Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and the related notes thereto included in this Quarterly Report on Form 10-Q (“Quarterly Report”) and with our audited financial statements and the related notes thereto included in our Annual Report on Form 10-K (“Annual Report”), filed with the Securities and Exchange Commission (the “SEC”). This discussion and analysis contains forward-looking statements regarding the industry outlook, estimates and assumptions concerning events and financial and industry trends that may affect our future results of operations or financial condition and other non-historical statements. These forward-looking statements are subject to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in “—Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors.” Our actual results may differ materially from those contained in or implied by these forward-looking statements. As used in this Quarterly Report, except where the context otherwise requires or where otherwise indicated, the terms “Company,” “NCS,” “we,” “our” and “us” refer to NCS Multistage Holdings, Inc.
Overview
We are a leading provider of highly engineered products and support services that facilitate the optimization of oil and natural gas well completions and field development strategies. We provide our products and services primarily to exploration and production (“E&P”) companies for use in onshore wells, predominantly wells that have been drilled with horizontal laterals in unconventional oil and natural gas formations. Our products and services are utilized in oil and natural gas basins throughout North America and in selected international markets, including Argentina, China, the Middle East and the North Sea. We have provided our products and services to various customers, including leading large independent oil and natural gas companies and major oil companies.
Our primary offering is our fracturing systems products and services, which enable efficient pinpoint stimulation: the process of individually stimulating each entry point into a formation targeted by an oil or natural gas well. Our fracturing systems products and services are typically utilized in cemented wellbores and enable our customers to precisely place stimulation treatments in a more controlled and repeatable manner as compared with traditional completion techniques. Our fracturing systems products and services are utilized in conjunction with third-party providers of pressure pumping, coiled tubing and other services.
We own a 50% interest in Repeat Precision, LLC (“Repeat Precision”), which sells composite frac plugs and related products. We provide tracer diagnostics services for well completion and reservoir characterization that utilize downhole chemical and radioactive tracers. We sell products for well construction, including our AirLock casing buoyancy system, liner hanger systems and toe initiation sleeves. We operate in one reportable segment.
COVID-19 Impacts on the Oil & Gas Market and NCS Multistage
Coronavirus disease 2019 (“COVID-19”) is an infectious disease caused by severe acute respiratory syndrome coronavirus 2. The World Health Organization (“WHO”) declared the COVID-19 outbreak a public health emergency of international concern on January 30, 2020 and a pandemic on March 11, 2020. According to Johns Hopkins University, as of April 30, 2021 there have been over 150 million confirmed cases, resulting in over 3.1 million deaths related to COVID-19 on a global basis.
Federal, state, provincial and local governments around the world have implemented measures designed to slow the spread of COVID-19. In many countries, the most restrictive measures were eased throughout the second quarter of 2020, though case counts began rising during the third and fourth quarters of 2020 in some areas, including several states in the U.S. and in Europe, following the relaxation of the restrictions.
These measures taken to slow the spread of COVID-19 have had material impacts on the global economy, resulting in a significant reduction in global gross domestic product (“GDP”) in 2020 and continued to negatively impact GDP in early 2021. In addition, businesses have been forced to shut down, either temporarily or permanently, resulting in a significant growth in unemployment rates, which have partially declined, but remain at elevated levels by historical standards.
Several vaccines have been approved for use since the fourth quarter of 2020, with vaccination rates increasing through early 2021. Several new variants of COVID-19 have emerged and vaccines approved to date have lower efficacy in combating some of these new variants. Accordingly, the uncertainty of the continued development, availability, distribution and acceptance of effective vaccines precludes any prediction as to the continued impact of COVID-19 on our business.
The demand for crude oil has been materially reduced as a result of the measures taken by governments around the world to mitigate the spread of COVID-19, primarily due to significant reductions in air and motor vehicle travel, which has reduced the demand for jet fuel, diesel and gasoline, the key refined products derived from crude oil. In its January 2021 Oil Market Report, the International Energy Agency (“IEA”) stated that demand for crude oil for the full year in 2020 contracted by 8.8 MMBBL/D as compared to 2019, as a result of COVID-19 case counts and the timing of and nature of global economic activity. In its April 2021 Oil
Market Report, IEA predicts that demand for crude oil will rise by 5.7 MMBBL/D in 2021 but is dependent upon the economic recovery and vaccine deployment. Even if demand increases to the level predicted by the IEA, this increase in projected 2021 demand would not offset the significant demand reduction of 2020, leaving 2021 demand 3.1 MMBBL/D below 2019 levels.
The significant reduction in global demand that began in early 2020 led to a decline in the average WTI crude oil price which was $27.96/BBL in the second quarter of 2020 before measures to restrict the spread of COVID-19 were put in place for most of the world. The WTI crude oil price recovered to $48.35/BBL at the end of December 2020 and averaged $58.09/BBL over the first quarter of 2021 but remains volatile. Members of OPEC and certain other countries, including Russia (informally known as “OPEC+”), agreed to a collective reduction in oil production of 9.7 MMBBL/D in May through July of 2020, 7.7 MMBBL/D in August through December 2020 and approximately 7 MMBBL/D through April 2021. In April 2021, OPEC + approved the production level adjustments of 6.6 MMBBL/D, 6.2 MMBBL/D, and 5.8 MMBBL/D in May, June and July 2021, respectively. Saudi Arabia announced an additional voluntary supply reduction of 1.0 MMBBL/D in February through April of 2021 due to demand concerns stemming from restrictions put in place in late 2020 in response to a surge in infections. However, Saudi Arabia plans to phase out this voluntary reduction over May, June and July 2021. The intent of the voluntary supply reductions is to attempt to increase the realized price of crude oil, and more specifically to return global oil storage capacity to normal levels over time as the economy and oil demand recovers. Given the uncertainty related to the rate of new COVID-19 infections, vaccinations, economic recovery and oil demand recovery, OPEC+ plans to continue to meet monthly during 2021 to evaluate potential increases or decreases to the targeted level of reduction in production.
