SUPERIOR DRILLING PRODUCTS, INC. 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 ofSeptember 30, 2021 , and our results of operations for the three and nine months endedSeptember 30, 2021 and 2020. 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 endedDecember 31, 2020 and 2019, which were included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 , which was filed with theSecurities 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 toSuperior Drilling Products, Inc. and all of its subsidiaries.
Forward- Looking Statements
This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Statements contained in all parts of this document that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control of the Company. You can identify the Company's forward-looking statements by the words "anticipate," "estimate," "expect," "may," "project," "believe" and similar expressions, or by the Company's discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurances can be given that these expectations will prove to be correct. These forward-looking statements include the following types of information and statements as they relate to the Company:
? future operations, financial results, business plans, cash flow and cash
requirements;
? scheduled, budgeted and other future capital expenditures;
? working capital requirements;
? the availability of expected sources of liquidity;
? the introduction into the market of the Company's future products;
? the market for the Company's existing and future products;
? the opportunity to diversify the markets served by the Company or products
provided within the existing oil and gas industry as a result of receiving the
ISO-9001 certification;
? 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 costsassociated with environmentally related penalties, capital expenditures,
remedial actions and proceedings;
? effects of potential legal proceedings; and
? changes in customers' future product and service requirements that may not be
cost effective or within the Company's capabilities.
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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 endedDecember 31, 2020 and the following: ? 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 ability to develop and commercialize new and/or innovative drilling and
completion tool technologies;
? our ability to diversify products/services provided to customers and markets
in which we operate;
? the continued 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;
? 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
regulatory actions and political unrest in other countries;
? the potential impact of major health crises on our business and results of
operations;
? terrorist threats or acts, war and civil disturbances;
? our ability to protect our intellectual property;
? impact of environmental matters, including future environmental regulations;
? implementing and complying with safety policies;
? breaches of security in our information systems and other cybersecurity risks;
? related party transactions with our founders; and ? risks associated with our common stock. 16
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. Executive Summary
We innovate, design, engineer, manufacture, sell, and repair drilling and
completion tools in
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.
Our strategy for growth is to expand the global market penetration of our
current drilling tool solutions and to leverage our expertise in drilling tool
technologies and precision machining in order to broaden our product offerings
and solutions for the oil and gas industry, as well as other industries that
require precision machining and quality. We believe through our patented
technologies, as well as technologies under development, that we can offer the
oil and gas industry the solutions it demands to improve drilling efficiencies
and reduce production costs.
Recent Developments and Trends
The COVID-19 pandemic has caused and continues to cause disruption to theU.S. and global economies, including the impact of government and company actions to reduce the spread of the virus and consumer behavior in response to the same; and, althoughthe United States and other countries have continued to roll out vaccinations, it is uncertain how quickly and effectively such vaccinations will be distributed or help to control the spread of COVID-19 and its variants. We continue to actively monitor the impacts and potential impacts of the COVID-19 pandemic in all aspects of our business. Although we are unable to predict the total impact of the COVID-19 pandemic on our business, results of operations, liquidity or capital resources at this time, we expect we may be negatively affected if the pandemic and related public health measures result in substantial manufacturing or supply chain problems, disruptions in local and global future economies, volatility in the global financial markets, overall reductions in demand, delays in payment, restrictions on the shipment of our products, or other ramifications. Currently we are experiencing raw material delays and difficulties in hiring and retaining direct laborers. These current conditions are a result of COVID-19. The totalU.S. rig count as reported byBaker Hughes as ofOctober 29, 2021 was 544 rigs, an increase of 248 rigs from a year ago, as well as an increase of 150 rigs from the rig count as ofDecember 31, 2020 . We expect North American onshore activity to continue to improve in 2021 and into 2022 compared with
the fourth quarter of 2020. TheMiddle East market is a softer market due to the COVID-19 impact. Although this segment of our business is rebounding, the improvements are at a slower rate compared to the Company's domestic market.
CONSOLIDATED RESULTS OF OPERATIONS
Three and Nine Months Ended
The following table represents summary consolidated operating results for the
periods indicated:
Three-Months Ended September 30, Nine-Months Ended September 30,
(in thousands) 2021 2020 2021 2020Tool revenue 2,346 66 % 1,191 77 % 6,284 67 % 6,147 69 % Contract services 1,216 34 % 356 23 % 3,102 33 % 2,782 31 % Revenue$ 3,562 100 %$ 1,547 100 % 9,386 100 % 8,929 100 % Operating costs and expenses 3,399 95 % 3,094 200 % 10,063 107 % 11,307 127 % Operating income (loss) 163 5 % (1,546 ) (100 )% (677 ) (7 )% (2,378 ) (27 )% Other expense (130 ) (4 )% (85 ) (5 )% (415 ) (4 )% (291 ) (3 )% Income tax expense (39 ) (1 )% (100 ) (6 )%
(83 ) (1 )% (106 ) (1 )%
Net income (loss)
(1,175 ) (12 )% (2,775 ) (31 )%
Material changes of certain items in our statements of operations included in our financial statements for the comparative periods are discussed below. Comparisons are to the prior-year period unless stated otherwise.
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Three Months Ended
Revenue. Our revenue increased approximately$2,014,000 or 130%. Tool revenue increased$1,155,000 or 97% from the prior-year period while contract services increased$859,000 or 241%. The increase in revenue was due to increased demand from continued growth in the number of end users and percentage of rigs using our Drill-N-Ream tool combined with an improvement in market conditions and increased drilling activity.
