Item
1. Financial Statements (Unaudited).
Superior
Drilling Products, Inc.
Condensed
Consolidated Balance Sheets (Unaudited)
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Superior
Drilling Products, Inc.
Condensed
Consolidated Statements of Operations (Unaudited)
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Superior
Drilling Products, Inc.
Condensed
Consolidated Statements of Cash Flows (Unaudited)
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Superior
Drilling Products, Inc.
Condensed
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
| |
Common Stock | | |
Additional
Paid-in | | |
Accumulated | | |
Total
Shareholders’ | |
| |
Shares | | |
Par Value | | |
Capital | | |
Deficit | | |
Equity | |
Balance - December 31, 2021 | |
| 28,235,001 | | |
| 28,235 | | |
| 43,071,201 | | |
| (36,951,508 | ) | |
| 6,147,928 | |
Balance | |
| 28,235,001 | | |
| 28,235 | | |
| 43,071,201 | | |
| (36,951,508 | ) | |
| 6,147,928 | |
Share-based compensation expense | |
| - | | |
| - | | |
| 210,133 | | |
| - | | |
| 210,133 | |
Net income | |
| - | | |
| - | | |
| - | | |
| 149,837 | | |
| 149,837 | |
Balance - March 31, 2022 | |
| 28,235,001 | | |
$ | 28,235 | | |
$ | 43,281,334 | | |
$ | (36,801,671 | ) | |
$ | 6,507,898 | |
Balance | |
| 28,235,001 | | |
$ | 28,235 | | |
$ | 43,281,334 | | |
$ | (36,801,671 | ) | |
$ | 6,507,898 | |
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
1.
NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature
of Operations
Superior
Drilling Products, Inc. (the “Company”, “SDPI”, “we”, “our” or “us”) is an
innovative drilling and completion tool technology company providing cost saving solutions that drive production efficiencies for the
oil and natural gas drilling industry. Our drilling solutions include the patented Drill-N-Ream® well bore conditioning tool (“Drill-N-Ream
tool”) and the patented Strider™ Drill String Oscillation System technology (“Strider technology” or “Strider”).
In addition, the Company is a manufacturer and refurbisher of PDC (polycrystalline diamond compact) drill bits for a leading oil field
services company. We operate a state-of-the-art drill tool fabrication facility, where we manufacture solutions for the drilling industry,
as well as customers’ custom products. Our headquarters and manufacturing operations are located in Vernal, Utah.
Our
subsidiaries include (a) Superior Drilling Solutions, LLC (previously known as Superior Drilling Products, LLC), a Utah limited liability
company (“SDS”), together with its wholly owned subsidiary Superior Design and Fabrication, LLC, a Utah limited liability
company (“SDF”), (b) Extreme Technologies, LLC, a Utah limited liability company (“ET”), (c) Meier Properties
Series, LLC, a Utah limited liability company (“MPS”), (d) Meier Leasing, LLC, a Utah limited liability company (“ML”),
and (e) Hard Rock Solutions, LLC (“HR” or “Hard Rock”).
Basis
of Presentation
The
Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted
in the United States of America (“GAAP”). The condensed 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.
These
condensed consolidated financial statements for the three months ended March 31, 2023 and 2022, and the related footnote disclosures
included herein, are unaudited. The preparation of financial statements in conformity with GAAP requires the use of management’s
estimates. The results of operations for the three months ended March 31, 2023 are not necessarily indicative of the results of operations
expected for the year ended December 31, 2023. These condensed consolidated financial statements should be read in conjunction with the
audited consolidated financial statements of the Company for the years ended December 31, 2022 and 2021 and the notes thereto, which
were included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, filed with the Securities and Exchange
Commission (the “SEC”).
Significant
Accounting Policies
The
Company’s accounting policies are set forth in Note 1 – Summary of Significant Accounting Policies of the Notes to Consolidated
Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC. There
were no significant updates or revisions to our accounting policies during the three months ended March 31, 2023.
Concentrations
of Credit Risk
The
Company has two significant customers that represented 87% and 90% of its revenue for the three months ended March 31, 2023 and 2022,
respectively. These customers had approximately $1,880,000 and $1,751,000 in accounts receivable as of March 31, 2023 and December 31,
2022, respectively.
