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
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 industry the
solutions it demands to improve drilling efficiencies and reduce production
costs.



With our recent AS9100D with ISO 9001:2015 certification there is opportunity to
expand into new revenue streams that are decoupled from the upstream oil and gas
industry, which can leverage our operating assets and mitigate the impact on our
results of operations that is caused by the ongoing and unpredictable cyclic
nature of energy markets.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 significant decline in oil demand due to COVID-19 coupled with a global over
supply of oil drove down oil prices. This resulted in our customers announcing
significant reductions to their capital expenditure budgets for 2020. This was
evidenced by the significant decline in U.S. onshore rig counts. As of December
31, 2020, U.S. onshore rig count was 351 rigs compared with 796 rigs as of
December 31, 2019. We expect oil and gas related markets to continue to
experience significant weakness in 2021. Despite these current challenges, the
oil and gas industry is beginning to experience slight improvements including an
increase in the number of active rigs in the U.S. from 2020 lows, and we expect
additional rig count improvement to occur throughout the year, although likely
not to pre-COVID levels.



Worldwide military, political and economic events have contributed to oil and
natural gas price volatility and are likely to continue to do so in the future.
Although the Company has seen demand for its oil and gas related products and
services in the United States and Canada impacted by these industry conditions,
we continue to aggressively market our drilling products. The oil and gas
industry is increasingly using directional (e.g., horizontal) drilling in their
exploration and production activities because of significantly 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 performance or are not well suited for directional
drilling. In addition, current and expected oil and natural gas prices combined
with more technically challenging horizontal drilling has driven the demand for
new technologies. We believe the value of our Drill-N-Ream tool has proven to
provide significant operational efficiencies and costs savings for horizontal
drilling activity and, combined with our low market penetration, provide us
sales opportunities in soft as well as robust markets.



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, rental and other related income

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 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.



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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.

Cost of running our business

The principal elements of cost of sales for manufacturing, repair, rental and
sale of tools ("product") are the direct and indirect costs to manufacture,
repair and supply the product, 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 (expenses), net, consists primarily of interest expenses in connection with outstanding borrowings less interest income, gains (losses) on assets sold and the collection of promissory notes on related parties.

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RESULTS OF OPERATIONS

The following table shows our abridged consolidated income statement for the specified periods:

                                               For the Years Ended December 31,
       (in thousands)                            2020                      2019
       Tool revenue                      $    7,051         67 %    $ 12,116        64 %
       Contract services                      3,420         33 %       6,881        36 %
       Total revenue                     $   10,471        100 %    $ 18,997       100 %

Operating costs and expenses 14,293 137% 19,899 105%

       Loss from continuing operations       (3,822 )      (36 )%       (902 )      (5 )%
       Other income                             508          5 %         (16 )      (0 )%
       Income tax expense                      (115 )       (1 )%        (18 )      (0 )%
       Net loss                          $   (3,430 )      (32 )%   $   (936 )      (5 )%

Material changes to certain items in our income statement that are included in our financial statements for the comparative periods are discussed below.

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Revenue. Our revenue decreased approximately $8,526,000, or 45%, to $10,471,000.
The decrease was a result of the COVID-19 pandemic induced decline in the demand
for oil and gas which resulted in a significant reduction in drilling activity
globally. Despite the decline in drilling activity, International revenue
increased $565,000 or 43% to $1,880,000.

Tool turnover was $ 7,051,000, by 42% or $ 5,066,000, from the same period last year. Revenue from contract services decreased by approximately $ 3,461,000, or 50%, too
$ 3,420,000.

Operating Costs and Expenses. Significant cost management efforts led to total
operating costs and expenses declining approximately $5,605,000, or 28%, during
2020 compared with 2019.

? Cost of sales decreased by approx $ 3,077,000 and was driven by a

Decline in sales and the impact of cost savings due to

Force reduction and closure of our Abilene DNR tool repair center. As a

percentage of sales, cost of sales amounted to 49% in the past year December 31,

2020 and 43% for the past year December 31, 2019.

