Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion and analysis of our financial condition and results of operations as of, and for, the periods presented. You should read the following discussion and analysis of our financial condition and results of operations together with the sections entitled Item 1A. “Risk Factors,” “—Cautionary Note Regarding Forward-Looking Statements,” and our consolidated financial statements and related notes thereto included elsewhere in this Form 10-K. This section and other parts of the Form 10-K contain 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 Item 1A. “Risk Factors.” Our actual results may differ materially from those contained in or implied by these forward-looking statements.
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 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 provided our products and services to over 225 customers in 2021, 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, 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 casing buoyancy system, liner hanger systems and toe initiation sleeves. We offer enhanced recovery systems, which enable our customers to inject water, other fluids, or gases in a controlled manner with the objective of increasing the amount of hydrocarbons produced from their assets. We operate in one reportable segment that has been identified based on how our chief operating decision maker manages our business.
Outlook
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.
Drilling activity in the United States bottomed in the third quarter of 2020 before increasing in the fourth quarter of 2020 and throughout 2021. Completion activity in the United States also increased throughout 2021, although customer drilling and completion activity in the United States in the first quarter of 2021 was negatively impacted by winter storm Uri. The Canadian rig count, which was also well below typical seasonal levels during the last three quarters of 2020, experienced the expected seasonal increase in the first quarter of 2021 but was 26% below the same period of 2020; however, by the second quarter of 2021, the Canadian rig count had surpassed 2020 levels and was 82% higher in the fourth quarter of 2021 compared to the fourth quarter of 2020. Additionally, during the third and fourth quarters of 2021, the Canadian rig count surpassed 2019 levels, prior to the COVID-19 pandemic, indicating a stronger industry recovery in Canada than in the United States.
Based on capital budgets for 2022 that have been set by E&P companies, we believe that industry drilling and completion activity in the United States will be higher in 2022 than in 2021, with drilling activity increasing by over 20%, a faster rate than completion activity, which we expect to increase by over 10%. We expect drilling and completion activity to increase by 10% to 15% in Canada in 2022, with year-over-year increases highest in the first quarter before moderating over the remainder of the year. We currently expect international industry activity to improve by over 10% in 2022 as compared to 2021, reflecting recent increases in the international rig count. Many of our customers in North America continue to be committed to generating free cash flow while maintaining production at year-end 2021 levels, though privately-owned operators have increased activity as commodity prices improved and have contributed to the majority of activity increases since the end of 2020. Oil and natural gas prices continued to rise in early 2022, and spot pricing increased further following Russia’s invasion of Ukraine in late February.
Despite the recent and expected improvements in industry activity levels, we continue to face intense competitive pressure across all of our product and services offerings, which may negatively impact our market share as well as our margins.
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COVID-19 Impacts on the Oil & Gas Market and NCS Multistage
In 2020, the COVID-19 pandemic and associated actions taken around the world to mitigate the spread of COVID-19 caused unprecedented declines in economic activity, energy demand and oil and natural gas prices. Governments around the world implemented measures designed to slow the spread of COVID-19; however, in many countries, the most restrictive measures were eased throughout the second quarter of 2020 and further reduced with the distribution of vaccines in early 2021. 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 global GDP in 2021 as compared to 2019.
The demand for crude oil was materially reduced as a result of the measures taken by governments around the world to mitigate the spread of COVID-19. In response, members of OPEC+ agreed to a collective reduction in oil production of 9.7 MMBBL/D in May through July of 2020. With the distribution of vaccines and reopening of certain economic activities that resulted in increases in demand for oil and natural gas, much of this production has since been restored, with OPEC+ currently scheduled to add 0.4 MMBBL/D of production each month until production would be fully-restored in September 2022. 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 2022 to evaluate potential increases or decreases to the targeted level of production.
As a result of the rapid and material reduction in oil pricing in 2020, E&P companies responded by significantly reducing their capital expenditure budgets for that year, which resulted in significant reductions in drilling and completion activity. While commodity prices recovered in late 2020, capital budgets for E&P companies in the United States in 2021 were relatively in line with 2020, while E&P capital spending in 2021 exceeded 2020 levels in Canada. Preliminary capital budgets for 2022 indicate increases from 2021, led by private companies as public E&P companies continue to prioritize free cash flow with limited production growth.
The factors mentioned above have also led to an increase in consolidation amongst E&P companies, especially large, independent publicly-traded E&P companies. During 2020 and 2021, several large consolidation transactions were consummated. We provided products and services to several of the companies involved in consolidation transactions, and have experienced a reduction in spending with certain customers, especially for Repeat Precision’s products, and may 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 provide.
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. The continuing impacts of the COVID-19 pandemic are contributing to ongoing supply chain disruptions and cost inflation, including labor cost inflation, the effects of which have continued into 2022.
In response to the reduction in demand for our products and services, including as a result of the COVID-19 pandemic, throughout 2020 and 2021 NCS has undertaken, and the Board has and continues to monitor and evaluate initiatives to reduce our cost structure, limit capital expenditures and enhance our liquidity and access to capital, including:
Reductions in force and reductions to salaries and hourly rates for substantially all employees, not paying 2019 or 2020 bonuses, and a temporary elimination of the employer matching contributions for NCS’s U.S. 401(k) plan and its Registered Retirement Savings Plan in Canada. Such salaries were substantially reinstated in mid-2021, salary increases were implemented in the first quarter of 2022 and employer matching contributions were restored in 2022;
A moratorium on non-essential travel for all employees, negotiation of new rates, work rules and payment schedules with vendors, and reductions in third-party spend, including information technology, financial services and third-party research and development;
Deferral of U.S. employer payroll taxes for 2020, as permitted under the CARES Act, application for, and receipt of, benefits under the Canada Emergency Wage Subsidy (“CEWS”) and Canada Emergency Rent Subsidy (“CERS”) programs, and application for, and receipt of, refundable employee retention tax credits under the Taxpayer Certainty and Disaster Tax Relief Act of 2020;
Reducing planned capital expenditures for 2020 and 2021 and selling excess vehicles;
Closing our district operational facilities in Corpus Christi and Oklahoma City and relocating our U.S. assembly operations; and
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 9. Debt” in our 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 structure 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, with no significant severance or termination benefits incurred during the year ended December 31, 2021. For additional information, see “Note 11. Severance and Other Termination Benefits” of our 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 identifiable 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 year ended December 31, 2021. For additional information, see “Note 6. Property and Equipment” and “Note 7. Goodwill and Identifiable Intangibles” of our 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 United States under our Senior Secured Credit Facility to $25.0 million and further limited the amount we may borrow subject to a borrowing base calculated on eligible receivables, which does not include receivables 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 December 31, 2021 was $15.4 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 were to be further adversely impacted by a decline in market conditions, including as a result of the COVID-19 pandemic.
See Item 1A. Risk Factors for a discussion of additional actual or potential impacts of the COVID-19 pandemic on our business and operations.
Market Conditions
Oil and Natural Gas Drilling and Completion Activity
Oil and natural gas prices remain volatile, with WTI crude oil pricing at approximately $61/BBL at the end of December 2019, falling to approximately $48/BBL at the end of December 2020 before increasing to approximately $75/BBL at the end of December 2021, with crude oil pricing continuing to be supported by voluntary oil production reductions by members of OPEC+ as discussed above. WTI crude oil pricing has continued to rise in 2022 reaching approximately $90 per barrel by mid-February before rising to over $100 per barrel following Russia’s invasion of Ukraine. The improvement in oil demand from 2020 lows, combined with OPEC+ production curtailments has led to global oil and refined products storage levels being below long-term averages, which has also supported oil pricing.
Natural gas pricing was at an average level of $2.56 per MMBtu during the year ended 2019 as supply growth exceeded demand growth. Natural gas pricing fell even further to an average level of $2.03 per MMBtu during the year ended 2020 as it was negatively impacted by the COVID-19 pandemic and resulting market conditions. Natural gas pricing increased to an average level of $3.89 per MMBtu during 2021 but was volatile during the year. 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. Natural gas pricing in the United States has been supported by increased demand for exports of liquified natural gas (“LNG”) in late 2021 and early 2022, especially for power generation in Europe and Asia.
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 reduce drilling and completion activity, which could negatively impact our business.
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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:
Average Price
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Listed and depicted below are the average number of operating onshore rigs in the United States and in Canada per quarter since the first quarter of 2019, as provided by Baker Hughes. The quarterly changes in the Canadian land rig count can be partially attributed to seasonality of activity in that market:
Average Drilling Rig Count
Quarter Ended U.S. Land Canada Land North America Land
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. Both the rig count and completion activity in the United States 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 2021, the average U.S. land rig count continued to increase to an average of 545 during the fourth quarter of 2021, which was 84% higher than the fourth quarter of 2020, but remained 32% below the fourth quarter of 2019. The average land rig count in Canada for the fourth quarter of 2021 was 82% higher than in the same period in 2020 and 17% higher than the same period in 2019. We expect U.S. and Canadian rig counts and completion activity to continue to rise in 2022 compared to prior year levels.
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 well 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 United States exhausted their capital budgets prior to the end of the year, leading to reductions in drilling and completion activity during the fourth quarter.
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 United States. 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
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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 supported sales of our 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 provides opportunities for 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 and enhanced recovery 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, casing buoyancy system, liner hanger systems and toe initiation sleeves products.
Product sales represented 70%, 70% and 71% of our revenues for the years ended December 31, 2021, 2020 and 2019, 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 30%, 30% and 29% of our revenues for the years ended December 31, 2021, 2020 and 2019, 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.
For the years ended December 31, 2021, 2020 and 2019, approximately 62%, 45% and 42%, respectively, of our revenues were derived from sales in Canada and were denominated in Canadian dollars. 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 we 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 services 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. In addition, we are monitoring prices for certain raw materials, including steel and purchased components, which have increased during 2021, with such increases continuing into 2022. While we strive to pass through some of the increases in raw material and component 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
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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 selling, general and administrative (“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.
During 2021, we began to experience tight labor conditions which is leading to increased employee turnover and delays in filling open positions as well as labor cost inflation, which impacts both our cost of sales and our SG&A expenses. This labor cost inflation, which is continuing into 2022, includes increases in salaries and hourly pay rates and is expected to result in increased benefits costs as well.