The
Company had two vendors that represented 13% of its purchases for each of the three months ended March 31, 2023 and 2002, respectively.
These vendors had approximately $354,000 and $136,000 in accounts payable as of March 31, 2023 and December 31, 2022, respectively.
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
2.
REVENUE
Disaggregation
of Revenue
The
following table presents revenue disaggregated by type:
SCHEDULE OF REVENUE DISAGGREGATED BY REVENUE
| |
2023 | | |
2022 | |
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Tool revenue: | |
| | | |
| | |
Tool and product sales | |
$ | 1,537,380 | | |
$ | 664,300 | |
Tool rental | |
| 806,153 | | |
| 385,150 | |
Other related revenue | |
| 1,910,676 | | |
| 1,719,797 | |
Total tool revenue | |
| 4,254,209 | | |
| 2,769,247 | |
Contract services | |
| 2,027,005 | | |
| 1,360,917 | |
Total revenue | |
$ | 6,281,214 | | |
$ | 4,130,164 | |
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.
Contract
Costs
We
did not incur any material costs of obtaining contracts.
3.
INVENTORIES
Inventories
were comprised of the following:
SCHEDULE
OF INVENTORIES
| |
March 31, | | |
December 31, | |
| |
2023 | | |
2022 | |
Raw material | |
$ | 1,156,935 | | |
$ | 1,334,669 | |
Work in progress | |
| 478,906 | | |
| 168,214 | |
Finished goods | |
| 613,020 | | |
| 578,377 | |
Total inventories | |
$ | 2,248,861 | | |
$ | 2,081,260 | |
4.
PROPERTY, PLANT & EQUIPMENT
Property,
plant and equipment was comprised of the following:
SCHEDULE
OF PROPERTY, PLANT AND EQUIPMENT
| |
March 31, | | |
December 31, | |
| |
2023 | | |
2022 | |
Land | |
$ | 880,416 | | |
$ | 880,416 | |
Buildings | |
| 4,764,441 | | |
| 4,764,441 | |
Leasehold improvements | |
| 755,039 | | |
| 755,039 | |
Machinery, equipment, and rental tools | |
| 16,494,647 | | |
| 14,546,060 | |
Office equipment, fixtures and software | |
| 628,358 | | |
| 628,358 | |
Transportation assets | |
| 265,760 | | |
| 265,760 | |
Property, plant and equipment, gross | |
| 23,788,661 | | |
| 21,840,074 | |
Accumulated depreciation | |
| (13,547,569 | ) | |
| (13,263,223 | ) |
Total property, plant and equipment, net | |
$ | 10,241,092 | | |
$ | 8,576,851 | |
Depreciation
expense related to property, plant and equipment for the three months ended March 31, 2023 and 2022 was $284,347 and $369,066 respectively.
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
5.
INTANGIBLE ASSETS
Intangible
assets were comprised of the following:
SCHEDULE
OF INTANGIBLE ASSETS
| |
March 31, | | |
December 31, | |
| |
2023 | | |
2022 | |
Developed technology | |
$ | 7,000,000 | | |
$ | 7,000,000 | |
Customer contracts | |
| 6,400,000 | | |
| 6,400,000 | |
Trademarks | |
| 1,500,000 | | |
| 1,500,000 | |
Total intangible assets, gross | |
| 1,500,000 | | |
| 1,500,000 | |
Less: accumulated amortization | |
| (14,872,222 | ) | |
| (14,830,556 | ) |
Total intangible assets, net | |
$ | 27,778 | | |
$ | 69,444 | |
Amortization
expense related to intangible assets for the three months ended March 31, 2023 and 2022 was $41,667 and $41,667, respectively.
6.
RELATED PARTY RECEIVABLE
In
January 2014, we entered into a Note Purchase and Sale Agreement under which we agreed to purchase a loan made to Tronco Energy Corporation
in order to take over the legal position as Tronco’s senior secured lender. Tronco is an entity owned by Troy and Annette Meier.