As a result of the rapid and material reduction in oil pricing, E&P companies responded by significantly reducing their capital expenditure budgets for 2020, which resulted in significant reductions in drilling and completion activity. In North America, capital expenditures in 2020 were typically reduced by 30% or more from the original E&P company capital budgets, with some only spending the capital required to safely operate their existing productive assets. Reductions in activity began in mid-to-late March of 2020 and decreases in completions activity occurred faster than reductions to drilling activity, as completions equipment is typically contracted on a short-term basis, while drilling rigs may be contracted for several months or years. Many E&P companies partially shut in production in areas where the marginal cash operating cost exceeds the market price. The amount of shut-in capacity in North America is believed to have peaked in May 2020, with the volume of shut-in production reducing over time. Initial 2021 budgets for E&P companies suggest a slight reduction from 2020 expenditures with an objective of generating free cash flow and maintaining production levels near those in late 2020. We believe that North American E&P companies may be hesitant to increase their 2021 capital expenditure budgets out of concern that OPEC+ may reverse any agreed-to collective reduction in oil production, which would be expected to lead to a reduction in realized prices.
Low commodity prices in 2020 also impacted E&P companies that carry significant debt on their balance sheets and companies that rely on liquidity from loans that are based on the value of their oil and gas reserves. There have been numerous Chapter 11 bankruptcy filings by E&P companies, and the credit quality of the upstream oil and gas sector, our customer base, has been negatively impacted by the decline in market conditions, primarily related to the COVID-19 pandemic. We recorded a provision for doubtful accounts of $0.8 million during 2020 and a recovery of $0.1 million during the three months ended March 31, 2021. In addition, perceptions of the industry in which we operate, by investors and financial institutions, have reduced the availability of financing for our customers and increased their cost of financing.
The factors mentioned above have led to an increase in consolidation amongst E&P companies, especially large, independent publicly-traded E&P companies. During late 2020, several large consolidation transactions were announced, including Chevron Corp’s acquisition of Noble Energy, ConocoPhillips’ acquisition of Concho Resources, Devon Energy’s merger with WPX Energy and Pioneer Natural Resources’ acquisition of Parsley Energy. These consolidation transactions allow the combined entities to reduce costs, in part due to economies of scale, and can lead to reduced capital spending on a pro forma basis than would have been spent had the transaction not occurred. NCS has provided products and services to several of the companies involved in consolidation transactions, and we have experienced a reduction in spending with certain customers and may continue to further experience a reduction in future business with consolidating customers if combined capital spending is reduced, if procurement strategies are altered, or if the counterparty in the consolidation has other preferred vendors for the products and services we have been providing.
The reduction in customer capital spending and responses as a result of a decline in market conditions primarily related to the COVID-19 pandemic began to impact NCS in March 2020. Customers in North America began to quickly reduce the number of active completions crews, travel restrictions began to impact international operations, and activity in certain regions, including Argentina and China, was shut down due to government actions to contain the spread of COVID-19. In addition, throughout 2020, customers further reduced their capital spending and the resulting drilling and completion activity, which reduced the level of demand for our products and services and the pricing we received for our products and services.
While we experienced modest disruptions to our supply chain as a result of the COVID-19 pandemic, including delays in importation of certain chemical products from China and temporary work-from-home orders that reduced the capacity at the Repeat Precision machine shop operations in Mexico, such disruptions were temporary in nature, the impacted products are available through
alternative sources of supply and we maintained sufficient inventory on hand to meet customer demand. We also experienced delays in access to certain materials and products utilized in our research and development activities, which has led, and may continue to lead, to delays in new product introductions.
In response to the reduction in demand for our products and services, including as a result of the COVID-19 pandemic, NCS has undertaken, and the Board of Directors monitored and evaluated, multiple initiatives to reduce our cost structure, limit capital expenditures and enhance our liquidity and access to capital, including:
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·
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Reductions in force which reduced our headcount in the U.S. and Canada by approximately 190 people and reductions to salaries and hourly rates for substantially all employees, including reductions in salaries for executives averaging 20%. These actions resulted in over $19 million in cost savings during 2020, with approximately 70% of that amount associated with selling, general and administrative (“SG&A”) expenses. In addition, our 2021 long-term incentive award grants were based on lower base salary levels;
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Not paying 2019 or 2020 bonuses;
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A temporary elimination of the employer matching contributions for NCS’s U.S. 401(k) plan and its Registered Retirement Savings Plan in Canada;
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A moratorium on non-essential travel for all employees;
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Negotiation of new rates, work rules and payment schedules with vendors;
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Strategies to reduce third-party spend, including information technology, financial services and third-party research and development;
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Deferral of U.S. employer payroll taxes, as permitted under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”);
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Application for, and receipt of, benefits under the Canada Emergency Wage Subsidy (“CEWS”) and Canada Emergency Rent Subsidy (“CERS”) programs;
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Accelerating the filing of our 2019 U.S. federal tax return to utilize net operating loss (“NOL”) carryback provisions from the CARES Act;
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Reducing planned capital expenditures for 2020 and 2021 and selling excess vehicles;
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·
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Closing our district operational facilities in Corpus Christi and Oklahoma City and relocating our U.S. assembly operations to better align with our supply chain partners, which reduces overhead and improves fixed cost absorption;
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In April 2020, Repeat Precision entered into a new promissory note providing up to $5.0 million in additional borrowing capacity; and
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Amending our revolving credit facility to modify certain covenants and to establish a borrowing base related to our accounts receivable, which we believe provides us with enhanced financial flexibility (as described in more detail in “Note 8. Debt” in our unaudited condensed consolidated financial statements).
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NCS continues to evaluate market conditions and will continue to take necessary actions to further reduce our cost base and enhance liquidity should there be a further reduction in the demand for our products and services.