Operating Costs and Expenses. Total operating costs and expenses increased
approximately
? Cost of revenue increased approximately
a percentage of revenue, cost of revenue was 40% and 56% of revenue for
the three months ended September 30, 2021 and 2020, respectively. Thedecline in the cost of revenue as a percent of revenue was the result of
strong operating leverage from higher volume.
? Selling, general and administrative expenses increased approximately
? Depreciation and amortization expense decreased approximately
41%, to
a portion of the Company's intangible assets and fully depreciating
manufacturing center equipment.
Other Expense. Other expense primarily consists of interest expense and interest income.
? Interest expense for the three months ended
was approximately $130,000 and $126,000 , respectively.
Income Tax Expense. The decrease in income tax expense from the prior year is due to a year-to-date foreign income tax adjustment in 2020.
Nine Months Ended
Revenue. Our revenue increased approximately
Operating Costs and Expenses. Total operating costs and expenses decreased
approximately
? Cost of revenue decreased approximately $444,000 due to reduced costsresulting from the Company's reduction in force implemented throughout
2020. As a percentage of revenue, cost of revenue was 41% and 48% of
revenue for the nine months ended September 30, 2021 and 2020,
respectively.
? Selling, general and administrative expenses decreased approximately
prior-year period. The decline in expenses was due to cost reduction
measures implemented in 2020 in response to the impact on demand resulting
from the rapid decline in the oil & gas industry due to the global
COVID-19 pandemic.
? Depreciation and amortization expense decreased approximately
21%, to $1,681,000 . The decrease was primarily a result of fully
amortizing a portion of the Company's intangible assets and fully
depreciating manufacturing center equipment.
Other Expense. Other expense primarily consists of interest expense, interest income, and gain/loss on sale of assets.
? Interest expense for the nine months ended
approximately
? The Company recorded a loss of approximately
during the nine months ended September 30, 2021 . The Company sold its
airplane in February 2020 for a gain of approximately $142,000 .
Income Tax Expense. The decrease in income tax expense from the prior year is due to a foreign income tax adjustments in 2020.
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Liquidity and Capital Resources
AtSeptember 30, 2021 , we had working capital of approximately$1,500,000 . 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 match revenue trends, accelerating collections of international receivables, and managing our working capital and debt to enhance liquidity. If we are unable to continue generating positive cash flow, 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. However, onOctober 19, 2021 , the Company completed an equity offering of 1,739,131 shares of our common stock to certain institutional investors, at a purchase price of$1.15 per share. The Company paid approximately$261,000 in total offering costs. Net proceeds from the equity offering were approximately$1,700,000 . In addition, the significant decline in demand for oil due to the impacts of COVID-19 on the global economy, 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 may continue to be impacted in 2021 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 minimal planned capital expenditures for the remainder of
2021 of$600,000 .
The Hard Rock Note had a remaining balance of$750,000 as ofSeptember 30, 2021 . It accrues interest at 8.00% per annum and is due in full byOctober 5, 2022 . InOctober 2021 , the Company made a payment of$15,123 related to accrued interest. Under the amended terms of the Hard Rock Note, we are required to make the following payments: accrued interest onJanuary 5 ,April 5 ,July 5 andOctober 5 in 2022; with the remaining balance of principal and accrued interest on the Hard Rock Note due onOctober 5, 2022 . For the nine months endedSeptember 30, 2021 , the Company has made a total of$839,754 in principal and interest payments related to the Hard Rock Note. Our Credit Agreement is comprised of$1,000,000 Term Loan and$3,500,000 Revolving Loan. As ofSeptember 30, 2021 , we had$416,662 outstanding on the Term Loan and$1,000,462 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 ofSeptember 30, 2021 , may not exceed$1,000,000 , 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 . AtSeptember 30, 2021 , we had approximately$12,000 of accrued interest. The interest rate for the Term Loan and the Revolving Loan is prime plus 2%. AtSeptember 30, 2021 , the interest rate for the Term Loan was 8.85%, which includes a 3.6% management fee rate. The effective interest rate for the Revolving Loan for the quarter endingSeptember 30, 2021 was 9.78%. The obligations of the Company under the agreement are secured by a security interest in substantially all of the tangible and intangible assets of the Company, other than any assets owned by the Company that constitute real property (and fixtures affixed to such real property), certain excluded equipment, intellectual property, or aircraft. The Credit Agreement matures
onFebruary 20, 2023 . 19 Cash Flows
Nine Months Ended
Net cash provided by operating activities was approximately$878,000 and$1,269,000 for the nine months endedSeptember 30, 2021 and 2020, respectively. For the nine months endedSeptember 30, 2021 , the Company had approximately$1,175,000 of net loss, approximately$1,168,000 increase in accounts payable and accrued expenses, depreciation and amortization expense of approximately$1,681,000 , which were offset by an approximately$700,000 decrease in accounts receivable. For the nine months endedSeptember 30, 2020 , the Company had approximately$2,775,000 of net loss, an approximately$2,409,000 increase in accounts receivable, and depreciation and amortization expense of approximately$2,134,000 . Net cash used in investing activities was approximately$26,000 for the nine months endedSeptember 30, 2021 and$37,000 for the nine months endedSeptember 30, 2020 .
Net cash used in financing activities was approximately
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 withU.S. GAAP. During the preparation of our financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. While we believe that the estimates and assumptions used in the preparation of our consolidated condensed financial statements are appropriate, actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated condensed financial statements. Our estimates and assumptions are evaluated periodically and adjusted when necessary. The more significant estimates affecting amounts reported in our consolidated condensed financial statements include, but are not limited to: stock based compensation, determining the allowance for doubtful accounts, valuation of inventories, recoverability of long-lived assets, useful lives used in calculating depreciation and amortization, and valuation of intangible assets.
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