Effective August 2017, the Company fully reserved the related party note receivable of $6,979,043, which reduced the related party note
receivable balance to $0. The Company holds 8,267,860 shares of the Company’s common stock as collateral. The Company will record
a recovery of the loan upon receiving repayment of the note or interest in other income.
On
March 31, 2023, the Company entered into a fourth amended and restated loan agreement and note with Tronco to extend the maturity date
of the principal to March 31, 2033. As amended, the interest rate on the note is fixed at 2.8% per annum and provides for principal and
accrued interest payments in the amount of $750,000 annually on March 31, 2024 through 2032, with the balance of all remaining outstanding
principal and accrued interest due on March 31, 2033. In the event the average closing price for the Company’s common stock for
10 consecutive trading days is equal to or greater than $3.00 per share, Tronco shall pay fifty percent of the then outstanding principal
balance together with all accrued, unpaid interest within ten days of the date on which the 10-day trading average first equals or exceeds
$3.00. In the event the average closing price for 10 consecutive trading days is $4.00 per share or greater, Tronco shall pay the entire
outstanding principal balance together with all accrued, unpaid interest within ten (10) days of the date on which the 10-day average
first equals or exceeds $4.00. In addition, in the event of a sale of all or substantially all of the assets or a controlling equity
interest in the Company, Tronco and the Meiers must utilize the proceeds received from such sale to pay the entire outstanding principal
balance on the note receivable together with all accrued, unpaid interest. On March 24, 2023, there was a principal and interest payment
of $350,262 which was reflected as a recovery of related party note receivable in other income and expense on the Condensed Consolidated
Statement of Operations. The Tronco note balance, including accrued interest, was approximately $6,567,000 and $6,884,000 as of March
31, 2023 and December 31, 2022, respectively.
7.
LONG-TERM DEBT
Long-term
debt is comprised of the following:
SCHEDULE
OF DEBT OBLIGATIONS
| |
March 31, | | |
December 31, | |
| |
2023 | | |
2022 | |
Credit Agreement | |
$ | 1,000,466 | | |
$ | 813,713 | |
Machinery loans | |
| 629,866 | | |
| 664,674 | |
Transportation loan | |
| 16,850 | | |
| 20,027 | |
Insurance loan | |
| - | | |
| 156,949 | |
Total long-term debt | |
| 1,647,182 | | |
| 1,655,363 | |
Less: current portion of long-term debt, net of discounts | |
| (1,157,879 | ) | |
| (1,125,864 | ) |
Total long-term debt, less current portion, net of discounts | |
$ | 489,303 | | |
$ | 529,499 | |
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
Credit
Agreement
In
February 2019, the Company entered into a Loan and Security Agreement (the “Credit Agreement”) with Austin Financial Services,
Inc. (“AFS”). The Credit Agreement provides a $4,300,000 credit facility, which includes a $800,000 term loan (the “Term
Loan”) and a $3,500,000 line of credit (the “Line of Credit”). The Credit Agreement originally was to mature on February
20, 2023, subject to early termination pursuant to the terms of the agreement or extension as may be agreed by the parties, but it has
been renewed to February 20, 2024. Cancellation is allowed with a 60-day notice. The balance of the Credit Agreement totaled approximately
$1,001,000 and $814,000 as of March 31, 2023 and December 31, 2022, respectively.
Amounts
outstanding under the Line of Credit 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. As of March 31, 2023, the Company had approximately $101,000 of availability under the Line of Credit.
The
interest rate for the Term Loan and the Line of Credit is prime plus 2%. At March 31, 2023, the interest rate for the Line of Credit
was 13.60%, which includes a 3.6% management fee rate. Even if our borrowings under the Line of Credit are less than $1,000,000, we still
pay interest as if we had borrowed $1,000,000. The obligations of the Company under the Credit Agreement are secured by a security interest
in substantially all of the tangible and intangible assets of the Company, other than any assets owned by the Company that constitute
real property (and fixtures affixed to such real property), certain excluded equipment or intellectual property. A collateral management
fee is payable monthly on the used portion of the Line of Credit and Term Loan.