In connection with the reductions in force described above, NCS recorded severance expense of $5.7 million during the year ended December 31, 2020 and no significant severance or termination benefits during the three months ended March 31, 2021. For additional information, see “Note 10. Severance and Other Termination Benefits” of our unaudited condensed consolidated financial statements.
As a result of the decrease in crude oil pricing, customer capital spending plans and activity as a result of the decline in market conditions primarily related to the COVID-19 pandemic as well as the resulting decline in the quoted price of our common stock, we assessed the recoverability of the carrying value of our property and equipment and finite-lived intangible assets as of March 31, 2020 and determined that a triggering event had occurred. As a result of the analysis, we recorded impairment charges of $9.7 million in property and equipment and $40.5 million related to identifiable intangible assets, which we recorded during the first quarter of 2020. There were no impairment charges recorded on our property and equipment or identifiable intangible assets during the remainder of 2020 or for the three months ended March 31, 2021. For additional information, see “Note 5. Property and Equipment” and “Note 6. Goodwill and Identifiable Intangibles” of our unaudited condensed consolidated financial statements.
On August 6, 2020, we entered into an amendment to our Senior Secured Credit Facility which, among other changes, reduced the lender commitments in the U.S. under our Senior Secured Credit Facility to $25.0 million and further limited the amount we may borrow dependent on a borrowing base calculated based on eligible receivables, which does not include receivable balances at Repeat Precision. See —Liquidity and Capital Resources—Financing Arrangements for a description of the amendment. Our borrowing base
under the Senior Secured Credit Facility as of March 31, 2021 was $14.4 million. The amount available to be drawn under the Senior Secured Credit Facility may decline from current levels due to reductions in our borrowing base or a springing financial covenant, if our business continues to be adversely impacted by a decline in market conditions primarily related to the COVID-19 pandemic.
Outlook
Based on initial capital budgets for 2021 that have been set by E&P companies, we believe that industry drilling and completions activity in North America will be modestly lower in 2021 than in 2020. Many of our customers in North America committed to generating free cash flow while maintaining production at levels consistent with late 2020. Drilling activity in the U.S. declined sequentially throughout the first half of 2020 before bottoming in the third quarter and increasing in the fourth quarter of 2020 and in early 2021. Completions activity in the U.S. also increased in the first quarter of 2021 as compared to the fourth quarter of 2020, however customer drilling and completion activity in the U.S. in the first quarter of 2021 was negatively impacted by winter storm Uri, which resulted in widespread, but temporary, production shut-ins, unsafe road conditions and other logistical challenges particularly in the Permian Basin and other areas in Texas and Oklahoma. We believe that the rig count in Canada in the second quarter of 2020 was at the lowest levels of the last 50 years and did not experience a material seasonal increase in the third quarter of 2020. The Canadian rig count recovered, but it remained well below seasonal averages in the fourth quarter of 2020. Similarly, the Canadian rig count experienced the expected seasonal increase in the first quarter of 2021 but was 26% below the same period of 2020. We expect that customer drilling and completion activity in the U.S. and Canada in the second quarter of 2021 will be above the historically low levels experienced during the second quarter of 2020 and that customer drilling and completion activity in the U.S. and Canada in the second half of 2021 will also be above the levels experienced in 2020. The low level of industry activity has led, and is expected to continue to lead, to intense competitive pressure across all of our product and service offerings in North America, which impacts our market share as well as our margins. We currently expect international industry activity to be relatively flat in 2021 as compared to 2020, with activity levels increasing throughout the year.
Market Conditions
Oil and Natural Gas Drilling and Completion Activity
Our products and services are primarily sold to North American E&P companies and our ability to generate revenues from our products and services depends upon oil and natural gas drilling and completion activity in North America. Oil and natural gas drilling and completion activity is directly related to oil and natural gas prices.
Oil and natural gas prices remain volatile, with WTI crude oil pricing of approximately $48/BBL at the end of December 2020 before increasing to approximately $58/BBL over the first quarter of 2021, with crude oil pricing continuing to be supported by voluntary oil production reductions by members of OPEC and OPEC + as discussed above.
Natural gas pricing was at an average level of $2.03 per MMBtu during 2020 but has increased to an average level of $3.50 per MMBtu during the first quarter of 2021 as demand increased, due in part to colder weather in February 2021 and the industry experienced supply disruption due to widespread production freeze-offs. Realized natural gas prices for Canadian E&P customers are typically at a discount to U.S. Henry Hub pricing. Spot pricing for Canadian natural gas at the AECO hub has been volatile since mid-2017, with discounts to Henry Hub pricing narrowing over time as infrastructure bottlenecks have been partially alleviated.
Sustained declines in commodity prices, or sustained periods when the local pricing received in regional markets is below benchmark pricing, known in the industry as high differentials, would be expected to lead North American E&P companies to further reduce drilling and completion activity, which could negatively impact our business.
Listed and depicted below are recent crude oil and natural gas pricing trends, as provided by the Energy Information Administration (“EIA”) of the U.S. Department of Energy:
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Average Price
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Quarter Ended
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WTI Crude
(per Bbl)
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Brent Crude
(per Bbl)
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Henry Hub Natural Gas
(per MMBtu)
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3/31/2020
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$
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45.54
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$
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50.45
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$
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1.90
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6/30/2020
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27.96
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29.70
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1.70
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9/30/2020
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40.89
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42.91
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2.00
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12/31/2020
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42.52
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44.32
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2.52
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3/31/2021
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58.09
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61.04
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3.50
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Listed and depicted below are the average number of operating onshore rigs in the U.S. and in Canada per quarter since the first quarter of 2020, as provided by Baker Hughes Company (“Baker Hughes”). The quarterly changes in the Canadian land rig count can be partially attributed to seasonality of activity in that market:
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Average Drilling Rig Count
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Quarter Ended
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U.S. Land
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Canada Land
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North America Land
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3/31/2020
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764
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194
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958
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6/30/2020
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378
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23
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401
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9/30/2020
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241
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46
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287
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12/31/2020
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297
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88
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385
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3/31/2021
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378
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144
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522
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Over the past several years, North American E&P companies have been able to reduce their cost structures and have also utilized technologies, including ours, to increase efficiency and improve well performance. The rig count in the U.S. began to decline in 2019 and the decline accelerated in 2020 before bottoming in the third quarter and increasing during the fourth quarter of 2020. During the first quarter of 2021, the average U.S. rig count continued to increase to 378, which is an increase of 27% from 297 in the fourth quarter of 2020 but was 51% below the first quarter of 2020. The average land rig count in Canada for the first quarter of 2021 was 26% lower than in the same period in 2020. The U.S. and Canadian rig counts are expected to be higher than historically low prior year levels for the remainder of 2021.