? Selling and general administration costs have decreased by approx

$ 1,916,000 in 2020 compared to 2019. The decrease is mainly due to

Cost reduction measures that we implemented in 2020 to reduce the

Decrease in revenue. These measures included downsizing, salary

    reductions and the deferral of new product development initiatives.

? Depreciation and amortization expenses have decreased by approx $ 612,000 to

$ 2,816,000 for the year over December 31, 2020. Depreciation expense decreased

due to lower amortization costs through complete amortization of part of

    intangible assets in May 2019.




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Other income (expenses). Other income and expenses consist mainly of interest income, interest expenses, loan waivers and profit / loss from the sale of assets.

? The interest income for the years 2020 and 2019 amounted to approx. $ 6,000 and

$ 61,000, respectively.

? The interest expense for 2020 and 2019 was approx. $ 575,000 and

$ 765,000, respectively. The decrease in interest expense is essentially due to

reducing the outstanding balance of the Hard Rock Note.

? The company has recognized $ 933,000 Loan waiver for the past year

December 31, 2020. About $ 892,000 related to the company’s PPP

Loan and $ 41,000 in connection with an SBA equipment loan granted under

the CARES law.

? The company recorded a loss on assets held for sale of $ 30,000 in 2020 and

$ 6,000 in 2019.

? The company posted a profit of around $ 174,000 on assets sold in

2020 and a profit of approx. $ 16,000 in 2019.

? In 2019, the company recorded a collection of borrower’s note receivables from related parties.

Effective August 2017, the company has fully reserved the right to comment on related companies and persons

Promoting $ 6,979,043, whereby the borrower’s note receivables from related companies and persons were reduced

balance $ 0. In 2019, the company received consideration for the related

Debt note claim in the form of a instead of given

an annual allocation of restricted stock units to the CEO and COO and logged as

Reclaim the loan. The company will continue the recovery of appropriate

Debt note claim for consideration or payments on the loan in

    the future.

Liquidity and capital resources

At December 31, 2020, we had working capital of approximately $1,300,000. 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. We will continue to
work to grow revenue and manage costs to minimize negative net cash flow in
2021. If we are unable to do this, we may not be able to, among other things,
(i) maintain our current general and administrative spending levels; (ii) fund
certain obligations as they become due; and (iii) respond to competitive
pressures or unanticipated capital requirements. We cannot provide any assurance
that financing will be available to us in the future on acceptable terms.



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 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 2021 of $1,500,000 and we will further defer investment in new
technology development, including our Strider technology.



The Hard Rock Note had a remaining balance of $1,500,000 as of December 31,
2020, accrues interest at 8.00% per annum and is fully payable on October 5,
2022. Under the amended terms of the Hard Rock Note, we are required to make the
following remaining payments: accrued interest on January 5, April 5, July 5 and
October 5 in 2021 and 2022; plus $750,000 in principal on July 5, 2021 with the
remaining balance of principal and accrued interest on the Hard Rock Note due on
October 5, 2022.



Our Credit Agreement is comprised of $1,000,000 Term Loan and $3,500,000
Revolving Loan. As of December 31, 2020, we had $666,584 outstanding on the Term
Loan and $198,838 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 December 31, 2020, may not
exceed $314,517, 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
December 31, 2020, we had approximately $8,700 of accrued interest.



The interest rate for the Term Loan and the Revolving Loan is prime plus 2%. At
December 31, 2020, 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 year ending December 31, 2020 was 11.35%. The obligations of the Company
under the agreement are secured by a security interest in substantially all of
the tangible and intangible assets of the Company, other than any assets owned
by the Company that constitute real property (and fixtures affixed to such real
property), certain excluded equipment, intellectual property, or aircraft. The
Credit Agreement matures on February 20, 2023.