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 Line of Credit is classified
as current debt as a result of the required lockbox arrangement and the subjective acceleration clause. At March 31, 2023, we were in
compliance with the covenants in the Credit Agreement.
Machinery
Loans
The
Company financed the purchase of machinery and equipment through various loans. The outstanding loans have interest rates ranging from
5.50% to 5.94%, and repayment terms of 48-60 months. The balance of the machinery loans totaled approximately $630,000 and $665,000 as
of March 31, 2023 and December 31, 2022, respectively.
Transportation
Loan
The
Company financed the purchase of a vehicle with a loan agreement. The term of the loan is 60 months and matures in June 2024. The interest
rate of the loan is 6.99%. The loan is collateralized by the vehicle.
Insurance
Loan
In
June 2022, the Company financed insurance premiums with a loan agreement. In September 2022, an additional insurance amount was added
to the loan. The balance of the insurance loan totaled $156,949 as of December 31, 2022. The insurance loan was fully repaid in March
2023.
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
8.
FINANCING OBLIGATION LIABILITY
On
December 7, 2020, the Company entered into an agreement to sell land and property related to the Company’s headquarters and manufacturing
facility in Vernal, Utah (the “Property”) for a purchase price of $4,448,500 (the “Sale Agreement”). Concurrent
with the sale of the Property, the Company entered into a fifteen-year lease agreement (the “Lease Agreement”) to lease back
the Property at an annual rate of $311,395 with payments made monthly, subject to annual rent increases of 1.5%. Under the Lease Agreement,
the Company has an option to extend the term of the lease and to repurchase the Property. Due to this repurchase option, the Company
was unable to account for the transfer as a sale under ASC 842, Leases, and as such, the transaction is a failed sale-leaseback
that is accounted for as a financing transaction.
The
Company received cash of $1,622,106, retired real estate debt of $2,638,773 and recorded a financing obligation liability of $4,260,879
related to the transaction. There was no gain recorded since sale accounting was precluded. The financing obligation has an implied interest
rate of 6.0%. At the conclusion of the fifteen-year lease period, the financing obligation residual is estimated to be $2,188,710, which
corresponds to the carrying value of the property. The Company paid $18,971 and $16,796 of principal during the three months ended March
31, 2023 and 2022, respectively.
The
financing obligation liability is summarized below:
SCHEDULE
OF FINANCING OBLIGATION LIABILITY
| |
March 31, | | |
December 31, | |
| |
2023 | | |
2022 | |
Financing obligation for sale-leaseback transaction | |
$ | 4,093,686 | | |
$ | 4,112,658 | |
Current principal portion of finance obligation | |
| (76,406 | ) | |
| (74,636 | ) |
Non-current portion of financing obligation | |
$ | 4,017,280 | | |
$ | 4,038,022 | |
9.
COMMITMENTS AND CONTINGENCIES
We
are subject to litigation that arises from time to time in the ordinary course of our business activities. In February 2019, the Company
filed a patent infringement lawsuit in the United States District Court for the Western District of Louisiana, Lafayette Division, asserting
that Stabil Drill Specialties, LLC’s (“Stabil Drill”) Smoothbore Eccentric Reamer infringes the patents of Extreme
Technologies, LLC (one of our subsidiaries) on our patented Drill-N-Ream well bore conditioning tool. The lawsuit was subsequently moved
from Louisiana to the United States District Court for the Southern District of Texas, Houston Division. Additionally, on May 20, 2019,
Extreme Technologies, LLC sued Short Bit & Tool Co. and Lot William Short, Jr. (“Defendants”) in the Northern District
of Texas-Dallas Division for their work manufacturing the Smoothbore Eccentric Reamer for Stabil Drill. The Dallas lawsuit is stayed
pending resolution of the first-filed, Houston suit. On October 1, 2020, Superior Energy Services, Stabil Drill’s parent company,
filed for bankruptcy, which resulted in a brief, automatic stay of the litigation. Superior Energy Services announced on February 2,
2021, that it successfully completed its financial restructuring and emerged from Chapter 11 bankruptcy, but this bankruptcy did not
affect Extreme Technologies’ claims against Stabil Drill. On March 9, 2021, the Court lifted the automatic bankruptcy stay, and
on May 12, 2021, the Court denied Stabil Drill’s motion for summary judgment of non-infringement. On May 23, 2022, the Court issued
its Order on Claim Construction of the patents, adopting Extreme Technologies’ proffered interpretation on the disputed claim terms.