A substantial portion of our business is subject to quarterly variability. In Canada, we typically experience higher activity levels in the first quarter of each year, as our customers take advantage of the winter freeze to gain access to remote drilling and production areas. In the past, our revenue in Canada has declined during the second quarter due to warming weather conditions that result in thawing, softer ground, difficulty accessing drill sites and road bans that curtail drilling and completion activity. Access to well sites typically improves throughout the third and fourth quarters in Canada, leading to activity levels that are higher than in the second quarter, but lower than activity in the first quarter. Our business can also be impacted by a reduction in customer activity during the winter holidays in late December and early January. In recent years, many customers in the U.S. exhausted their capital budgets prior to the end of the year, leading to reductions in drilling and completion activity during the fourth quarter.
The market in Canada also continues to be impacted by logistical constraints in moving oil and natural gas from areas of production activity to demand centers. These constraints have led to lower realized pricing for our Canadian customers.
The industry experienced a reduction in completions activity in the United States which extended through 2019 and into 2020, with the reduction further accelerating beginning in March 2020 before activity bottomed in the third quarter and began to increase during the fourth quarter of 2020, with increases continuing in early 2021. Initial capital budgets from E&P companies indicate that full-year capital spending in 2021 is expected to be slightly below capital spending in 2020 though E&P capital spending for the last three quarters of 2021 is expected to be higher than during the same period in 2020.
Adoption of Pinpoint Stimulation
Traditional well completion techniques, including plug and perf and ball drop, currently account for the majority of unconventional well completions in North America and over 90% of unconventional well completions in the U.S. We believe that pinpoint stimulation provides benefits compared to these traditional well completion techniques. Our ability to grow our market share, as evidenced by the percentage of horizontal wells in North America completed using our products and services, will depend in large part on the industry’s further adoption of pinpoint stimulation to complete wells, our ability to continue to innovate our technology to compete against continuing technological advances in competing traditional well completions techniques, and our ability to successfully compete with other providers of pinpoint stimulation products and services, including adjusting our pricing in certain markets to respond to customer demands and to competitors that may provide discounted pricing to our customers.
Increasing Well Complexity and Focus on Completion Optimization
In recent years, E&P companies have drilled longer horizontal wells and completed more hydraulic fracturing stages per well to maximize the volume of hydrocarbon recoveries per well. This trend towards longer and more complex wells has resulted in us selling more sliding sleeves or composite frac plugs per well on average, which increases our revenue opportunity per well completion and has led to increased sales of our AirLock casing buoyancy systems. Additionally, E&P companies have become increasingly focused on well productivity through optimization of completion designs and we believe this trend may further the adoption of pinpoint stimulation, and in turn, increase the opportunity for sales of our products and services if our customers observe operational benefits and long-term production results from the application of pinpoint stimulation. This trend towards more complex well completions has also resulted in increased use of tracer diagnostics services, which can be utilized to assess the effectiveness of various well completion techniques and well spacing strategies in support of completion and field development optimization efforts.
How We Generate Revenues
We derive our revenues from the sale of our fracturing systems products and the provision of related services, the sale of composite frac plugs and related products through Repeat Precision and from sales of our tracer diagnostics services, AirLock casing buoyancy system, liner hanger systems and toe initiation sleeves products.
Product sales represented 71% and 72% of our revenues for the three months ended March 31, 2021 and 2020, respectively. Most of our sales are on a just-in-time basis, as specified in individual purchase orders, with a fixed price for our products. We occasionally supply our customers with large orders that may be filled on negotiated terms. Services represented 29% and 28% of our revenues for the three months ended March 31, 2021 and 2020, respectively. Services include our tool charges and associated services related to our
fracturing systems and tracer diagnostics services (which are classified together as “services” in our financial results). Services are provided at agreed upon rates to customers for the provision of our downhole frac isolation assembly, our personnel and for the provision of tracer diagnostics services.
During periods of low drilling and well completion activity or as may be needed to compete in certain markets we will, in certain instances, lower the prices of our products and services. Our revenues are also impacted by well complexity, with wells with more stages resulting in longer jobs and increased revenue attributable to selling more sliding sleeves or composite frac plugs and the provision of our services.
The percentages of our revenue derived from sales in Canada and denominated in Canadian dollars were approximately 71% and 54% for the three months ended March 31, 2021 and 2020, respectively. Because our Canadian contracts are typically invoiced in Canadian dollars, the effects of foreign currency fluctuations impact our revenues and are regularly monitored.
Although most of our sales are to North American E&P companies, we also have sales to customers outside of North America and expect sales to international customers to increase over time. These international sales are made through local NCS entities or to our local operating partners on a free on board or free carrier basis with a point of sale in the United States. Some of the locations in which we have operating partners or sales representatives include China and the Middle East. Our operating partners and representatives do not have authority to contractually bind NCS but market our products in their respective territories as part of their product or service offering.