On December 7, 2020, the Company closed a sale-leaseback agreement for its
headquarters and manufacturing facilities. Under the terms of the transaction,
the Company sold the property for $4.5 million and simultaneously entered into a
15-year lease. After fees, the Company netted approximately $4.2 million in
proceeds of which $2.5 million was used to repay in full the outstanding
mortgage on the property. 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 Topic 842, Leases, and as such, the transaction is accounted for

as a
financing transaction.



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Contractual Obligations

The following table presents our contractual obligations as of December 31,
2020. Our obligations to make payments in the future may vary due to certain
assumptions including the duration of our obligations and anticipated actions by
third parties according to the following table (in thousands):



                            2021        2022       2023      2024      2025       Thereafter       Total

Debt (1)                   $ 1,384     $ 1,299     $ 156     $ 119     $   4     $          -     $ 2,962
Operating leases                82          15         8         -         -                -         105
Financial obligation (2)       312         316       321       326       331            1,432       3,038

Total                      $ 1,778     $ 1,630     $ 485     $ 445     $ 335     $      1,432     $ 6,105

(1) Amounts represent the expected cash payments of principal and interest

Amounts related to our long-term debt.

(2) Refers to the sale-leaseback transaction that the company completed in December

2020. The contractual obligation does not include the residual value thereof

    property of $2,160,242. See Note 10 - Financing Obligation to our
    consolidated financial statements.

The total outstanding balance of our borrower’s note loan liabilities less discounts on December 31, 2020, was about $ 2,848,000 with interest rates from 0% to 8.85%.

Cash Flow



Operating Cash Flows



For 2020, net cash provided by our operating activities was approximately
$575,000. The Company had approximately $3,430,000 of net loss, an approximately
$2,505,000 decrease in accounts receivable, depreciation and amortization
expense of approximately $2,816,000, which were offset by an approximately
$1,042,000 increase in inventories and $933,000 gain on forgiveness of the

PPP
loan and SBA equipment loan.



Investing Cash Flows



For 2020, the Company used approximately $222,000 in investing activities for
property, plant and equipment purchases primarily to increase tool repair
capacity to support product expansion in the Middle East. This was offset by
proceeds from the sale of fixed assets of approximately $150,000.



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Financing Cash Flows

For 2020, the net cash inflow from our financing activities was approx
$ 241,000 and primarily related to proceeds from the PPP loan and proceeds from the sale-leaseback transaction, which were offset by amortization of debt.

Off-balance sheet regulations

None.



Critical Accounting Policies



The discussion of our financial condition and results of operations is based
upon our consolidated financial statements, which have been prepared in
accordance with GAAP. During the preparation of these 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 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 financial statements. Our estimates and assumptions are evaluated
periodically and adjusted when necessary. Described below are the most
significant policies we apply in preparing our consolidated financial
statements, some of which are subject to alternative treatment under GAAP. We
also describe the most significant estimates and assumptions we make in applying
these policies. See Note 1 to our consolidated financial statements.



Segment reporting is not applicable to us as we have a single, company-wide
management team that administers the Company as a whole, rather than by discrete
business units. While we have three business product lines and report the
revenues by product line internally and externally, we do not capture expenses
by product line and as such, we do not maintain complete separate financial
statement information by product line. We evaluate our business performance as a
single segment and we report as a single segment. We operate in the United
States and the Middle East. Approximately 82% of our revenue is from the United
States and approximately 18% is from the Middle East for the year ended December
31, 2020. For the year ended December 31, 2019, approximately 93% of our revenue
was from the United States and approximately 7% was from the Middle East.



Revenue Recognition



We are a drilling and completion tool technology company and we generate revenue
from the manufacturing, repair, rental 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.



Stock-Based Compensation



Stock-based compensation is measured at the grant date, based on the fair value
of the award, and is recognized ratably as an expense over the vesting period of
the award. Determining the appropriate fair value model and calculating the fair
value of stock-based payment awards require the use of subjective assumptions,
including the expected life of the stock-based payment awards and stock price
volatility. Management uses the Black-Scholes option pricing model to value
award grants and determine the related compensation expense. The assumptions
used in calculating the fair value of stock-based payment awards represent
management's best estimates, but the estimates involve inherent uncertainties
and the application of management judgment. As a result, if factors change and
management uses different assumptions, the Company's stock-based compensation
expense could be materially different in the future. The Company expects to
continue to grant stock-based awards in the future, and to the extent that the
Company does, its actual stock-based compensation expense recognized in future
periods will likely increase.