On February 13, 2023, the lawsuit was reassigned to United States District Judge Drew B. Tipton and United States Magistrate Judge Peter
Bray. On March 27, 2023, Magistrate Bray entered an amended Scheduling Order. In accordance with such amended Scheduling Order, fact
discovery ended on April 14, 2023, and expert discovery is scheduled to end on or before June 8, 2023. The parties are preparing this
case for trial and expect a jury trial setting during the fall or early winter of 2023.
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.
10.
EARNINGS PER SHARE
Basic
and diluted earnings per share of common stock have been computed as follows:
SCHEDULE
OF BASIC AND DILUTED EARNINGS PER SHARE
| |
2023 | | |
2022 | |
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Numerator: | |
| | |
| |
Net income | |
$ | 1,513,219 | | |
$ | 149,837 | |
Denominator: | |
| | | |
| | |
Weighted average shares of common stock outstanding - basic | |
| 29,245,080 | | |
| 28,235,001 | |
Effect of dilutive options | |
| 60,136 | | |
| 70,100 | |
Weighted average shares of common stock outstanding - diluted | |
| 29,305,216 | | |
| 28,305,101 | |
| |
| | | |
| | |
Earnings per common share - basic | |
$ | 0.05 | | |
$ | 0.01 | |
Earnings per common share - diluted | |
$ | 0.05 | | |
$ | 0.01 | |
Superior Drilling Products, Inc. Notes to Condensed Consolidated Financial Statements (Unaudited) |
11.
LEASES
The
Company leases certain facilities Utah and Dubai under long-term operating leases with lease terms of one year to two years. The operating
lease expense was approximately $62,748 and $1,800 for the three months ended March 31, 2023 and 2022, respectively.
Other
information related to operating leases:
SCHEDULE OF OTHER INFORMATION RELATED TO OPERATING LEASE
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Cash paid for amounts included in the measurement of lease liabilities: | |
| | | |
| | |
Operating cash flows | |
$ | 54,138 | | |
$ | 38,559 | |
Weighted average remaining lease-term (in years) | |
| 2.7 | | |
| .75 | |
Weighted average discount rate | |
| 7.25 | % | |
| 7.25 | % |
12.
SEGMENT REPORTING
We
report our segment results based on our geographic areas of operations, North America and International. These segments have similarities
from a product perspective, but management believes that due to operational differences, such as sales models and regulatory environments,
information about the segments would be useful to readers of the financial statements.
|
● |
North
America includes our PDC drill bit and specialty tool sales and contract services business in the United States and Mexico, which
have been aggregated |
|
● |
International
includes our specialty tool rental business in the Middle East |
Revenues
and certain operating expenses are directly attributable to our segments.
Unallocated
corporate costs primarily include corporate shared costs, such as payroll and compensation, professional fees, and rent, as well as costs
associated with certain shared research and development activities.
Our
operating segments are not evaluated using asset information. Prior periods have been restated to conform with the current year presentation.
This change was made due to international revenue becoming more significant in the current year.
The
following table summarizes information about our segments:
SCHEDULE
OF SEGMENTS INFORMATION WITH GEOGRAPHIC AREAS
| |
2023 | | |
2022 | |
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Revenues: | |
| | |
| |
North America | |
$ | 5,475,061 | | |
$ | 3,745,014 | |
International | |
| 806,153 | | |
| 385,150 | |
Total revenue | |
$ | 6,281,214 | | |
$ | 4,130,164 | |
| |
| | | |
| | |
Operating income: | |
| | | |
| | |
North America | |
$ | 3,605,959 | | |
$ | 2,096,321 | |
International | |
| 109,810 | | |
| (144,871 | ) |
Corporate costs, unallocated | |
| (2,338,007 | ) | |
| (1,646,565 | ) |
Total operating income | |
$ | 1,377,762 | | |
$ | 304,885 | |
North
America revenue includes revenue from operations in Mexico totaling approximately $15,000 and $18,000 for the three months ended March
31, 2023 and 2022, respectively. The remainder of the North America revenue was derived from operations in the United States of America.