Costs of Conducting our Business
Our cost of sales is comprised of expenses relating to the manufacture of our products in addition to the costs of our support services. Manufacturing cost of sales includes payments made to our suppliers for raw materials and payments made to machine shops for the manufacturing of product components and finished assemblies and costs related to our employees that perform quality control analysis, assemble and test our products. Our strategic 50% purchase of Repeat Precision has allowed us to reduce our costs for certain product categories. We review forecasted activity levels in our business and either directly procure or ensure that our vendors procure the required raw materials with sufficient lead time to meet our business requirements. On September 24, 2018, the United States implemented a tariff of 10% on a significant number of commodities originating from China, including certain chemicals utilized in our tracer diagnostics business. The tariffs were subsequently increased to 25% in May 2019. The increased tariffs have resulted in an increase in our cost of sales. We are monitoring prices for certain raw materials, including steel, which have been increasing during 2021. While we strive to pass through some of the increases in raw material costs to our customers, there can be no assurance that we will be able to do so. Cost of sales for support services includes compensation and benefit-related expenses for employees who provide direct revenue generating services to customers in addition to the costs incurred by these employees for travel and subsistence while on site. Cost of sales includes other variable manufacturing costs, such as shrinkage, obsolescence, revaluation and scrap related to our existing inventory and costs related to the chemicals and laboratory analysis associated with our tracer diagnostics services.
Our SG&A expenses are comprised of compensation expense, which includes compensation and benefit-related expenses for our employees who are not directly involved in revenue generating activities, including those involved in our research and development activities, as well as our general operating costs. These general operating costs include, but are not limited to: rent and occupancy for our facilities, information technology infrastructure services, software licensing, advertising and marketing, third party research and development, risk insurance and professional service fees for audit, legal and other consulting services. Our SG&A expenses also include severance expenses, litigation expenses and provisions for doubtful accounts. As a result of being a public company, our legal, accounting and other expenses have increased and may further increase for costs associated with our compliance with the Sarbanes-Oxley Act.
The percentage of our operating costs denominated in Canadian dollars (including cost of sales and SG&A expenses but excluding depreciation and amortization expense) approximated 27% and 30% for the three months ended March 31, 2021 and 2020, respectively.
Results of Operations
Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020
The following table summarizes our revenues and expenses for the periods presented (dollars in thousands):
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Three Months Ended
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March 31,
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Variance
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2021
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2020
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$
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%
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Revenues
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Product sales
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$
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20,174
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$
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39,430
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$
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(19,256)
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(48.8)
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%
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Services
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8,340
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15,120
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(6,780)
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(44.8)
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%
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Total revenues
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28,514
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54,550
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(26,036)
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(47.7)
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%
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Cost of sales
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Cost of product sales, exclusive of depreciation and amortization expense shown below
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13,921
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23,448
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(9,527)
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(40.6)
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%
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Cost of services, exclusive of depreciation and amortization expense shown below
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4,357
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7,166
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(2,809)
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(39.2)
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%
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Total cost of sales, exclusive of depreciation and amortization expense shown below
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18,278
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30,614
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(12,336)
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(40.3)
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%
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Selling, general and administrative expenses
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12,784
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20,835
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(8,051)
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(38.6)
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%
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Depreciation
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937
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1,452
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(515)
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(35.5)
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%
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Amortization
|
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167
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1,133
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(966)
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(85.3)
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%
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Impairment
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—
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50,194
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(50,194)
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(100.0)
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%
|
Loss from operations
|
|
|
(3,652)
|
|
|
(49,678)
|
|
|
46,026
|
|
92.6
|
%
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
(168)
|
|
|
(322)
|
|
|
154
|
|
47.8
|
%
|
Other income, net
|
|
|
341
|
|
|
158
|
|
|
183
|
|
115.8
|
%
|
Foreign currency exchange gain, net
|
|
|
150
|
|
|
10
|
|
|
140
|
|
NM
|
%
|
Total other income (expense)
|
|
|
323
|
|
|
(154)
|
|
|
477
|
|
309.7
|
%
|
Loss before income tax
|
|
|
(3,329)
|
|
|
(49,832)
|
|
|
46,503
|
|
93.3
|
%
|
Income tax expense (benefit)
|
|
|
128
|
|
|
(925)
|
|
|
1,053
|
|
113.8
|
%
|
Net loss
|
|
|
(3,457)
|
|
|
(48,907)
|
|
|
45,450
|
|
92.9
|
%
|
Net (loss) income attributable to noncontrolling interest
|
|
|
(60)
|
|
|
2,642
|
|
|
(2,702)
|
|
(102.3)
|
%
|
Net loss attributable to
NCS Multistage Holdings, Inc.
|
|
$
|
(3,397)
|
|
$
|
(51,549)
|
|
$
|
48,152
|
|
93.4
|
%
|
_______________
|
(1)
|
|
NM – Percentage not meaningful
|
Revenues
Revenues were $28.5 million for the three months ended March 31, 2021 as compared to $54.6 million for the three months ended March 31, 2020. This decrease reflected reductions in product sales and services volumes in all geographic areas as well as lower pricing for certain products and services, including composite plugs and tracer diagnostics. We believe the decrease in both activity and pricing resulted from the decline in market conditions primarily related to the COVID-19 pandemic, which had a negative impact on our revenues during the three months ended March 31, 2021 as drilling rig and completion activity was substantially lower in the first quarter of 2021 as compared to 2020, particularly in North America. Product sales for the three months ended March 31, 2021 were $20.2 million as compared to $39.4 million for the three months ended March 31, 2020. Services revenue was $8.3 million for the three months ended March 31, 2021 as compared to $15.1 million for the three months ended March 31, 2020.