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 25%, 19% and 22%, for the years ended December 31, 2021, 2020 and 2019, respectively.
Results of Operations
The following table summarizes our revenues and expenses for the years ended December 31, 2021 and 2020. A discussion of our results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019 is included in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 8, 2021 and is incorporated by reference into this Form 10-K.
Year Ended December 31, Variance
Revenues
Cost of sales
Other income (expense)
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Year Ended December 31, 2021 compared to Year Ended December 31, 2020
Revenues
Revenues were $118.5 million for the year ended December 31, 2021 as compared to $107.0 million for the year ended December 31, 2020. This increase reflected higher product sales and services volumes in Canada, an increase in services volumes in the United States and higher international product sales partially offset by reductions in international services volumes and decreased U.S. product sales as well as lower pricing for certain products and services, including at Repeat Precision. Year-over-year increases in activity since the second quarter of 2021 as compared to 2020, more than offset the year-over-year decrease in activity in the first quarter of 2021 as compared to 2020. This reflects the timing of the impact of the decline in market conditions primarily related to the COVID-19 pandemic, which had a negative impact on our revenues beginning in March 2020 and resulted in industry activity that reached trough levels during the third quarter of 2020 before beginning to recover. Activity in Canada experienced a stronger recovery from trough levels than the United States and other international markets. Product sales for the year ended December 31, 2021 were $83.2 million as compared to $75.2 million for the year ended December 31, 2020. Our services revenue was $35.3 million for the year ended December 31, 2021 as compared to $31.8 million for the year ended December 31, 2020.
Cost of sales
Cost of sales was $70.0 million, or 59.1% of revenues, for the year ended December 31, 2021 as compared to $62.9 million, or 58.8% of revenues, for the year ended December 31, 2020. Cost of sales as a percentage of total revenues increased slightly despite the modest increase in revenue primarily due to lower activity levels outside of North America and a reduction in pricing for certain products and services. Cost of sales in the first half of 2021 was also impacted by higher scrap expense and inventory reserves at Repeat Precision related to product design changes. We believe that our cost of sales as a percentage of revenue was negatively impacted by pricing reductions that were the result of a decline in oil and gas market activity levels primarily related to the COVID-19 pandemic and which we have not yet been able to recover. Cost of product sales was $51.9 million or 62.4% of product sales revenue and cost of services was $18.1 million or 51.4% of services revenue for the year ended December 31, 2021. For the year ended December 31, 2020, cost of product sales was $46.6 million or 62.0% of product sales revenue and cost of services was $16.3 million or 51.2% of services revenue.
Selling, general and administrative expenses
Selling, general and administrative expenses were $49.1 million for the year ended December 31, 2021 as compared to $59.4 million for the year ended December 31, 2020. This overall decrease in expense reflects reductions in compensation and benefits associated with lower headcount and lower salary and wages, share-based compensation, professional fees, and bad debt expense of $3.0 million, $1.9 million, $1.6 million and $0.9 million, respectively. Severance charges declined by $5.6 million as compared to 2020 due to the timing of workforce reductions. In addition, the decrease reflects a benefit of $2.3 million in 2021 associated with the U.S. employee retention credit claims. See “Note 10. Commitments and Contingencies” of our consolidated financial statements for additional detail. The overall decrease was partially offset by increases in litigation expenses of $3.6 million and bonus accruals of $3.7 million.
Depreciation
Depreciation was $3.8 million for the year ended December 31, 2021 as compared to $4.4 million for the year ended December 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 and we have sold excess vehicles financed through capital leases. See “Note 6. Property and Equipment” and “Note 15. Leases” of our consolidated financial statements for additional detail.
Amortization
Amortization was $0.7 million for the year ended December 31, 2021 as compared to $1.5 million for the year ended December 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 7. Goodwill and Identifiable Intangibles” of our consolidated financial statements for additional detail.
Impairment
On March 31, 2020, we evaluated our property and equipment and identifiable 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
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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 identifiable intangible assets.See “Note 2. Summary of Significant Accounting Policies,” “Note 6. Property and Equipment” and “Note 7. Goodwill and Identifiable Intangibles” of our consolidated financial statements for additional detail related to these charges. There were no additional impairment charges related to our goodwill, property and equipment or identifiable intangible assets during the remainder of 2020 or for the year ended December 31, 2021.
Interest expense, net
Interest expense, net was $0.7 million for the year ended December 31, 2021 as compared to $1.8 million for the year ended December 31, 2020. The decrease in interest expense, net was primarily a result of the $0.6 million write-off of deferred loan costs associated with the amendment to our Senior Secured Credit Facility in August 2020 and a reduction in the average debt outstanding in 2021 compared to 2020.
Gain on patent infringement settlement
Gain on patent infringement settlement was $25.7 million for the year ended December 31, 2020, which represents the gain realized from the settlement of the final court judgment against Diamondback Industries, Inc. (“Diamondback”) and includes $1.1 million of proceeds from our directors and officers liability insurance related to the reimbursement of legal expenses that we incurred to defend a director and officer in the Diamondback litigation and is net of related legal fees incurred in 2020 of $2.7 million. See “Note 10.Commitments and Contingencies” of our consolidated financial statements.
Foreigncurrencyexchange gain (loss), net
Foreign currency exchange gain was $0.3 million for the year ended December 31, 2021 as compared to a loss of $(1.1) million for the year ended December 31, 2020. The change was primarily due to the movement in the foreign currency exchange rates between the periods.
Income tax expense (benefit)
Income tax expense (benefit) was $0.3 million for the year ended December 31, 2021 as compared to $(7.8) million for the year ended December 31, 2020.
Included in tax expense for the year ended December 31, 2021, was an expense of $1.0 million for tax effects of stock awards and a benefit of $(0.2) million related to effects of taxes on foreign operations.
Included in the tax benefit for the year ended December 31, 2020 were several U.S. tax expense (benefit) adjustments related to the enactment of the CARES Act, including a tax benefit of $(0.9) million for a net operating loss carryback that was previously unavailable and a tax expense of $6.5 million for an increase in a valuation allowance on deferred tax assets not expected to be realized. Also included in the tax benefit for the year ended December 31, 2020 was a tax expense of $1.4 million for a valuation allowance against our Canadian deferred tax asset, a benefit of $(1.5) million related to non-U.S. income taxed at different rates, and an expense of $1.0 million for tax effects of stock awards.
How We Evaluate our Results of Operations
Our management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our results of operations and profitability and include:
Revenues
We primarily sell our products and services under purchase orders with pricing negotiated with individual customers. Our revenues are generated primarily from the sales of our fracturing systems, enhanced recovery systems, well construction and composite plug products and from services related to the utilization of our downhole frac isolation assembly as well as from the provision of tracer diagnostics services. We compare our actual revenue performance on a monthly, quarterly and annual basis to our annual budget, our most recent estimate for the relevant period, and to applicable market metrics.
Adjusted EBITDA and Adjusted EBITDA Less Share-Based Compensation
EBITDA is defined as net (loss) income before interest expense, net, income tax (benefit) expense and depreciation and amortization. Adjusted EBITDA is defined as EBITDA adjusted to exclude certain items which we believe are not reflective of ongoing operating performance or which, in the case of impairments and share-based compensation, are non-cash in nature. Adjusted
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EBITDA Less Share-Based Compensation is calculated in the same manner as Adjusted EBITDA, with the sole exception being that it does not addback non-cash share-based compensation expense. We believe that Adjusted EBITDA is an important measure that excludes costs that management believes do not reflect our ongoing operating performance and certain costs associated with our capital structure. We believe that Adjusted EBITDA Less Share-Based Compensation presents our financial performance in a manner that is comparable to the presentation provided by many of our peers. Accordingly, Adjusted EBITDA and Adjusted EBITDA Less Share-Based Compensation are key metrics that management uses to assess the period-to-period performance of our core business operations. We believe that presenting these metrics enables investors to assess our performance from period to period using the same metrics utilized by management and to evaluate our performance relative to other companies that are not subject to such factors. EBITDA, Adjusted EBITDA and Adjusted EBITDA Less Share-Based Compensation are not defined under GAAP, are not measures of net income, income from operations or any other performance measure derived in accordance with GAAP and are subject to important limitations. Adjusted EBITDA and Adjusted EBITDA Less Share-Based Compensation may not be comparable to similarly titled measures of other companies in our industry and are not measures of performance calculated in accordance with GAAP.
A reconciliation of net (loss) income, the most directly comparable GAAP measure, to Adjusted EBITDA and Adjusted EBITDA Less Share-Based Compensation on a consolidated basis for the periods indicated follows (in thousands):
Year Ended December 31,
Income tax expense (benefit) 263 (7,783)
Gain on patent infringement settlement (3) — (25,678)
Net benefit of ERC (6) (1,908) —
Foreign currency (gain) loss (7) (283) 1,060
Severance and other termination benefits (8) — 5,661
Adjusted EBITDA Less Share-Based Compensation $ 4,873 $ (5,539)
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(1)Includes the remaining deferred loan costs of $0.6 million related to prior credit agreements that were expensed when the debt was amended and repaid during 2020.
(2)Represents non-cash impairment charges recorded in 2020 related to property and equipment and intangible assets.
(3)Represents gain realized from the final court judgment against Diamondback. See “Note10. Commitments and Contingencies” of our consolidated financial statements.
(4)Represents non-cash compensation charges related to share-based compensation granted to our officers, employees and directors.
(5)Represents non-capitalizable costs of professional services incurred in connection with legal proceedings and the evaluation of potential acquisitions.
(6)Represents ERC benefits recorded during 2021 less the effect on bonus and associated payroll burden accruals.
(7)Represents unrealized and realized foreign currency translation gains and losses primarily due to movement in the foreign exchange rates during the applicable periods.
(8)Represents charges incurred in connection with the reductions in workforce implemented in 2020.
(9)Represents the impact of a research and development subsidy that is included in income tax expense (benefit) in accordance with GAAP along with other charges and credits.