Information
about products and services
See
Note 2 – Revenue.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Superior
Drilling Products, Inc. is an innovative drilling and completion tool technology company providing cost saving solutions that drive production
efficiencies for the oil and natural gas drilling industry. Our 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 is a manufacturer of Drill-N-Ream tools and refurbisher of PDC (polycrystalline diamond compact) drill bits for a leading oil
field services company. We operate a state-of-the-art drill tool fabrication facility, where we manufacture solutions for the drilling
industry, as well as customers’ custom products.
Our
strategy for growth is to leverage our expertise in drill tool technology and precision machining in order to broaden our product offerings
and solutions for the oil and gas industry. We believe through our patented technologies, as well as technologies under development,
that we can offer the oil and gas industry the solutions it demands to improve drilling efficiencies and reduce production costs.
In
December 2020, the Company successfully obtained ISO 9000 certification and is now qualified to bid on projects in industries outside
oil and gas. We believe that with this certification, and our history of supplying high quality parts to research and development departments
operating in the aerospace industry, we can effectively execute our industry diversification strategy.
Industry
Trends and Market Factors
The
Russia – Ukraine conflict is a global concern. The Company does not have any direct exposure to Russia or Ukraine through its operations,
employee base, investments or sanctions. The Company does not receive goods or services sourced from those countries, does not anticipate
any disruption in its supply chain and has no business relationships, connections to or assets in Russia, Belarus or Ukraine. No impairments
to assets have been made due to the conflict. The global oil industry has been impacted by this situation, but the Company’s operations
and business in the Middle East has not been disrupted to date. The increase in oil producing activities in the United States has benefitted
the Company’s operations. We are unable at this time to know the full ramifications of the Russia – Ukraine conflict and
its effects on our business.
Inflationary
and/or recessionary factors relating to the oil and gas industry may directly affect the Company’s operations. The increased demand
for oil and gas production has benefited the Company’s operations. The Company is not immune to the effects of inflation on its
labor requirements, supply chain and costs of revenues. The Company continues to monitor these economic trends as part of its strategic
forward planning.
The
total U.S. rig count as reported by Baker Hughes as of March 31, 2023 was 755 rigs, an increase of 105 rigs from the rig count as of
March 31, 2022.
The
Middle East market began to improve during 2022 after a slow rebound from the COVID-19 impact. Total rig count in that region as of March
31, 2023 was 323 compared with 303 at the same time last year.
How
We Generate our Revenue
We
are a drilling and completion tool technology company. We generate revenue from the refurbishment, manufacturing, repair, rental and
sale of drill string tools. Our manufactured products are produced in a standard manufacturing operation, even when produced to our customer’s
specifications. We also earn royalty fees under certain arrangements for certain tools we sell.
Tool
sales, rentals and other related 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: Rental revenue is recognized upon completion of the customer’s job for which the tool was rented. While the duration
of the rental will vary by job and number of runs, these rentals 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 of the product. Shipping and handling costs related to refurbishing services are paid directly by the
customer at the time of shipment. We also provide contracting manufacturing services to customers.
Costs
of Conducting Our Business
Cost
of revenue is comprised of direct and indirect costs to manufacture, repair and supply our products, including labor, materials, utilities,
equipment repair, lease expense related to our facilities, supplies and freight.
Selling,
general and administrative expense is comprised of costs such as new business development, technical product support, research and development
costs, compensation expense for general corporate operations including accounting, human resources, risk management, etc., information
technology expenses, safety and environmental expenses, legal and professional fees and other related administrative functions.
Other
income (expense), net is comprised primarily of interest expense and recovery of a fully reserved related party note receivable.