Cost of sales
Cost of sales was $18.3 million, or 64.1% of revenues, for the three months ended March 31, 2021 as compared to $30.6 million, or 56.1% of revenues, for the three months ended March 31, 2020. Cost of sales as a percentage of total revenues increased due to the significant reduction in revenue, leading to under-utilization of manufacturing capacity and field service personnel, even after the reduction of our capacity and staff, as well as a reduction in pricing for certain products and services. Cost of sales in the first quarter of 2021 was also impacted by higher scrap expense and inventory reserves at Repeat Precision related to product design changes implemented during the quarter. We believe that our cost of sales as a percentage of revenue was negatively impacted by a decline in oil and gas market activity levels primarily related to the COVID-19 pandemic. Cost of product sales was $13.9 million, or 69.0% of product sales revenue, and cost of services was $4.4 million, or 52.2% of service revenue, for the three months ended March 31,
2021. For the three months ended March 31, 2020, cost of product sales was $23.4 million, or 59.5% of product sales revenue, and cost of services was $7.2 million, or 47.4% of service revenue.
Selling, general and administrative expenses
Selling, general and administrative expenses were $12.8 million for the three months ended March 31, 2021 as compared to $20.8 million for the three months ended March 31, 2020. This overall decrease in expense reflects reductions in compensation and benefits associated with lower headcount and lower salary and wages, professional fees, share-based compensation and bad debt expense of $2.9 million, $1.1 million, $0.6 million and $0.4 million, respectively. We believe that travel restrictions enacted in response to the COVID-19 pandemic had a slightly favorable impact on our SG&A expense, primarily due to a reduction in travel and entertainment expenses, which decreased by $0.4 million. In addition, we incurred incremental severance charges of $1.4 million in 2020 due to the timing of workforce reductions.
Depreciation
Depreciation was $0.9 million for the three months ended March 31, 2021 as compared to $1.5 million for the three months ended March 31, 2020. The decrease is primarily attributable to a non-cash impairment charge of $9.7 million during the first quarter of 2020, which reduced the carrying values of our land, building and improvements and machinery and equipment. Additionally, our capital expenditures in 2020 and 2021 have been lower than in prior years. See “Note 5. Property and Equipment” of our unaudited condensed consolidated financial statements for additional detail.
Amortization
Amortization was $0.2 million for the three months ended March 31, 2021 as compared to $1.1 million for the three months ended March 31, 2020. The decrease in amortization was related to non-cash impairment charges of $40.5 million during the first quarter of 2020, which reduced the carrying values of technology, internally-developed software, customer relationships, and trademarks. See “Note 6. Goodwill and Identifiable Intangibles” of our unaudited condensed consolidated financial statements for additional detail.
Impairment
On March 31, 2020, we evaluated our property and equipment and finite-lived intangible assets for impairment due to current industry conditions such as a reduction in global economic growth expectations, a significantly reduced demand for crude oil and refined products, the significant decline in commodity prices and the corresponding impact on future expectations of demand for our products and services primarily related to the COVID-19 pandemic as well as the resulting decline in the quoted price of our common stock. We determined that the carrying amount of certain of our long-lived assets exceeded the corresponding fair value. We recorded impairment charges of $9.7 million in property and equipment and $40.5 million in finite-lived intangible assets. See “Note 5. Property and Equipment” and “Note 6. Goodwill and Identifiable Intangibles” of our unaudited condensed consolidated financial statements for additional detail.
Income tax expense (benefit)
Income tax expense (benefit) was $0.1 million for the three months ended March 31, 2021 as compared to $(0.9) million for the three months ended March 31, 2020. Included in the tax expense for the three months ended March 31, 2021 was a tax expense of $0.7 million for an increase in a valuation allowance on deferred tax assets not expected to be realized and a tax expense of $0.3 for foreign taxes. Included in the tax benefit for the three months ended March 31, 2020 were several U.S. tax (benefit) expense adjustments related to the enactment of the CARES Act including a tax benefit of $(1.4) million related to a NOL carryback allowed under the CARES Act that was previously unavailable, and a tax expense of $10.3 million for an increase in a valuation allowance on deferred tax assets not expected to be realized. Also included in tax benefit for the three months ended March 31, 2020 was a tax expense in the amount of $1.6 million for a valuation allowance against our Canadian deferred tax asset based on management’s position that NCS has not met the more likely than not condition of realizing part of the deferred tax asset. Additionally, the tax expense (benefit) for the three months ended March 31, 2021 and 2020 included a tax expense of $0.4 million and $1.1 million, respectively, for the tax effect of stock awards.
As a result of the geographic mix of earnings and losses, including discrete items, our tax rate has been and will continue to be volatile.
Liquidity and Capital Resources
Our primary sources of liquidity are our existing cash and cash equivalents, cash provided by operating activities and borrowings under our Senior Secured Credit Facility. As of March 31, 2021, we had cash and cash equivalents of $12.0 million and total outstanding indebtedness of $5.7 million, of which no amount is currently outstanding under our Senior Secured Credit Facility. The Senior Secured Credit Facility consists of a senior secured revolving credit facility in an aggregate principal amount of $25.0 million. Total borrowings are limited to a borrowing base calculated based on eligible receivables, provided that it does not include receivables at Repeat Precision. We were in compliance with our debt covenants at March 31, 2021. We believe that our cash on hand, cash flows from operations and potential borrowings under our Senior Secured Credit Facility will be sufficient to fund our capital expenditure and liquidity requirements for the next twelve months. Our borrowing base under the Senior Secured Credit Facility at March 31, 2021 was $14.4 million. The amount available to be drawn under the Senior Secured Credit Facility may decline from current levels due to reductions in our borrowing base or a springing financial covenant if our business continues to be adversely impacted by a decline in market conditions primarily related to the COVID-19 pandemic. Our principal liquidity needs have been, and are expected to continue to be, capital expenditures, working capital, debt service and potential mergers and acquisitions.
Our capital expenditures for the three months ended March 31, 2021 and 2020 were $0.1 million and $0.5 million, respectively. We plan to incur approximately $1.0 million to $2.0 million in capital expenditures during 2021, which includes (i) additional machining and other capital equipment at Repeat Precision, (ii) internally-developed software, (iii) additional equipment to support our tracer diagnostics services and (iv) vehicles used in international operations.