Free Cash Flow and Free Cash Flow Less Distributions to Non-Controlling Interest
We utilize free cash flow to evaluate the cash generated by our operations and results of operations. We define free cash flow as net cash provided by (used in) operating activities less purchases of property and equipment (inclusive of the purchase and development of software and technology) plus proceeds from sales of property and equipment, as presented in our consolidated statement of cash flows. Management believes free cash flow is useful because it provides information to investors regarding the cash that was available in the period that was in excess of our needs to fund our capital expenditures and other investment needs. We define free cash flow less distributions to non-controlling interest as free cash flow (as defined above) less distributions to non-controlling interest, as presented in the net cash used in financing activities section of our consolidated statements of cash flows. Management believes that free cash flow less distributions to non-controlling interest is useful because it provides information to investors
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regarding the cash that was available in the period that was in excess of our needs to fund our capital expenditures, other investment needs, and cash distributions to our joint venture partner. Free cash flow and free cash flow less distributions to non-controlling interest do not represent our residual cash flow available for discretionary expenditures, as we have non-discretionary expenditures, including, but not limited to, repayment of outstanding balances under our Senior Secured Credit Facility, that are not deducted in calculating either free cash flow or free cash flow less distributions to non-controlling interest. Free cash flow and free cash flow less distributions to non-controlling interest are non-GAAP financial measures and should not be considered as an alternative to cash provided by operating activities as a cash flow measurement.
A reconciliation of net cash provided by (used in) operating activities, the most directly comparable GAAP measure, to each of free cash flow and free cash flow less distributions to non-controlling interest for the periods indicated is as follows (in thousands):
Year Ended December 31,
Net cash provided by operating activities $ 11,583 $ 35,117
Purchases of property and equipment (495) (2,098)
Purchase and development of software and technology (338) (55)
Proceeds from sales of property and equipment 389 1,094
Distributions to non-controlling interest (2,750) (17,550)
Free cash flow less distributions to non-controlling interest $ 8,389 $ 16,508
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 December 31, 2021, we had cash and cash equivalents of $22.2 million, and total outstanding indebtedness of $7.8 million related to capital lease obligations, of which $1.5 million is due within 12 months. Our 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, which does not include receivables at Repeat Precision. At December 31, 2021, our borrowing base under the Senior Secured Credit Facility was $15.4 million, with no outstanding borrowings and less than $0.1 million in letter of credit commitments utilized. 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 were to be adversely impacted by a decline in market conditions. We were in compliance with our debt covenants at December 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 and after. Our principal liquidity needs have been, and are expected to continue to be, capital expenditures, working capital, debt service and potential mergers and acquisitions.
We plan to incur approximately $2 million to $3 million in capital expenditures during 2022, which includes (i) upgrades to our tracer diagnostics deployment and sampling equipment, (ii) machining equipment and molds to increase manufacturing capacity at Repeat Precision, (iii) new computers and engineering workstations and (iv) equipment to support growth in our Canadian liner hanger operations. Our capital expenditures, including the purchase and development of software and technology, for the years ended December 31, 2021 and 2020 were $0.8 million and $2.2 million, respectively. Our 2021 capital expenditures included (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.
To the extent we require additional liquidity to fund our capital requirements or repay existing indebtedness, we would expect to obtain it 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 manage 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.
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Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented (in thousands):
Year Ended December 31,
Net cash provided by operating activities $ 11,583 $ 35,117
Net cash used in investing activities (444) (1,059)
Net cash used in financing activities (4,265) (29,773)
Effect of exchange rate changes on cash and cash equivalents (251) 17
Net change in cash and cash equivalents $ 6,623 $ 4,302
Operating Activities
Net cash provided by operating activities was $11.6 million compared to $35.1 million for the years ended December 31, 2021 and 2020, respectively. The decrease in cash flow was primarily driven by the receipt of $21.4 million in cash proceeds at Repeat Precision in 2020 associated with a patent infringement settlement and unfavorable changes in accounts receivable, inventories and other liabilities as well as lower non-cash share-based compensation and depreciation and amortization expenses. The decrease was partially offset by higher net income in 2021 as compared to 2020, after adjusting for impairment charges and the gain on patent infringement settlement, due to higher activity levels in 2021 as markets begin to recover from the COVID-19 pandemic shut-downs during 2020. In addition, there were favorable changes in accounts payable, accrued expenses, income taxes receivable/payable and prepaid expenses and other assets.
Investing Activities
Net cash used in investing activities was $0.4 million and $1.1 million for the years ended December 31, 2021 and 2020, respectively. The decrease in cash used in investing activities during the year ended December 31, 2021 as compared to the year ended December 31, 2020 was primarily related to reduced capital expenditures for property and equipment partially offset by an increase in purchase and development of software and technology and lower asset sale proceeds.
Financing Activities
Net cash used in financing activities for the years ended December 31, 2021 and 2020 was $4.3 million and $29.8 million, respectively. Our primary use of funds during the year ended December 31, 2021 was $2.8 million of distributions to our joint venture partner and principal payments under finance leases of $1.3 million. The primary use of funds during the year ended December 31, 2020 was distributions to our joint venture partner of $17.6 million, net repayments under the Senior Secured Credit Facility of $10.0 million, and principal payments under finance leases of $1.5 million.
Material Cash Requirements
Our material cash requirements include the following contractual and other obligations.
Financing Arrangements
Our Senior Secured Credit Facility consists of a senior secured revolving credit facility in an aggregate principal amount of $25.0 million. Total borrowings available under the Senior Secured Credit Facility may be limited subject to a borrowing base calculated on eligible receivables, which does not include receivables at Repeat Precision. At December 31, 2021, our borrowing base under the Senior Secured Credit Facility was $15.4 million, we had no outstanding indebtedness under the Senior Secured Credit Facility, and we utilized letter of credit commitments of less than $0.1 million.
Repeat Precision also has an outstanding promissory note with an aggregate borrowing capacity of up to $4.3 million as of December 31, 2021, subject to a borrowing base. As of December 31, 2021, Repeat Precision had no outstanding indebtedness under the promissory note.
See “Note 9. Debt” to our consolidated financial statements for additional details regarding our credit agreement and the promissory note.
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Leases
We have operating and finance leases for facilities, vehicles, and equipment. As of December 31, 2021, we had lease payment obligations, including interest payments for finance leases of $15.0 million, with $3.6 million payable within 12 months. See “Note 15. Leases” to our consolidated financial statements for additional information on lease obligations and maturities.
Purchase Obligations
Our purchase obligations in the amount of $9.4 million primarily represent commitments to purchase goods or services to be utilized in the normal course of business, of which $7.8 million is payable within 12 months and is not reflected in the accompanying consolidated balance sheets.
Tax Obligations
Our tax obligations of $0.7 million, of which $0.4 million is due within 12 months, include deferred FICA taxes and a mandatory one-time tax on accumulated earnings of foreign subsidiaries resulting from the 2017 Tax Act. The deferred FICA taxes payable are due in 2022. The income tax payable related to the 2017 Tax Act is due in installments in varying percentages over the next four years.
Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations is derived from the review of our consolidated financial statements prepared in accordance with GAAP, which includes our interpretation of accounting guidance and application through accounting policies. See “Note 2. Summary of Significant Accounting Policies.” The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. Our actual results may differ from these estimates. The accounting estimates that we believe to be the most critical to an understanding of our financial condition and results of operations and that require the most complex and subjective management judgments are discussed below.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses that may result from the inability of our customers to make required payments. We evaluate collectability of customer accounts based upon credit approval practices, industry and customer historical experience as well as the current and projected financial condition of the specific customer. Amounts deemed to be uncollectible are applied against the allowance for doubtful accounts. Our business has seasonality, and the balance of our outstanding receivables fluctuates during the fiscal year based upon activity levels, sales volume, and general industry conditions. We periodically record bad debt expense or recoveries, which totaled a recovery of $0.1 million and expense of $0.8 million and $3.5 million for the years ended December 31, 2021, 2020 and 2019, respectively, though we have been successful historically recovering some of these amounts over time. Further, to the extent deemed necessary by management, and depending on the circumstances, we may issue customer credits or concessions which reduce our revenues, but do not impact our bad debt expense. The nature of these concessions may be to maintain a customer relationship. Historically, these concessions have not been significant to our financial condition or results of operations and would likely not be significant should there be a 10% change in the level of concessions within a fiscal year.
Inventories
Inventories of raw material, work in progress and finished goods are maintained and valued at the lower of cost or estimated net realizable value, with cost determined at standard costs which approximates the first-in, first-out or average cost basis. Periodically, we evaluate our inventory to determine items that may be obsolete, slow-moving or in excess based upon historical sales experience and projected sales forecasts. Our estimates involve subjectivity and an evaluation of customer preferences over time which may impact our ability to recover the cost of inventory and generate a profitable return. Although we believe our estimates to be reasonable, we cannot assure that our reserves will be adequate to cover potential losses, or that we will have recoveries, if there are significant changes in market preferences or technological advancements by our competitors that render a portion of our current inventory as obsolete. We have incurred charges to cost of sales related to obsolescence of $1.8 million, $1.8 million, and $0.9 million for the years ended December 31, 2021, 2020 and 2019, respectively. An increase of obsolescence expense by 10%, or $0.2 million, would not be deemed material to our financial statements.
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Impairments
We evaluate our property and equipment and identifiable intangible assets including goodwill for impairment whenever changes in circumstances indicate that the carrying amount of an asset group may not be recoverable or if there are potential indicators of impairment. Estimating future net cash flows requires us to make judgments regarding long-term forecasts of future revenues and costs related to the assets subject to review. These forecasts are uncertain in that they require assumptions about our revenue growth, operating margins, capital expenditures, future market conditions and technological developments. In addition, if we are required to determine the fair value of our reporting units to test goodwill for impairment, we must apply estimates, assumptions, and judgment regarding revenue growth, operating margins, capital expenditures, future market conditions, weighted average costs of capital and terminal growth rate, and we must evaluate the metrics of a deemed set of comparable companies and market earnings multiples. Actual results may not align with these assumptions, and our expectations regarding future net cash flows may change such that a material impairment could result. In recent periods, we have recorded impairments associated with property and equipment, identifiable intangible assets and goodwill, as further described in the accompanying consolidated financial statements. We believe that the estimates and assumptions used in our impairment assessments are reasonable. However, if market conditions change dramatically, as seen during early 2020 as a result of the COVID-19 pandemic, the impact on our forecasts and projections may be significant which could result in future impairments for our reportable units with long-term assets including goodwill.