Results
of Operations
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Revenue | |
| | |
| | |
| | |
| |
Tool revenue | |
$ | 4,254,209 | | |
| 68 | % | |
$ | 2,769,247 | | |
| 67 | % |
Contract services | |
| 2,027,005 | | |
| 32 | % | |
| 1,360,917 | | |
| 33 | % |
Total revenue | |
| 6,281,214 | | |
| 100 | % | |
| 4,130,164 | | |
| 100 | % |
Operating cost and expenses | |
| | | |
| | | |
| | | |
| | |
Cost of revenue | |
| 2,238,597 | | |
| 36 | % | |
| 1,767,903 | | |
| 43 | % |
Selling, general, and administrative expenses | |
| 2,338,841 | | |
| 37 | % | |
| 1,646,643 | | |
| 40 | % |
Depreciation and amortization expense | |
| 326,014 | | |
| 5 | % | |
| 410,733 | | |
| 10 | % |
Total operating cost and expenses | |
| 4,903,452 | | |
| 78 | % | |
| 3,825,279 | | |
| 93 | % |
Operating income | |
| 1,377,762 | | |
| 22 | % | |
| 304,885 | | |
| 7 | % |
Other income (expense) | |
| 213,069 | | |
| 3 | % | |
| (123,664 | ) | |
| -3 | % |
Income before income taxes | |
| 1,590,831 | | |
| 25 | % | |
| 181,221 | | |
| 4 | % |
Income tax expense | |
| (77,612 | ) | |
| -1 | % | |
| (31,384 | ) | |
| -1 | % |
Net income | |
$ | 1,513,219 | | |
| 24 | % | |
$ | 149,837 | | |
| 4 | % |
Comparison
of the Three Months Ended March 31, 2023 and 2022
Revenue
Our
revenue increased approximately $2,151,000, or 52%, for the three months ended March 31, 2023 compared with the same period in the prior
year. The increase was driven by approximately $1,485,000, or 54%, increase in tool revenue compared to the prior year reflecting the
strong market share of our patented Drill-N-ReamTM well bore conditioning tool (“Drill-N-Ream tool” or “DNR”)
in the U.S. and expansion of our business in the Middle East which contributed approximately $420,000 of the increase in tool revenue.
Contract services revenue increased by $666,000, or 49%, over the prior year, primarily due to expansion of services for our major customer
and increased activity in the oil and gas industry.
Operating
Costs and Expenses
Cost
of Revenue
Cost
of revenue increased approximately $471,000, or 27%, for the three months ended March 31, 2023 compared with the same period in the prior
year. The increase was driven by higher sales volume, consistent with the 52% increase in revenue compared with the prior year. Cost savings were realized due to a better product mix and efficiencies
in manufacturing. International cost of revenue increased 59% in 2023 due
to higher payroll costs, additional facility expenses and higher tool repair costs associated with the increase in revenue.
Selling,
general and administrative expenses
Selling,
general and administrative expenses increased approximately $692,000, or 42%, for the three months ended March 31, 2023 compared with
the same period in the prior year. The increase was the result of increased payroll costs primarily attributable to reinstatement of
executive management salaries and increased legal fees.
Depreciation
and amortization expenses
Depreciation
and amortization expenses decreased approximately $85,000 or 21%, for the three months ended March 31, 2023 compared with the same period
in the prior year. The decrease was primarily due to a portion of the intellectual property intangible balance that reached its full
amortization.
Other
Income (Expenses)
Interest
Income
Interest
income increased to approximately $17,000 for the three months ended March 31, 2023 compared with approximately $200 for the same period
in the prior year. The increase was due to an increase in interest rates earned on the cash balance held in interest bearing accounts.
Interest
Expense
Interest
expense increased approximately $30,000, or 24%, for the three months ended March 31, 2023 compared with the same period in the prior
year. The increase was due primarily to an increase in interest rates and an increase in customer quick-pay options.
Recovery
of related party note receivable
Recovery
of related party note receivable increased approximately $350,000, or 100%, for the three months ended March 31, 2023 compared with the
same period in the prior year. The increase was due to a principal and interest payment applied to a fully reserved related party note
receivable. There was no such payment during the three months ended March 31, 2022. See Note 6 – Related Party Receivable of the
notes to condensed consolidated financial statements within this Quarterly Report on Form 10-Q.
