to retainproceed against their collateral and use the Drill-N-Ream Collateral in our businessthis could cause a significant loss of our investment and might have a material adverse effect on our business and financial condition and results of operation, as well as our ability to grow our drill string tool business.

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

 

As noted above, we are required to make payments on the Hard Rock Note of $2.0 million (plus accrued interest) in 2018 and $4.0 million (plus accrued interest) for 2019, with the balance of $2.0 million due on maturity in January 2020. Interest will continue to accrue on the Hard Rock Note based on the $1,000,000 value of the shares of common stock until such shares are registered. In addition, we are required to make monthly payments of approximately $100,000 on our other indebtedness.

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

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

We have two large customers that currently comprise 96% of our total revenue. It is likely that we will continue to derive a portion of our revenue from a relatively small number of customers in the future. If a major customer decided not to continue to use our services or significantly reduces its drilling plans, or if we are unable to expand our channels to market or further commercialize, our revenue would decline and our operating results and financial condition could be harmed. In addition, we are subject to credit risk due to the concentration of our customer base. Any increase in the nonpayment of and nonperformance by our counterparties, either as a result of changes in financial and economic conditions or otherwise, could have a material effect on our business, results of operations and financial condition and could adversely affect our liquidity.

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*32.1** Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for G. Troy Meier andMeier.**
32.2**Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Christopher D. Cashion.**
   
101.INS * XBRL Instance
   
101.XSD * XBRL Schema
   
101.CAL * XBRL Calculation
   
101.DEF * XBRL Definition
   
101.LAB * XBRL Label
   
101.PRE * XBRL Presentation

 

** 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 9, 20176, 2020By:/s/ G. TROY MEIER
  

G. Troy Meier, Chief Executive Officer

(Principal Executive Officer)

   
November 9, 20176, 2020By:/s/ CHRISTOPHER CASHION
  Christopher Cashion, Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)

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