Income Taxes
We are taxed as a corporation as defined under the Internal Revenue Code. The liability method is used in accounting for deferred income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when these differences are expected to reverse. The realizability of deferred tax assets is evaluated annually and a valuation allowance is provided if it is more likely than not that the deferred tax assets will not give rise to future benefits. We recognize tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained, based upon technical merits, upon examination by the taxing authorities. If the income tax position is expected to meet the more likely than not criteria, the benefit recorded in the consolidated financial statements equals the largest amount that is greater than 50% likely to be realized upon its ultimate settlement. A valuation allowance to reduce deferred tax assets is established when it is more likely than not that some portion or all the deferred tax assets will not be realized.
We have incurred operating losses during each of the years ended December 31, 2021, 2020 and 2019. We have applied valuation allowances to reduce our deferred tax assets as of December 31, 2021 and 2020, based upon our forecasts of future taxable income in the jurisdictions in which these deferred tax assets are recorded. Our financial statements could be materially affected if: (i) our actual results differ significantly from our forecast estimates; (ii) there are future changes in enacted tax laws with retroactive application; or (iii) tax authorities do not agree with our application of the tax law to our circumstances and the matter is not ultimately resolved in our favor.
Litigation
In the ordinary course of business, from time to time, we have various claims, lawsuits and administrative proceedings that are pending or threatened with respect to commercial, intellectual property and employee matters. We accrue for contingencies where the occurrence of a material loss is probable and can be reasonably estimated, based on our estimate of the expected liability. Our assessment of the likely outcome of litigation matters is based on our judgment of several factors, including experience with similar matters, prior history, precedents, relevant financial information and other evidence and facts specific to the matter. Although the outcome of any legal proceeding cannot be predicted with any certainty, if a settlement is deemed to be probable and estimable, management would consider relevant facts and circumstances to determine the potential range of loss exposure or gain on settlement, if any. Future settlements which result in loss or awards could be material to our financial statements and cannot be predicted with certainty. For example, during 2020, we received a favorable judgement associated with a Repeat Precision litigation matter which resulted in a gain on patent infringement settlement of $25.7 million.
Recently Issued Accounting Pronouncements
See “Note 2. Summary of Significant Accounting Policies” to our consolidated financial statements for discussion of the accounting pronouncements we recently adopted and the accounting pronouncements recently issued by the Financial Accounting Standards Board (“FASB”).
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 (i) the last day of our fiscal year (a) following the fifth anniversary of the completion of our IPO, (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
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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 (ii) 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 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our financial position is exposed to a variety of risks, including commodity price risk, foreign currency exchange rate risk, interest rate risk and credit risk. We have seen an increase in these risks and related uncertainties with increased volatility in oil and gas prices and the financial markets as a result of the COVID-19 pandemic.
Commodity Price Risk
The market for our products and services is indirectly exposed to fluctuations in the prices of crude oil and natural gas to the extent such fluctuations impact drilling and completion activity levels and thus impact the activity levels of our customers in the E&P industry. Additionally, because we do not sell our products under long-term contracts, we believe we are particularly exposed to short-term fluctuations in the prices of crude oil and natural gas. We do not currently intend to hedge our indirect exposure to commodity price risk.
Foreign Currency Exchange Rate Risk
A substantial amount of our revenues is derived in Canada and, accordingly, our competitiveness and financial results are subject to foreign currency fluctuations where revenues and costs are denominated in Canadian dollars rather than USD. During the years ended December 31, 2021, 2020 and 2019, approximately 62%, 45% and 42%, respectively, of our revenues were attributable to our operations in Canada. We may use foreign currency forward exchange contracts to hedge our future exposure to CAD. We also derive revenue from several jurisdictions outside of North America, including countries that occasionally experience periods of significant inflation, which occurred in Argentina in 2019, 2020 and 2021. We do not currently intend to hedge our future exposure to the Argentine Peso or other foreign currencies.
Interest Rate Risk
We are primarily exposed to interest rate risk through our Senior Secured Credit Facility, which was amended on August 6, 2020. As of December 31, 2021, we had no outstanding indebtedness under our Senior Secured Credit Facility.
Borrowings under the Senior Secured Credit Facility may be made in USD for Adjusted Base Rate Advances, and in USD, 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 applicable interest rate at December 31, 2021 was 3.5%.
Credit Risk
Our customers are E&P companies and other oilfield services companies. This concentration of counterparties operating in a single industry may increase our overall exposure to credit risk, in that the counterparties may be similarly affected by changes in economic, regulatory or other conditions. We manage credit risk by analyzing the counterparties’ financial condition prior to accepting new customers and prior to adjusting existing credit limits.
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Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
Page
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 2021 and 2020 55
Notes to Consolidated Financial Statements 60
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Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
NCS Multistage Holdings, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheet of NCS Multistage Holdings, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2021, the related consolidated statements of operations, comprehensive loss, shareholders’ equity, and cash flows for the year ended December 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Companyas of December 31, 2021, and the results of itsoperations and itscash flows for the year ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2021.
Houston, Texas
March 8, 2022
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of NCS Multistage Holdings, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of NCS Multistage Holdings, Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and the related consolidated statements of operations, of comprehensive loss, of changes in stockholders’ equity and of cash flows for each of the two years in the period ended December 31, 2020, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
March 8, 2021
We served as the Company’s auditor from 2013 to 2021, which includes periods before the Company became subject to SEC reporting requirements.
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NCS MULTISTAGE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, December 31,
Assets
Current assets
Prepaid expenses and other current assets 3,290 2,975
Noncurrent assets
Identifiable intangibles, net 5,744 6,413
Deferred income taxes, net 236 205
Liabilities and Stockholders’ Equity
Current liabilities
Current maturities of long-term debt 1,483 1,347
Noncurrent liabilities
Long-term debt, less current maturities 6,335 4,442
Operating lease liabilities, long-term 3,779 3,989
Deferred income taxes, net 114 13
Commitments and contingencies (Note 10)
Stockholders’ equity
Accumulated other comprehensive loss (82,094) (81,780)
Total liabilities and stockholders' equity $ 142,325 $ 138,678
The accompanying notes are an integral part of these consolidated financial statements.
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NCS MULTISTAGE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended December 31,
Revenues
Cost of sales
Change in fair value of contingent consideration — — 37
Other income (expense)
Gain on patent infringement settlement — 25,678 —
Foreign currency exchange gain (loss) 283 (1,060) (958)
Net income attributable to non-controlling interest 955 18,493 10,005
Loss per common share
Weighted average common shares outstanding
The accompanying notes are an integral part of these consolidated financial statements.
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NCS MULTISTAGE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
Year Ended December 31,
Foreign currency translation adjustments, net of tax of $0 (314) (969) 3,219
Comprehensive income attributable to non-controlling interest 955 18,493 10,005
The accompanying notes are an integral part of these consolidated financial statements.
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NCS MULTISTAGE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands, except share data)
Shares Amount Shares Amount Capital Loss Deficit Shares Amount Interest Equity
Share-based compensation — — — — 12,204 — — — — — 12,204
Distribution to noncontrolling interest — — — — — — — — — (6,000) (6,000)
Vesting of restricted stock — — 10,320 — — — — — — — —
Shares withheld — — — — — — — (3,218) (315) — (315)
Cemblend exchangeable shares (1) — 66,347 1 (1) — — — — — —
Proceeds from the issuance of ESPP shares — — 13,584 — 1,024 — — — — — 1,024
Currency translation adjustment — — — — — 3,219 — — — — 3,219
Share-based compensation — — — — 7,723 — — — — — 7,723
Distribution to noncontrolling interest — — — — — — — — — (17,550) (17,550)
Exercise of stock options — — 675 — — — — — — — —
Vesting of restricted stock — — 26,028 1 (1) — — — — — —
Shares withheld — — — — — — — (7,441) (157) — (157)
Currency translation adjustment — — — — — (969) — — — — (969)
Share-based compensation — — — — 4,221 — — — — — 4,221
Distribution to noncontrolling interest — — — — — — — — — (2,750) (2,750)
Vesting of restricted stock — — 25,774 — — — — — — — —
Shares withheld — — — — — — — (5,318) (197) — (197)
Currency translation adjustment — — — — — (314) — — — — (314)
The accompanying notes are an integral part of these consolidated financial statements.
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NCS MULTISTAGE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
Cash flows from operating activities
Adjustments to reconcile net loss to net cash provided by operating activities:
Amortization of deferred loan cost 281 296 312
Deferred income tax expense (benefit) 96 (3,202) 9,000
Gain on sale of property and equipment (378) (592) (312)
Write-off of deferred loan costs — 606 —
Gain on patent infringement settlement — (25,678) —
Change in fair value of contingent consideration — — 37
Net proceeds from patent infringement settlement — 21,370 —
Payment of contingent consideration — — (3,042)
Proceeds from note receivable 281 302 —
Changes in operating assets and liabilities:
Prepaid expenses and other assets (437) (3,022) 488
Cash flows from investing activities
Purchases of property and equipment (495) (2,098) (6,123)
Purchase and development of software and technology (338) (55) (251)
Proceeds from sales of property and equipment 389 1,094 1,372
Net cash used by investing activities (444) (1,059) (5,002)
Cash flows from financing activities
Equipment note borrowings — — 835
Payments on equipment note and finance leases (1,318) (1,513) (5,021)
Revolver and line of credit borrowings 360 5,000 —
Payment of contingent consideration — — (6,958)
Proceeds from the issuance of ESPP shares — — 1,024
Effect of exchange rate changes on cash and cash equivalents (251) 17 471
Supplemental cash flow information
Cash paid for interest, net of amounts capitalized $ 423 $ 929 $ 1,070
Cash paid for income taxes (net of refunds) (3,528) (1,924) 122
Noncash investing and financing activities
Return of vehicles under finance lease $ (187) $ (798) $ —
Changes in accounts payable related to capital expenditures 6 (184) (599)
The accompanying notes are an integral part of these consolidated financial statements.
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Note 1. Organization and Basis of Presentation
Organization
NCS Multistage Holdings, Inc., a Delaware corporation, through its wholly owned subsidiaries and subsidiaries for which it has a controlling voting interest (collectively referred to as the “Company,” “NCS,” “we,” “our” and “us”), is primarily engaged in providing engineered products and support services for oil and natural gas well completions and field development strategies. We offer our products and services primarily to exploration and production companies for use in onshore wells. We operate through service facilities principally located in Houston and Odessa, Texas; Tulsa, Oklahoma; Billings, Montana; Morgantown, West Virginia; Calgary, Red Deer, Grande Prairie and Estevan, Canada; Neuquén, Argentina and Stavanger, Norway.