We anticipate that to the extent we require additional liquidity to fund our capital requirements or repay existing indebtedness, it will be funded through the incurrence of additional indebtedness, the proceeds of equity issuances, or a combination thereof. We cannot assure you that we will be able to obtain this additional liquidity on reasonable terms, or at all. Our liquidity and our ability to meet our obligations and fund our capital requirements are also dependent on our future financial performance and ability to reduce costs, which is subject to general economic, financial and other factors that are beyond our control, including the COVID-19 pandemic. Accordingly, we cannot assure you that our business will generate sufficient cash flow from operations or that funds will be available from additional indebtedness, the capital markets or otherwise to meet our liquidity needs. If we decide to pursue one or more significant acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions, which could result in additional expenses or dilution.
Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
March 31,
|
|
|
2021
|
|
2020
|
Net cash (used in) provided by operating activities
|
|
$
|
(1,815)
|
|
$
|
3,608
|
Net cash used in investing activities
|
|
|
(64)
|
|
|
(438)
|
Net cash (used in) provided by financing activities
|
|
|
(1,733)
|
|
|
1,367
|
Effect of exchange rate changes on cash and cash equivalents
|
|
|
29
|
|
|
(295)
|
Net change in cash and cash equivalents
|
|
$
|
(3,583)
|
|
$
|
4,242
|
Operating Activities
Net cash (used in) provided by operating activities was $(1.8) million and $3.6 million for the three months ended March 31, 2021 and 2020, respectively. The decrease in cash flow was primarily driven by lower net income in 2021 compared to 2020, after adjusting for impairment charges, and unfavorable changes in other liabilities as well as lower non-cash share-based compensation and depreciation and amortization expenses. The decrease was partially offset by favorable changes in accounts receivable and prepaid expenses and other assets.
Investing Activities
Net cash used in investing activities was $0.1 million and $0.4 million for the three months ended March 31, 2021 and 2020, respectively. The decrease in cash used in investing activities during the three months ended March 31, 2021 as compared to the three months ended March 31, 2020 was primarily related to reduced capital expenditures for property, equipment, software and technology which totaled $0.1 million and $0.5 million, respectively.
Financing Activities
Net cash (used in) provided by financing activities was $(1.7) million and $1.4 million for the three months ended March 31, 2021 and 2020, respectively. Our primary use of funds for the three months ended March 31, 2021 was $1.3 million of distributions to our joint venture partner and principal payments under finance leases of $0.3 million. The primary source of cash from financing activities in 2020 was borrowing $5.0 million under our Senior Secured Credit Facility, partially offset by distributions to our joint venture partner of $3.1 million.
Financing Arrangements
On May 1, 2019, we entered into a Second Amended and Restated Credit Agreement (the “2019 Credit Agreement”) with Pioneer Investment, Inc., as U.S. borrower (the “U.S. Borrower”), NCS Multistage Inc., as Canadian borrower (the “Canadian Borrower”; together with the U.S. Borrower, the “Borrowers”), Pioneer Intermediate, Inc. (together with the Company, the “Parent Guarantors”), the lenders party thereto, Wells Fargo Bank, National Association as administrative agent (the “U.S. Agent”) in respect of the U.S. facility provided therein and Wells Fargo Bank, National Association, Canadian Branch, as administrative agent (the “Canadian Agent”) in respect of the Canadian Facility provided therein. The 2019 Credit Agreement amended and restated our prior credit agreement in its entirety. See “Note 8. Debt” to our unaudited condensed consolidated financial statements for additional details regarding our 2019 Credit Agreement.
On August 6, 2020, we entered into Amendment No. 1 to Second Amended and Restated Credit Agreement (the “Amendment”; the 2019 Credit Agreement, as amended by the Amendment, the “Amended Credit Agreement”) with the Borrowers, Pioneer Intermediate, Inc., certain subsidiaries of the Borrowers, the lenders party thereto, the U.S. Agent and the Canadian Agent. The facility provided pursuant to the Amended Credit Agreement is referred to herein as the “Senior Secured Credit Facility”.
The Senior Secured Credit Facility consists of a senior secured revolving credit facility in an aggregate principal amount of $25.0 million made available to the U.S. Borrower, of which up to $2.5 million may be made available for letters of credit and up to $2.5 million may be made available for swingline loans. The Canadian Borrower may make borrowings under the Senior Secured Credit Facility, subject to a $15.0 million sublimit. Total borrowings available to the Borrowers under the Senior Secured Credit Facility is limited to a borrowing base calculated based on eligible receivables, provided that it does not include receivables at Repeat Precision. The Senior Secured Credit Facility will mature on May 1, 2023.
Borrowings under the Senior Secured Credit Facility may be made in U.S. dollars for Adjusted Base Rate Advances, and in U.S. dollars, Canadian dollars or Euros for Eurocurrency Rate Advances (each as defined in the Amended Credit Agreement). Such advances bear interest at the Adjusted Base Rate or at the Eurocurrency Rate (each as defined in the Amended Credit Agreement) plus an applicable interest margin between 2.75% and 3.75%, depending on NCS’s leverage ratio.
The obligations of the Borrowers under the Senior Secured Credit Facility are guaranteed by the Parent Guarantors, as well as each of the other existing and future direct and indirect restricted subsidiaries of NCS organized under the laws of the United States and Canada (subject to certain exceptions), and are secured by substantially all of the assets of the Parent Guarantors, the Borrowers and such other subsidiary guarantors, in each case, subject to certain exceptions and permitted liens.
The Amended Credit Agreement requires us to (i) maintain liquidity (defined as availability under the Senior Secured Credit Facility plus certain cash deposits) of at least $7.5 million as of the date of each borrowing base certificate due to be delivered either monthly (if availability is greater than or equal to than 12%) or weekly (if availability is less than 12%) thereunder, (ii) maintain, for quarters during which availability is less than 20% of the borrowing base, a fixed charge coverage ratio of at least 1.0 to 1.0 and (iii) on the last business day of each week, prepay advances to the extent that available cash exceeds $12.0 million. As of March 31, 2021, we were in compliance with these financial covenants. The Amended Credit Agreement also contains customary affirmative and negative covenants, including, among other things, restrictions on the creation of liens, the incurrence of indebtedness, investments, dividends and other restricted payments, dispositions and transactions with affiliates.