Liquidity
and Capital Resources
At
March 31, 2023, we had working capital of approximately $4,514,000. Our principal uses of cash are operating expenses, working capital
requirements, capital expenditures and debt service payments. Our operational and financial strategies include managing our operating
costs and capital spending to reflect revenue trends, accelerating collections of international receivables, and controlling our working
capital and debt to enhance liquidity.
Credit
Agreement
We
have a Loan and Security Agreement with Austin Financial Services, Inc. (“AFS”) (the “Credit Agreement”). The
Credit Agreement provides a $4,300,000 credit facility, which includes a $800,000 term loan (the “Term Loan”) and a $3,500,000
line of credit (the “Line of Credit”). The Credit Agreement originally was to mature on February 20, 2023, subject to early
termination pursuant to the terms of the agreement or extension as may be agreed by the parties, but it has been renewed to February
20, 2024. Cancellation is allowed with a 60-day notice.
For
more details of the terms of the Credit Agreement, see Note 7 – Long-Term Debt of the notes to condensed consolidated financial
statements within this Quarterly Report on Form 10-Q.
Financing
Obligation Liability
We
have a financing obligation liability related to a failed sale-leaseback transaction. The balance of the financing obligation was approximately
$4,094,000 as of March 31, 2023.
For
more details on the terms of this transaction, see Note 8 – Financing Obligation Liability of the notes to condensed consolidated
financial statements within this Quarterly Report on Form 10-Q.
Machinery
Loans
The
Company financed the purchase of machinery and equipment in July 2022. The term of the loan is 60 months and matures in July 2027. The
loan has an interest rate of 5.50%. The balance of the machinery loans totaled approximately $630,000 as of March 31, 2023.
Cash
Flow
| |
Three Months Ended March 31, | |
| |
2023 | | |
2022 | |
Net cash provided by operating activities | |
$ | 1,045,380 | | |
$ | 1,083,106 | |
Net cash used in investing activities | |
| (1,217,262 | ) | |
| (919,127 | ) |
Net cash used in financing activities | |
| (30,240 | ) | |
| (131,986 | ) |
Net (decrease) increase in cash | |
$ | (202,122 | ) | |
$ | 31,993 | |
Operating
Cash Flows
For
the three months ended March 31, 2023, net cash provided by operating activities was approximately $1,045,000. The Company had approximately
$1,513,000 of net income, $608,000 of non-cash expenses, offset by $1,075,000 decrease in working capital accounts.
For
the three months ended March 31, 2022, net cash provided by operating activities was approximately $1,083,000. The Company had approximately
$150,000 of net income, approximately $621,000 of non-cash expenses and $312,000 increase in working capital accounts.
Investing
Cash Flows
For
the three months ended March 31, 2023, net cash used in investing activities was approximately $1,217,000, primarily related to
purchases of property, plant and equipment, offset by approximately $350,000 related to proceeds from recovery of the Tronco note receivable. The investment in property, plant and equipment will increase the DNR rental fleet and
expand capacity for all manufacturing capabilities. This will allow the company to add new customers, increase volumes, and grow in
potential new product lines.
For
the three months ended March 31, 2022, net cash used in investing activities was approximately $919,000, related to purchases of property,
plant and equipment.
Financing
Cash Flows
For
the three months ended March 31, 2023, net cash used in financing activities was approximately $30,000, primarily related to principal
payments on debt of approximately $214,000, offset by net proceeds from the revolving loan of approximately $184,000.
For
the three months ended March 31, 2022, net cash used in financing activities was approximately $132,000, primarily related to principal
payments on debt of approximately $132,000.
Off
Balance Sheet Arrangements
The
Company had no off balance sheet arrangements.
Critical
Accounting Policies and Estimates
There
have been no significant changes to our critical accounting policies and estimates from those disclosed on our Annual Report on Form
10-K for the year ended December 31, 2022. Please refer to information regarding our critical accounting policies and estimates included
in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on
Form 10-K for the or the year ended December 31, 2022.