Basis of Presentation
Our accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). All intercompany accounts and transactions have been eliminated in consolidation. We consolidate Repeat Precision, LLC (“Repeat Precision”), a 50% owned entity, because NCS has a controlling voting interest. The other party’s ownership is presented separately as a non-controlling interest.
Note 2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include but are not limited to estimated losses on accounts receivables, estimated realizable value on excess and obsolete inventories, estimates related to fair value of reporting units for purposes of assessing possible goodwill impairment, expected future cash flows from long lived assets to support impairment tests, share based compensation, amounts of deferred taxes and income tax contingencies. Actual results could materially differ from those estimates.
COVID-19 Pandemic Impacts
Coronavirus disease 2019 (“COVID-19”), an infectious disease caused by severe acute respiratory syndrome coronavirus 2, has spread globally. The World Health Organization declared the COVID-19 outbreak a public health emergency of international concern on January 30, 2020 and a pandemic on March 11, 2020.
As the impact of the pandemic continues to evolve, estimates and assumptions about future events and their effects cannot be determined with certainty and therefore require judgment. These estimates and assumptions may change in future periods and will be recognized in the consolidated financial information as new events occur and additional information becomes known. To the extent actual results differ materially from those estimates and assumptions, our future financial statements could be affected.
Foreign Currency
Our functional currency is the United States Dollar (“USD”). The financial position and results of operations of our significant foreign subsidiaries are generally measured using the local currency as the functional currency. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 830, Foreign Currency Matters, revenues and expenses of the significant foreign subsidiaries have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the rates of exchange on the consolidated balance sheet date. The resulting translation gain and loss adjustments have been recorded directly as a separate component of other comprehensive (loss) in the accompanying consolidated statements of comprehensive (loss) income, and changes in stockholders’ equity.
Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the consolidated statements of operations as incurred.
Revenue Recognition
We derive our revenues primarily from highly engineered products and support services. Revenues are based upon a purchase order, contract or other persuasive evidence of an arrangement with the customer that includes a fixed or determinable price, provided that collectability is reasonably assured, but such arrangements do not generally include right of return or other similar provisions or other significant post-delivery obligations. Sales and value added taxes that we collect concurrent with revenue-producing activities
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are excluded from revenue. We recognize revenue through the following steps: (i) identify the contract, (ii) identify the performance obligations, (iii) determine the transaction price, (iv) allocate the transaction price and (v) satisfy the performance obligation.
On occasion, we issue credits to our customers that are related specifically to the performance of our products or the services we provide, with such credits reducing the amount of revenue for the completed sales. These credits are infrequent, situation specific and cannot be individually estimated in advance.
The payment terms and conditions in our customer contracts vary. We do not have contracts that contain a financing component and generally do not accept noncash consideration from customers.
NCS has elected to recognize shipping and handling costs when control of the product transfers to the customer. These costs are included in cost of sales in our consolidated statements of operations.
Product Sales Revenues
For product sale arrangements that are standard inventory products or modified inventory products with an alternative use, revenue is recognized at a point in time when control transfers. Control generally transfers upon shipment or delivery, and delivery is based on the customer instructions. Customers may also request bill and hold arrangements in writing. Once we have completed the bill and hold order, the products are segregated from the rest of inventory in the warehouse. The transaction price for product sales having a performance obligation is the price per unit times the unit quantity ordered and shipped to the customer or consumed at the well site.
Services Revenues
For service arrangements that do not have a contract provision with a right to a payment for services up to the date of termination, revenue is recognized when the job has been completed, which usually includes a customer signature or acknowledgement and when there are no additional services or future obligations required by us. The transaction price is determined by the contract unit day rate times the cumulative number of days of service provided upon the completion of the service and upon customer acceptance.
For service arrangements that do have a contract provision with a right to payment for services up to the date of termination, revenue is recognized over time using a unit rate (labor and materials) output method that corresponds to the value we would receive upon termination of the contract at a reporting period. In applying the output method at the end of a quarter, we confirm there is no material work in progress omitted from the measurement of the output. The transaction price for the period end is determined by the contract unit rate times the cumulative number of units earned up to the reporting period less any revenue recognized in prior periods.
Cash and Cash Equivalents
We consider all highly liquid instruments purchased with an original maturity date of three months or less to be cash equivalents. These items are carried at cost, which approximates fair value.
In accordance with ASC 230, Statements of Cash Flow, cash flows from our significant foreign subsidiaries are calculated based on our functional currency. As a result, amounts related to changes in assets and liabilities reported in the consolidated statements of cash flows will not necessarily agree to changes in the corresponding balances on the consolidated balance sheets.
Concentration of Credit Risk
Financial instruments that potentially subject us to credit risk are cash and cash equivalents and trade accounts receivable. Cash balances are maintained in financial institutions which, at times, exceed federally insured limits. We monitor the financial condition of the financial institutions in which the accounts are maintained and have not experienced any losses in such accounts.
Substantially all of our sales are to customers whose activities are directly or indirectly related to the oil and gas industry. We generally extend credit to these customers and, therefore, collectability of receivables is affected by market conditions in the oil and gas industry. We perform ongoing credit evaluations as to the financial condition of our customers with respect to trade accounts receivables. Generally, no collateral is required as a condition of sale.
For the year ended December 31, 2020, we recognized revenue from one customer totaling $10.2 million, which was more than 10% of total revenue. No single customer individually accounted for 10% or more of our consolidated revenue during 2021 or 2019. One customer accounted for 11%, 12% and 10% of our trade accounts receivable balance as of December 31, 2021, 2020 and 2019, respectively.
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Accounts Receivable, Trade and Allowance for Doubtful Accounts
Trade accounts receivable are recorded at their invoiced amounts and do not bear interest. We perform ongoing credit evaluations of our clients and monitor collections and payments.
We maintain an allowance for doubtful accounts for estimated losses that may result from the inability of our customers to make required payments. Earnings are charged with a provision for doubtful accounts based on a current review of the collectability of customer accounts by management. Such allowances are based upon several factors including, but not limited to credit approval practices, industry and customer historical experience as well as the current and projected financial condition of the specific customer. Accounts deemed uncollectible are applied against the allowance for doubtful accounts. As of December 31, 2021 and 2020, we have recorded $0.1 million and $0.6 million, respectively, in our allowance for doubtful accounts.
Inventories
Inventories consist primarily of raw material, product components, assembled products, certain components used to internally construct our frac isolation assemblies, and chemicals used in our tracer diagnostics services in raw materials or finished goods. Inventories are stated at the lower of cost or estimated net realizable value. Cost is determined at standard costs approximating the first-in, first-out or average cost basis. We continuously evaluate inventories, based on an analysis of inventory levels, historical sales experience and future sales forecasts, to determine obsolete, slow-moving and excess inventory. We utilize an excess and obsolete reserve to adjust such inventory to its estimated recoverable value, with an offset to cost of sales in the current period.
Impairments
We evaluate our property and equipment and identifiable intangible assets for impairment whenever changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Should the review indicate that the carrying value is not fully recoverable, the amount of the impairment loss is determined by comparing the carrying value to the estimated fair value. We assess recoverability based on undiscounted future net cash flows. Estimating future net cash flows requires us to make judgments regarding long-term forecasts of future revenues and costs related to the assets subject to review. These forecasts are uncertain in that they require assumptions about our revenue growth, operating margins, capital expenditures, future market conditions and technological developments. If changes in these assumptions occur, our expectations regarding future net cash flows may change such that a material impairment could result. There was no impairment of property and equipment and identifiable intangible assets during the years ended December 31, 2021 and 2019. For the year ended December 31, 2020, we recognized an impairment charge of $50.2 million related to property and equipment and identifiable intangible assets. See “Note 6. Property and Equipment” and “Note 7. Goodwill and Identifiable Intangibles” included herewith for further information related to these charges.
An assessment of potential goodwill impairment indicators is performed annually or whenever there is a triggering event that indicates an impairment loss may have been incurred. If required, we typically perform an annual impairment test for goodwill using an assessment date in the fourth quarter of the fiscal year. Under GAAP, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of one or more of our reporting units is greater than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, there is no need to perform any further testing. However, if we conclude otherwise, then we are required to perform a quantitative impairment test by calculating the fair value of the reporting unit and comparing this value with the carrying value of the reporting unit. We also have the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test. The fair value of the reporting unit is determined using a combination of a market multiple and a discounted cash flow approach. Determining the fair value of a reporting unit requires the use of estimates, assumptions and judgment. The principal estimates and assumptions that we use include revenue growth, operating margins, capital expenditures, future market conditions, weighted average costs of capital, a terminal growth rate, the set of comparable companies utilized, and the earnings metrics and multiples utilized. We believe that the estimates and assumptions used in impairment assessments are reasonable. If the fair value of the reporting unit is less than the carrying amount, an impairment charge is recorded in the amount of the difference. No impairment charge was recorded for the years ended December 31, 2021 and 2020. We recorded an impairment charge of $7.9 million for the year ended December 31, 2019. For additional information, see “Note 7. Goodwill and Identifiable Intangibles”.
Property and Equipment
Property and equipment are stated at historical cost adjusted for impairment, less accumulated depreciation. Equipment held under finance leases are stated at fair value which is typically the present value of minimum lease payments at the inception of the lease, less accumulated depreciation. Expenditures for property and equipment and for items which substantially increase the useful lives of existing assets are capitalized at cost and depreciated over their estimated useful life utilizing the straight-line method. Routine expenditures for repairs and maintenance are expensed as incurred. Depreciation is calculated over the estimated useful lives of the related assets using the straight-line method. Leasehold improvements and property under finance leases are amortized over the
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shorter of the remaining lease term or useful life of the related asset. Depreciation expense includes amortization of assets under finance leases. The cost and related accumulated depreciation of assets retired or otherwise disposed of are eliminated from the accounts, and any resulting gains or losses are recognized in the year of disposal as a component of other income, net.