The Amended Credit Agreement includes customary events of default for facilities of this type (with customary materiality thresholds and grace periods, as applicable). If an event of default occurs, the lenders party to the Amended Credit Agreement may elect (after the expiration of any applicable notice or grace periods) to declare all outstanding borrowings under such facility, together with accrued and unpaid interest and other amounts payable thereunder, to be immediately due and payable. The lenders party to the Amended Credit Agreement also have the right upon an event of default thereunder to terminate any commitments they have to provide further borrowings and to proceed against the collateral securing the Senior Secured Credit Facility.
Repeat Precision also has outstanding promissory notes with an aggregate borrowing capacity of up to $9.3 million as of March 31, 2021, subject to a borrowing base. See “Note 8. Debt” of our consolidated financial statements for further information regarding the promissory notes.
Contractual Obligations
There have been no material changes in our contractual obligations and commitments from those disclosed in the Annual Report for the year ended December 31, 2020.
Off-Balance Sheet Arrangements
We have no off-balance sheet financing arrangements.
Critical Accounting Policies
There are no other material changes to our critical accounting policies from those included in the Annual Report for the year ended December 31, 2020.
Recently Issued Accounting Pronouncements
See “Note 1. Basis of Presentation” to our unaudited condensed consolidated financial statements for a discussion of the accounting pronouncements we recently adopted and the accounting pronouncements recently issued by the Financial Accounting Standards Board.
Emerging Growth Company and Smaller Reporting Company Status
We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). We will remain an emerging growth company until the earlier of (1) the last day of our fiscal year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenue of at least $1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the last business day of our most recently completed second fiscal quarter, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. Additionally, we are also a “smaller reporting company” as defined by Section 12b-2 of the Securities Exchange Act of 1934, as amended (“Exchange Act”), meaning that we are not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent company that is not a smaller reporting company and have a public float of less than $250 million. As an emerging growth company and a smaller reporting company, we may take advantage of specified reduced reporting and other burdens that are otherwise applicable generally to public companies that do not qualify for those classifications.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects” and similar references to future periods, or by the inclusion of forecasts or projections. Examples of forward-looking statements include, but are not limited to, statements we make regarding the outlook for our future business and financial performance, including the effects of the COVID-19 pandemic thereon, such as those contained in this Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause our actual results to differ materially from those in the forward-looking statements include regional, national or global political, economic, business, competitive, market and regulatory conditions and the following:
|
·
|
|
the risks and uncertainties relating to public health crises, including the COVID-19 pandemic and its continuing impact on market conditions and our business, financial condition, results of operations, cash flows and stock price;
|
|
·
|
|
declines in the level of oil and natural gas exploration and production activity within Canada and the United States;
|
|
·
|
|
oil and natural gas price fluctuations;
|
|
·
|
|
the financial health of our customers including their ability to pay for products or services provided;
|
|
·
|
|
inability to successfully implement our strategy of increasing sales of products and services into the United States;
|
|
·
|
|
significant competition for our products and services that results in pricing pressures, reduced sales, or reduced market share;
|
|
·
|
|
loss of significant customers;
|
|
·
|
|
our inability to successfully develop and implement new technologies, products and services;
|
|
·
|
|
our inability to protect and maintain critical intellectual property assets;
|
|
·
|
|
losses and liabilities from uninsured or underinsured business activities;
|
|
·
|
|
our failure to identify and consummate potential acquisitions;
|
|
·
|
|
our inability to integrate or realize the expected benefits from acquisitions;
|
|
·
|
|
currency exchange rate fluctuations;
|
|
·
|
|
impact of severe weather conditions;
|
|
·
|
|
risks resulting from the operations of a joint venture arrangement;
|
|
·
|
|
restrictions on the availability of our customers to obtain water essential to the drilling and hydraulic fracturing processes;
|
|
·
|
|
changes in legislation or regulation governing the oil and natural gas industry, including restrictions on emissions of greenhouse gases;
|
|
·
|
|
our inability to meet regulatory requirements for use of certain chemicals by our tracer diagnostics business;
|
|
·
|
|
change in trade policy, including the impact of additional tariffs;
|
|
·
|
|
our inability to accurately predict customer demand, which may result in us holding excess or obsolete inventory;
|
|
·
|
|
failure to comply with or changes to federal, state and local and non-U.S. laws and other regulations, including anti-corruption and environmental regulations, the CARES Act and the U.S. Tax Cuts and Jobs Act of 2017;
|
|
·
|
|
loss of our information and computer systems;
|
|
·
|
|
system interruptions or failures, including complications with our enterprise resource planning system, cyber security breaches, identity theft or other disruptions that could compromise our information;
|
|
·
|
|
impairment in the carrying value of long-lived assets and goodwill;
|
|
·
|
|
our failure to establish and maintain effective internal control over financial reporting;
|
|
·
|
|
our success in attracting and retaining qualified employees and key personnel;
|
|
·
|
|
risks and uncertainties relating to cost reduction efforts or savings we may realize from such cost reduction efforts;
|
|
·
|
|
the reduction in our Senior Secured Credit Facility borrowing base or our inability to comply with the covenants in our debt agreements; and
|
|
·
|
|
our inability to obtain sufficient liquidity on reasonable terms, or at all.
|
For the reasons described above, as well as factors identified in “Item 1A. Risk Factors” in this Quarterly Report and the section of the Annual Report entitled “Risk Factors,” we caution you against relying on any forward-looking statements. Any forward-looking statement made by us in this Quarterly Report speaks only as of the date on which we make it. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.