Concentration of Credit Risk



Substantially all of our revenue is derived from our refurbishing of PDC drill
bits for Baker Hughes and from DTI when we 1) sell the Drill-N-Ream tool, 2)
repair the DNR tool, and 3) earn royalty on our customer's rental of the DNR
tool to the end user.



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Accounts receivable and allowance for doubtful accounts

Accounts receivable are generally due within 60 days of the invoice date. No
interest is charged on past-due balances. We grant credit to our customers based
upon an evaluation of each customer's financial condition. We periodically
monitor the payment history and ongoing creditworthiness of our customers. An
allowance for doubtful accounts is established at a level estimated by
management to be adequate based upon various factors including historical
experience, aging status of customer accounts, payment history and financial
condition of our customers. The allowance for doubtful accounts was $0 and
$9,288 at December 31, 2020 and 2019, respectively.



Intangible Assets

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 December 31, 2020, the Company
performed an evaluation of the intangible assets. Based on this assessment, we
have determined no impairment was needed.



Valuation of Inventories



Inventories consist of raw materials, work-in-process and finished goods and are
stated at the lower of cost, determined using the weighted-average cost method,
or net realizable value. Finished goods inventories include raw materials,
direct labor and production overhead. The Company regularly reviews inventories
on hand and current market conditions to determine if the cost of finished goods
inventories exceed current market prices and impairs the cost basis of the
inventory accordingly. The Company wrote off $4,800 and $79,200 related to slow
moving inventory in 2020 and 2019, respectively.

Property, plant and equipment

Tangible assets are valued at acquisition cost. Ordinary maintenance and repair costs are charged to operating expenses, while critical component replacements and major improvements are capitalized. Depreciation on property, plant and equipment is calculated using the straight-line method over the estimated useful life of the asset as follows:

          Buildings and leasehold improvements               2-39 years
          Machinery, equipment and rental tools     18 months -10 years
          Office equipment, fixtures and software             3-7 years
          Transportation equipment                         5 - 30 years

Property, plant and equipment is reviewed for impairment on an annual basis or
whenever events or changes in circumstances indicate the carrying value of an
asset or asset group may not be recoverable. Indicative events or circumstances
include, but are not limited to, matters such as a significant decline in market
value or a significant change in business climate. An impairment loss is
recognized when the carrying value of an asset exceeds the estimated
undiscounted future cash flows from the use of the asset and its eventual
disposition. The amount of impairment loss recognized is the excess of the
asset's carrying value over its fair value. Assets to be disposed of are
reported at the lower of the carrying value or the fair value less cost to sell.
There were no impairment losses related to fixed assets during 2020 and 2019.
Upon sale or other disposition of an asset, the Company recognizes a gain or
loss on disposal measured as the difference between the net carrying value of
the asset and the net proceeds received.

Promissory note claim to related parties party

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' s senior secured lender. That agreement provided that, upon
our full repayment of the Tronco loan from the proceeds of our initial public
offering, 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.



The Meier Guaranties were determined not to be substantive based on GAAP that
states that the substance of a personal guarantee depends on the ability of the
guarantor to perform, the practicality of enforcing the guarantee, and the
demonstrated intent to enforce the guarantee. Since the Company did not
demonstrate intent by either enforcing the redemption of collateral or the
guarantees by the borrowers to repay the loan when the related party note
receivable was due and payable on December 31, 2017 and instead modified the
loan by extending the payment term, the Company determined the guarantees are
not substantive and therefore should not serve as the basis for concluding the
loan is well secured and collateralized. As a result, the Company fully reserved
the related party note receivable effective August 2017. 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 receiving repayment of the note,
but there is no guarantee a full recovery of the loan will occur.

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