Depreciation on property and equipment, including assets held under finance leases, is calculated using the straight-line method over the following useful service lives or lease term (which includes reasonably assured renewal periods):
Years
Buildings 30
Building equipment and leasehold improvements 1 - 15
Machinery and equipment and service equipment 5 - 12
Computers and software 3 - 5
Furniture and fixtures 3 - 5
Vehicles 2 - 4
Right of use assets - finance leases (Lease term) 3 - 10
Business Combinations, Goodwill and Identifiable Intangible Assets
Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method of accounting, the total consideration transferred in connection with the acquisition is allocated to the tangible and intangible assets acquired, liabilities assumed, and any non-controlling interest in the acquiree based on their fair values. Goodwill acquired in connection with business combinations represents the excess of consideration transferred over the net tangible and identifiable intangible assets acquired. Certain assumptions and estimates are employed in evaluating the fair value of assets acquired and liabilities assumed. These estimates may be affected by factors such as changing market conditions, technological advances in the oil and natural gas industry or changes in regulations governing that industry. The most significant assumptions requiring judgment involve identifying and estimating the fair value of intangible assets and the associated useful lives for establishing amortization periods. To finalize purchase accounting for significant acquisitions, we utilize the services of independent valuation specialists to assist in the determination of the fair value of acquired intangible assets.
Costs related to the acquisition, other than those associated with the issuance of debt or equity securities, that we incur in connection with a business combination are expensed as incurred.
Any contingent consideration payable is recognized at fair value at the acquisition date. Liability-classified contingent consideration is remeasured each reporting period with changes in fair value recognized in earnings until the contingent consideration is settled.
All identifiable intangibles with definite lives are amortized on a straight-line basis over the estimated useful life or term of related agreements. Deferred loan costs are amortized to interest expense using the effective interest method. Certain costs incurred in the development of internal-use software applications are capitalized and costs incurred outside of the software application development stage are expensed as incurred. The amounts capitalized are included in intangible assets, categorized as internally developed software, and are amortized on a straight-line basis over the estimated useful life of the software when ready for the intended use. These assets are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.
Income Taxes
We are taxed as a corporation as defined under the Internal Revenue Code. The liability method is used in accounting for deferred income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when these differences are expected to reverse. The realizability of deferred tax assets is evaluated annually and a valuation allowance is provided if it is more likely than not that the deferred tax assets will not give rise to future benefits. We follow guidance in ASC 740, Income Taxes, for uncertainty in income taxes by prescribing the minimum recognition threshold an income tax position is required to meet before being recognized in the consolidated financial statements. Each income tax position is assessed using a two-step process. A determination is first made as to whether it is more likely than not that the income tax position will be sustained, based upon technical merits, upon examination by the taxing authorities. If the income tax position is expected to meet the more likely than not criteria, the benefit recorded in the consolidated financial statements equals the largest amount that is greater than 50% likely to be realized upon its ultimate settlement. A valuation allowance to reduce deferred tax assets is established when it is more likely than not that some portion or all the deferred tax assets will not be realized. We recognize accrued interest and penalties related to uncertain tax positions in other income, net on the consolidated statements of operations.
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Share-Based Compensation
We account for our stock-based compensation awards in accordance with ASC 718, Compensation—Stock Compensation (“ASC 718”). To measure the grant-date fair value of share-based compensation, we use the market price of our common stock for equity-classified restricted stock units (“RSUs”) and equivalent stock units, or cash-settled, liability-classified RSUs (“ESUs”), the Black-Scholes model for options and a Monte Carlo simulation for the performance stock unit awards (“PSUs”). We measure all share-based compensation awards at fair value on the date they are granted and recognize the compensation expense in the financial statements over the requisite period and record forfeitures as they occur. As the ESUs will be settled in cash, we record a liability, which is remeasured each reporting period at fair value based upon the closing stock price of our common stock until the awards are settled.
We also have an Employee Stock Purchase Plan (the “U.S. ESPP”) and an employee stock purchase plan specifically applicable to non-U.S. employees on substantially the same terms as the ESPP (the “Non-U.S. ESPP” and together with the U.S. ESPP, the “ESPP”), which allows eligible employees to purchase shares of our common stock. The purchase price of the stock is 85% of the lower of the stock price at the beginning or end of the plan period. The fair value of the employees’ purchase rights under the ESPP is also estimated using the Black-Scholes model. The ESPP was suspended for future offering periods beginning on July1,2019.
Fair Value
The carrying amounts for financial instruments classified as current assets and current liabilities approximate fair value due to the short maturity of such instruments. The book values of other financial instruments approximates fair value because interest rates charged are comparable to other financial instruments with similar terms and maturities and the rates vary in accordance with a market index consistent with ASC 820, Fair Value Measurements.
For the financial assets and liabilities disclosed at fair value, fair value is determined as the exit price, or the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The established fair value hierarchy divides fair value measurement into three broad levels:
Level 1—inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;
Level 2—inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly or indirectly; and
Level 3—inputs are unobservable for the asset or liability, which reflect the best judgment of management.
The financial assets and liabilities that are disclosed at fair value for disclosure purposes are categorized in one of the above three levels based on the lowest level input that is significant to the fair value measurement in its entirety. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment.
Severance and Other Termination Benefits
We accrue one-time severance costs pursuant to an approved workforce reduction plan at the communication date, when affected employees have been notified of the potential severance and sufficient information has been provided for the employees to calculate severance benefits, in the event the employee is involuntarily terminated. During 2020, we recorded $5.7 million of severance expense associated with one-time severance cost, of which a liability of $0.7 million remained as of December 31, 2020. We paid our obligations pursuant to this severance and other termination benefits liability as of April 2021, and we did not incur any additional significant severance or termination benefits related to these workforce reductions during the year ended December 31, 2021.
Earnings Per Share
Basic income per share is calculated by dividing net income (loss) attributable to NCS Multistage Holdings, Inc. by the weighted-average number of common shares outstanding during the period. The diluted income (loss) per share computation is calculated by dividing net income (loss) attributable to NCS Multistage Holdings, Inc. by the weighted-average number of common shares outstanding during the period, taking into effect, if any, shares that would be issuable upon the exercise of outstanding stock options, unvested RSUs and PSUs and purchases under the ESPP, reduced by the number of shares purchased by us at cost, when such amounts are dilutive to the income per share calculation.
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Research and Development
Research and development costs are incurred both through engaging third parties to perform development activities under our coordination and management as well as through the utilization of our employees to create and develop new ideas and products. We incurred approximately $2.1 million, $1.9 million and $2.8 million in research and development costs for the years ended December 31, 2021, 2020 and 2019, respectively. These costs are recorded in selling, general and administrative (“SG&A”) expenses on the consolidated statements of operations. Occasionally a customer may contract us to provide research and development of a product, for which we are compensated. We recognize the revenue when the project is completed and accepted by the customer, and record the corresponding research and development costs as cost of goods sold. In addition, customers may agree to fund certain research and development activities for which we retain the rights to intellectual property. These customer reimbursements are treated as a reduction of research and development costs included in SG&A expenses.
Recent Accounting Pronouncements
Pronouncements Adopted in 2021
In March 2020, the FASB issued Accounting Standards Update (“ASU”) No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”) or other interest rates used globally that could be discontinued. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. We adopted ASU No. 2020-04 on January 1, 2021, with no material impact on our consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU No. 2019-12 removes certain exceptions to the general principles in Topic 740 and clarifies and amends existing guidance to improve consistent application. For public entities, this guidance became effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. We adopted ASU No. 2019-12 on a prospective basis on January 1, 2021, with no material impact on our consolidated financial statements.
Pronouncements Not Yet Effective
In November 2021, the FASB issued ASU No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance, to increase transparency of disclosure regarding government assistance including the types of assistance, an entity’s method of accounting for the assistance, and the effect of the assistance on an entity’s financial statements. This standard is effective for fiscal years beginning after December 15, 2021 and should be applied either prospectively or retrospectively. Early adoption is permitted. We are currently evaluating the impact of the adoption of this guidance.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU introduces a new impairment model that is based on expected credit losses rather than incurred credit losses for financial instruments, including trade accounts receivable. It requires an entity to measure expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The new standard was to become effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In November 2019, the FASB issued ASU No. 2019-10, which deferred the effective dates for certain accounting guidance. The effective date for ASU No. 2016-13 remained the same for public business entities that are Securities and Exchange Commission (“SEC”) filers, except for entities who are deemed smaller reporting companies (“SRC”). The effective date for all other entities, including SRCs, begins during the first interim period of fiscal years beginning after December 15, 2022. NCS qualifies as an SRC. We are currently evaluating the impact of the adoption of this guidance.
Note 3. Revenues
Disaggregation of Revenue
We sell our products and services primarily in North America and in selected international markets. Revenue by geography is attributed based on the current billing address of the customer. See “Note 18. Segment and Geographic Information” for our disaggregated revenue by geographic area.
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Contract Balances
If the timing of the delivery of products and provision of services is different from the timing of the customer payments, we recognize either a contract asset (performance precedes contractual due date in connection with estimates of variable consideration) or a contract liability (customer payment precedes performance) on our consolidated balance sheet.
The following table includes the current contract liabilities as of December 31, 2021, 2020 and 2019 (in thousands):
Additions —
Revenue recognized (8)
Revenue recognized (1,036)
We currently do not have any contract assets or non-current contract liabilities. Our contract liability as of December 31, 2021 and 2020 is included in current liabilities on our consolidated balance sheets. Our performance obligations for our product and services revenues are satisfied before the customer’s payment; however, prepayments may occasionally be required. Revenue recognized from the contract liability balance was $1.0 million, $8 thousand and $0.6 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Contracts with Multiple Performance Obligations
Approximately 99% of our product and services revenues are considered a single performance obligation. Our self-service product line, which is approximately one percent of our revenue for the years ended December 31, 2021, 2020 and 2019 is made up of two performance obligations: (i) the delivery of tracer materials to a customer well site and (ii) the creation of diagnostic reports ordered by customers when we do not perform an integrated service. For these contracts, we do not allocate the transaction price as the individual performance obligations are sold at standalone prices in the customer order. The transaction prices for our self-service product line that have two performance obligations are (i) the price per unit times the quantity of tracer materials and (ii) prices charged for diagnostic reports ordered by and delivered to the customer.
Practical Expedients
We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within SG&A expenses on the consolidated statements of operations.
We do not disclose the value of unsatisfied performance obligations when the related contract has a duration of one year or less. We recognize revenue equal to what we have the right to invoice when that amount corresponds directly with the value to the customer of our performance to date.
Note 4. Inventories, net
Inventories consist of the following as of December 31, 2021 and 2020 (in thousands):
December 31, December 31,
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Note 5. Other Current Receivables
Other current receivables consist of the following as of December 31, 2021 and 2020 (in thousands):
December 31, December 31,
Current income tax receivables $ 2,226 $ 6,295
Total other receivables, net $ 4,726 $ 8,358
Employee receivables relate primarily to amounts paid by us for foreign withholding tax paid on behalf of employees working on international assignments, which is expected to be reimbursed to us by the employees when refunded as foreign tax credits on home-country tax returns. The other receivables balance as of December 31, 2021 includes the U.S. employee retention credit (“ERC”) claims we have filed but for which we have not yet received renumeration, as well as $0.7 million associated with our technical services and assistance agreement with Special Oilfield Services Co., LLC (“SOS”). See “Note 10. Commitments and Contingencies” for a discussion of both matters. The other receivables balance as of December31, 2020 includes $1.2 million due from SOS.
Note 6. Property and Equipment
Property and equipment by major asset class consist of the following as of December 31, 2021 and 2020 (in thousands):
December 31, December 31,
Right of use assets - finance leases 10,228 8,020
Less: Accumulated depreciation and amortization (17,752) (16,312)
Construction in progress 430 100
The following table presents the depreciation expense associated with the following income statement line items for the years ended December 31, 2021, 2020 and 2019 (in thousands):
Year Ended December 31,
Cost of sales
Selling, general and administrative expenses 1,742 1,704 1,900
The table above includes depreciation expense associated with land and three buildings in addition to vehicles for our transportation fleet acquired through finance leases. See “Note 15. Leases”.
We evaluate our property and equipment for impairment whenever changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. We determined there were no triggering events that indicated potential impairment of our property and equipment for the years ended December 31, 2021 and 2019, and accordingly no impairment loss was recorded.
During the first quarter of 2020, we performed an impairment analysis to assess the recoverability of the carrying values for our property and equipment because we determined that a triggering event had occurred. Evidence that led to a triggering event included the industry conditions, such as a reduction in global economic growth expectations, a significantly reduced demand for crude oil and
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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. As a result of the analysis, we recorded an impairment charge of $9.7 million in our property and equipment, primarily related to our land, building and improvements and machinery and equipment, to the extent the carrying value exceeded the estimated fair value as of March 31, 2020. We did not identify any triggering events after March 31, 2020 through December 31, 2020 that required further impairment testing. Therefore, we did not record any impairment charges after March 31, 2020.
Note 7. Goodwill and Identifiable Intangibles
Changes in the carrying amount of goodwill are as follows (in thousands):
December 31, December 31,
We perform an annual impairment analysis of goodwill as of December 31, or whenever there is a triggering event that indicates an impairment loss may have been incurred. Under GAAP, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of one or more of our reporting units is greater than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is more likely than not that the fair value of a reporting unit is greater than the carrying amount, there is no need to perform any further testing. However, if we conclude otherwise, then we are required to perform a quantitative impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value of the reporting unit is less than the carrying value, an impairment loss is recorded in the amount of that difference. We also have the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test. All goodwill impairment charges are included in “Impairments” in the consolidated statements of operations. See “Note 2. Summary of Significant Accounting Policies” for additional information.
As of December 31, 2021 and 2020, we elected to perform a qualitative assessment for Repeat Precision, our only reportable unit with goodwill, and determined the goodwill totaling $15.2 million has a fair value that exceeds its net carrying value. Therefore, no impairment has been recorded for the years ended December 31, 2021 and 2020.
During the second quarter of 2019, we performed an impairment analysis for goodwill using the quantitative method. Evidence of an indication of impairment included further deterioration in customer activity levels in North America, which resulted in lower demand for oilfield services driving a decrease in our market share and increased customer and competitor-driven pricing pressures in addition to a decline in the quoted price of our common stock. We determined that the carrying value of one of our reporting units exceeded its fair value and we recorded an impairment charge of $7.9 million for our tracer diagnostic services reporting unit Following the impairment, our tracer diagnostic services reporting unit had no remaining goodwill balance. We had one other reportable unit, Repeat Precision, with a goodwill balance at December 31, 2019. We performed a qualitative assessment and determined that Repeat Precision’s goodwill balance of $15.2 million was not impaired, as the fair value exceeded the net carrying value. Therefore, no impairment was required for this reportable unit for the year ended December 31, 2019.
Identifiable intangibles by major asset class consist of the following (in thousands):
Estimated Gross
Useful Carrying Accumulated Net
Lives (Years) Amount Amortization Balance
Total amortizable intangible assets $ 8,058 $ (2,362) $ 5,696
Technology - not subject to amortization Indefinite 48 — 48
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Estimated Gross
Useful Carrying Accumulated Net
Lives (Years) Amount Amortization Balance
Total amortizable intangible assets $ 8,058 $ (1,693) $ 6,365
Technology - not subject to amortization Indefinite 48 — 48
We did not incur costs to renew or extend the term of acquired intangible assets during the year ended December 31, 2021. In December 2020, we recognized a $3.8 million intangible asset related to the transfer of the U.S. Patent No. 9,810,035 (the “’035 Patent”) from Diamondback Industries, Inc. (“Diamondback”) to Repeat Precision in connection with a litigation settlement. See “Note 10. Commitments and Contingencies” for additional information. Substantially all identifiable intangibles as of December 31, 2021 and 2020 are related to our Repeat Precision asset group.
Identifiable intangibles are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Impairment charges related to identifiable intangibles are included in “Impairments” in the consolidated statements of operations. See “Note 2. Summary of Significant Accounting Policies” for additional information. There were no impairment charges recorded for our identifiable intangibles for the years ended December 31, 2021 or 2019.
As discussed in “Note 6. Property and Equipment,” on March 31, 2020, we identified a triggering event which indicated potential impairment. We evaluated our intangible assets for impairment and determined that the carrying values of certain intangible assets were no longer recoverable, which resulted in an impairment charge of $11.9 million in the asset group that includes fracturing systems and well construction related to technology and internally-developed software and an impairment charge of $28.6 million in our tracer diagnostics asset group related to customer relationships, technology, internally developed software and trademarks, each recorded on March 31, 2020. Following the impairment charges in the first quarter of 2020, we had no remaining identifiable intangible balances in the asset group that includes our fracturing systems and well construction or our tracer diagnostics asset group. There were no impairment charges recorded for our identifiable intangibles for the remainder of the year ended December 31, 2020.
Total amortization expense, which is associated with selling, general and administrative expenses on the consolidated statements of operations, was $0.7 million, $1.5 million and $4.6 million for the years ended December 31, 2021, 2020 and 2019, respectively.
The total weighted average amortization period is 13 years and estimated future amortization expense is as follows (in thousands):
Note 8. Accrued Expenses
Accrued expenses consist of the following as of December 31, 2021 and 2020 (in thousands):
December 31, December 31,
Accrued payroll and bonus $ 4,208 $ 999
Property and franchise taxes accrual 550 505
Severance and other termination benefits (Note 11) — 730
Accrued other miscellaneous liabilities 1,565 1,113
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Note 9. Debt
Our long-term debt consists of the following as of December 31, 2021 and 2020 (in thousands):
December 31, December 31,
Senior Secured Credit Facility $ — $ —
The estimated fair value of total debt for the years ended December 31, 2021 and 2020 was $7.5 million and $5.6 million, respectively. The fair value for the finance leases was estimated using Level 2 inputs by calculating the sum of the discounted future interest and principal payments at our incremental borrowing rate through the date of maturity.
Below is a description of our credit agreement and other financing arrangements.
Senior Secured Credit Facility
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.
On August 6, 2020, we entered into Amendment No. 1 to the 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 may be limited subject to a borrowing base calculated on eligible receivables, which does not include receivables at Repeat Precision. Our borrowing base under the Senior Secured Credit Facility as of December 31, 2021 was $15.4 million. The Senior Secured Credit Facility will mature on May 1, 2023. As of December 31, 2021 and 2020, we had no outstanding indebtedness under the Senior Secured Credit Facility, and we utilized letter of credit commitments of less than $0.1 million.
Borrowings under the Senior Secured Credit Facility may be made in USD for Adjusted Base Rate Advances, and in USD, 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 our leverage ratio. The applicable interest rate at December 31, 2021 was 3.5%. We incurred interest expense related to the Senior Secured Credit Facility, including commitment fees, of $0.1 million, $0.6 million and $0.7 million for the years ended December 31, 2021, 2020 and 2019, respectively.
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 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 December 31, 2021, we were in compliance with these financial covenants. The Amended Credit Agreement also contains customary affirmative and
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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 to provide further borrowings and to proceed against the collateral securing the Senior Secured Credit Facility.
We capitalized direct costs of $1.2 million in connection with the Senior Secured Credit Facility and our prior credit facility, which were being amortized over the term of the Senior Secured Credit Facility using the straight-line method. The Amendment reduced the overall potential capacity under the Amended Credit Agreement from $75.0 million to $25.0 million. Therefore, we expensed $0.6 million of deferred loan costs during the third quarter of 2020, which was commensurate with the reduction in potential capacity. We capitalized new deferred loan costs associated with the Amendment totaling $0.6 million, which is being amortized over the remaining term of the facility. Amortization expense of the deferred financing charges was included in interest expense, net of $0.3 million for each of the years ended December 31, 2021 and 2020, respectively, and $0.2 million for the year ended December 31, 2019.
Promissory Note
On February 27, 2017, Repeat Precision entered into a promissory note with Security State Bank & Trust, Fredericksburg. The note bears interest at a variable interest rate based on prime plus 1.00%. The promissory note is collateralized by certain equipment, inventory and receivables. The promissory note was renewed on February 16, 2018 for an aggregate borrowing capacity of $4.3 million and continues to be renewed on an annual basis. The note is currently scheduled to mature on February 11, 2023. Total borrowings may be limited subject to a borrowing base calculation, which includes a portion of Repeat Precision’s eligible receivables, inventory and equipment. As of December 31, 2021 and 2020, Repeat Precision had no outstanding indebtedness under the promissory note.
On April 30, 2020, Repeat Precision entered into a promissory note with Security State Bank & Trust, Fredericksburg, for an aggregate borrowing capacity of $5.0 million. The note bore interest at a variable interest rate based on prime plus 1.00%. The promissory note was collateralized by certain equipment and inventory. Total borrowings were potentially limited subject to a borrowing base calculation, which included a portion of Repeat Precision’s eligible receivables, inventory and equipment. As of December 31, 2020, Repeat Precision had no outstanding indebtedness under the promissory note. The note matured on April 30, 2021 and no payment was due.
Finance Leases
Finance leases include two buildings in Odessa, Texas and a laboratory in Tulsa, Oklahoma. We also maintain a vehicle leasing arrangement with a fleet management company through which we lease light vehicles and trucks that meet the finance lease criteria. See “Note 15. Leases” for additional information.
Note 10. Commitments and Contingencies
Litigation
In the ordinary course of our business, from time to time, we have various claims, lawsuits and administrative proceedings that are pending or threatened with respect to commercial, intellectual property and employee matters.
In accordance with GAAP, we accrue for contingencies where the occurrence of a material loss is probable and can be reasonably estimated, based on our estimate of the expected liability. If we have any outstanding legal accruals, we may increase or decrease these in the future, on a matter-by-matter basis, to account for developments. Our assessment of the likely outcome of litigation matters is based on our judgment of a number of factors, including experience with similar matters, past history, precedents, relevant financial information and other evidence and facts specific to the matter. While the outcome of any legal proceeding cannot be predicted with any certainty, based on a consideration of relevant facts and circumstances, our management currently does not expect that the results of these legal proceedings would have a material adverse effect on our financial position, results of operations or cash flows.
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Patent Infringement Settlement
On April 3, 2020, the United States District Court for the Western District of Texas, Waco Division issued a final judgment in connection with the litigation with Diamondback awarding Repeat Precision approximately $39.9 million (the “Award”) plus attorneys’ fees in connection with its breach of exclusive license, patent infringement of the ‘035 Patent and tortious interference claims. In addition, in April 2020, we received $1.1 million of proceeds from our directors and officers liability insurance related to the reimbursement of legal expenses that we incurred to defend a director and officer in the Diamondback litigation. On April 21, 2020, Diamondback filed for Chapter 11 bankruptcy protection which stayed collection efforts.
In October 2020, we entered into an agreement to settle the Award, which was effectuated through a Chapter 11 plan of reorganization that was filed by Diamondback that became effective on December 10, 2020. On the effective date, in connection with Repeat Precision releasing Diamondback and Derrek Drury (“Drury”) from the monetary damages in the Award and certain other claims, Repeat Precision received: (i) an upfront cash payment of approximately $15.5 million, (ii) the transfer of the ‘035 Patent from Diamondback to Repeat Precision, (iii) payments for future sales of certain setting tool sold by Diamondback or its successor as restitution, until $5.0 million has been paid in total, and (iv) a note from Drury payable in two years, which was paid off prior to year-end 2020, in the principal amount of $5.0 million. Repeat Precision and another claimant in the Diamondback bankruptcy have also agreed to provide mutual releases of all claims in exchange for consideration received by Repeat Precision. As of December 31, 2020, we recorded a $25.7 million gain on a patent infringement settlement in our consolidated financial statements related to this gain contingency, which also included the $1.1 million of proceeds from our directors and officers liability insurance mentioned above and is net of related legal fees incurred in 2020 of $2.7 million. During the year ended December31, 2021, we have received less than $0.1 million of preference claims related to this patent infringement settlement which are included as other income, net in the accompanying consolidated statements of operations.
Technical Services and Assistance Agreement
We entered into a technical services and assistance agreement with SOS, which is effective until the expiration of a specified contract between SOS and a third party or the expiration of other contracts entered into subsequent to the specified contract. Pursuant to the agreement, NCS provides chemical tracers and radioactive isotopes at a stated contract price with revenue recognized on the delivery of these materials when performance obligations are met. In addition, we provide technical support, training, literature and further technical back up to SOS pursuant to a collaborative arrangement. In consideration of these technical services, SOS shares the net profit or loss, excluding certain non-cash items, arising out of the specified contractual arrangement equally with NCS at the end of each year. The net profit or loss is calculated based on total revenues less expenses per year with SOS deducting a 10% withholding tax on any profit payable to NCS. All assets of the contractual arrangement are owned by SOS. The amount of profit sharing is determined at the end of the performance year, subject to an annual audit which is typically completed during the first quarter of the succeeding year. However, at the end of the performance period as of December 31, when the amount of the profit sharing is probable and reasonably estimable, we record a receivable related to this profit sharing provision, which totaled $0.7 million and $1.1 million, subject to withholding tax of $0.1 million for each of the years ended December 31, 2021 and 2020, respectively. A portion of the profit sharing income is allocated to tracer diagnostics services based upon the ratio of the standalone fair market value of the tracer materials and profit sharing elements of the contractual arrangement. For the years ended December 31, 2021 and 2020, we have recorded tracer diagnostics services revenue of $0.9 million and $1.6 million, respectively, and other income, net totaling $0.5 million and $0.9 million, respectively, related to this agreement in the consolidated statements of operations. We collected the $1.2 million receivable related to 2020 in May 2021 and expect to collect the receivable related to 2021 in April 2022.
Employee Retention Credit
A series of legislation was enacted in the United States during 2020 and 2021 in response to the COVID-19 pandemic that provided financial relief for individuals and businesses impacted by government-mandated shutdowns or work stoppages or other losses suffered by employers due to year-over-year revenue declines of at least 50%. The laws enacted include: the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) enacted in March 2020, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 enacted in December 2020, the American Rescue Plan Act of 2021 enacted in March 2021, and the Infrastructure Investment and Jobs Act enacted in November 2021. These laws refined the definition of small business employers to those who had fewer than 500 employees during 2019, and provided that qualified employers could (i) claim a refundable tax credit up to 70% of $10 thousand in eligible wages per U.S. employee, or a maximum benefit of $7 thousand per employee per quarter, for the first, second and third quarters of 2021 and (ii) qualify for expanded credits available for fiscal 2020. The ERC credits reduce the employer’s portion of social security tax.
We evaluated our eligibility for the ERC and determined that we were eligible for refundable tax credits totaling $3.2 million for the year ended December 31, 2021, of which $0.9 million is included in cost of sales and $2.3 million is included in general and administrative expenses in the accompanying consolidated statements of operations. The refundable tax credits include $0.5 million pertaining to Repeat Precision, of which $0.1 million is associated with credits earned for activity in 2020. Of the aggregate credits
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claimed during 2021, we received $2.1million and have included $1.1 million in other current receivables on our consolidated balance sheet as of December 31,2021.
Note 11. Severance and Other Termination Benefits
During 2020, we implemented various workforce reductions resulting in the termination of approximately 190 employees, temporary furloughs for certain employees and lower compensation levels for executives and employees not participating in furloughs in response to 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 and reduced demand for oil. In connection with these reductions in workforce and executive departures, we incurred $5.7 million in one-time severance costs, which were recorded in the consolidated statements of operations under general and administrative expenses for the year ended December 31, 2020. We did not incur any significant severance or termination benefits related to these workforce reductions during the year ended December 31, 2021.
Below is a reconciliation of the beginning and ending liability balance (in thousands):
Balance at December 31, 2019 $ —
Additions for costs expensed 5,661
Severance payments (4,969)
Currency translation adjustment 38
Severance payments (730)
Balance at December 31, 2021 $ —
We paid our obligations pursuant to this severance and other termination benefits liability as of April 2021.
Note 12. Stockholders’ Equity
Reverse Stock Split
In connection with our efforts to regain compliance with the minimum price per share criteria for continued listing set forth in Nasdaq Listing Rule 5450(a)(1), on December 1, 2020, we effected a reverse stock split of our issued and outstanding common stock in a ratio of 1-for-20 (the “reverse stock split”). The par value of the common and preferred stock was not adjusted as a result of the stock split. On October 27, 2020, funds affiliated with Advent International Corporation, who beneficially held an aggregate 29,568,536 shares on a pre-split basis as of the record date of the reverse stock split, or approximately 62.6% of our shares of common stock, executed and delivered to our board of directors (our “Board”) a written consent approving the proposal to effect a reverse stock split of our issued and outstanding common stock, with a ratio of 1-for-20, and to reduce the number of authorized shares of our common stock by the same ratio as the reverse stock split. Our Board also approved the above reverse stock split and authorized share reduction on October 27, 2020.
Our common stock began trading on Nasdaq on a split-adjusted basis when the market opened on December 1, 2020. The reverse stock split resulted in a reduction of the number of publicly held shares of NCS below the minimum 750,000 publicly held shares requirement set forth in Nasdaq Listing Rule 5450(b)(1)(B) and thus NCS applied to transfer its securities to the Nasdaq Capital Market on December 17, 2020, which was approved on December 22, 2020, with the transfer occurring at the opening of business on December 24, 2020. We believe that this transfer to the Nasdaq Capital Market has not significantly impacted the trading of our common stock. The Capital Market is a continuous trading market that operates in substantially the same manner as the Global Select Market.
Authorized and Outstanding Shares
On December 1, 2020, our certificate of incorporation was amended and the number of shares of common stock authorized to be issued was decreased from 225,000,000 to 11,250,000. The number of our authorized shares of preferred stock remained 10,000,000 shares. As of December 31, 2021 and 2020, 2,380,374 and 2,359,918 shares of common stock were outstanding, respectively.
Voting
The holders of common stock are entitled to one vote for each share of common stock held.
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Dividends
The holders of common stock are entitled to receive dividends as declared from time-to-time by our Board, to the extent permitted under the Senior Secured Credit Facility. No dividends were declared during the periods ended December 31, 2021 or December 31, 2020.
Note 13. Share-Based Compensation
Equity Incentive Plans
We maintain two equity incentive plans for the benefit of our employees, directors and other service providers: our 2012 Equity Incentive Plan (the “2012 Plan”) and our 2017 Equity Incentive Plan (the “2017 Plan”). The following is a summary of certain features of the 2012 Plan and the 2017 Plan.
2012 Plan