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 construction, well completions and field development strategies. We provide our products and services primarily to E&P companies for use in onshore and offshore wells, predominantly wells that have been drilled with horizontal laterals in both unconventional and conventional 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 245 customers in 2022, 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 can be used in both cemented and open-hole 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, perforating guns 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 casing buoyancy systems, 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 influenced by oil and natural gas prices.
Drilling and completion activity in the United States and Canada has increased steadily since falling to multi-decade lows in late 2020, as the global economy and oil and natural gas demand have recovered from the impact of the COVID-19 pandemic. While U.S. drilling and completion activity remains slightly lower than it was prior to the COVID-19 pandemic, the Canadian rig count surpassed comparable 2019 levels in the third quarter of 2021 and has remained above comparable 2019 levels since that time. Customer activity has continued to increase in 2022, with the U.S. and Canadian rig counts in the fourth quarter of 2022 higher by 39% and 18%, respectively, compared to the same period as 2021.
Based on E&P company announced capital budgets for 2023, we believe that annual average industry drilling and completion activity in the United States and Canada in 2023 will be equal to 2022 levels or higher by up to 10%, however, activity in the United States in 2023 may be lower than levels reached in the fourth quarter of 2022, reflecting rapid reductions in natural gas pricing in late 2022 and early 2023. We currently expect international industry activity to improve by over 10% in 2023 as compared to 2022. Many of our customers in North America continue to be committed to generating free cash flow while maintaining production at recent levels, while privately-owned operators have increased activity in recent years in response to improved commodity prices, contributing most of the activity increases since late 2020. Oil and natural gas prices were volatile in 2022, with increased spot pricing following Russia’s invasion of Ukraine in late February which decreased in the second half of the year due to increased uncertainty in demand and mounting concerns about a global economic recession. We have no material direct exposure to Russia or Ukraine, though we are affected by economic impacts resulting from the conflict, especially on raw material pricing and availability.
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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, our operating margins and our ability to increase prices in an inflationary environment.
Beginning in late 2021 and continuing throughout 2022, we experienced higher prices for certain raw materials, including steel and chemicals, and for purchased components and outsourced services, exacerbated by the impacts resulting from Russia’s continuing invasion of Ukraine. While we have increased customer prices because of our higher raw material and component costs, the increase in customer prices have not always offset our higher input costs and there has been a time lag in our ability to do so. If we experience even higher costs in 2023, we will strive to achieve further price increases with our customers, however, we are not always able to do so and, if we can, the impact of such price increases may lag the timing of cost increases. During this time, we also began to experience tight labor conditions which has led to increased employee turnover, delays in filling open positions and labor cost inflation, which impacts both our cost of sales and selling, general and administrative (“SG&A”) expenses. This labor cost inflation, which continued throughout 2022 and continues into 2023, has resulted in higher salaries, hourly pay rates and benefit costs.
In an effort to reduce inflationary pressures on the economy, central banks, including the U.S. Federal Reserve, has increased reference interest rates, an action which typically has the effect of increasing borrowing costs and restraining economic activity. There is a possibility that these actions could not only reduce the rate of global economic growth, but could lead to a recessionary environment in certain economies, including Europe and the United States. Any decline in economic activity resulting from such actions could result in moderating or declining demand for oil and natural gas. In addition, in 2022 the U.S. dollar strengthened relative to other currencies, including the Canadian dollar. Over 60% of our revenue is generated in Canada, and reductions in the value of the Canadian dollar as compared to the U.S. dollar, our reporting currency, result in lower reported revenue and gross profit, partially offset by lower reported SG&A expense.
COVID-19 Impacts on the Oil & Natural 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. As a result of the COVID-19 pandemic, there was a significant reduction in global gross domestic product (“GDP”) in 2020, and a decrease in demand for crude oil, which began to recover in 2021 as vaccines became available and mitigation measures eased. While there has been a significant recovery in demand for crude oil since 2020, demand is still below the 2019 levels and is not expected to reach back to pre-COVID levels until 2023. In response to these economic factors, OPEC+ members acted collectively to reduce oil production and E&P companies in North America reduced their capital spending budgets. This also led to consolidation amongst E&P companies, especially large, independent publicly-traded E&P companies, and this included customers for which we have provided products and services.
In 2020, we implemented several initiatives to reduce our costs restructure and to enhance liquidity, as more fully described in our Annual Report on Form 10-K for the year ended December 31, 2021. Those initiatives included reductions in force and temporary reductions in compensation and certain benefits. In early 2022, we substantially restored or increased employee compensation and benefits to pre-2020 levels.
The continuing impacts of the COVID-19 pandemic are contributing to occasional supply chain disruptions, particularly in China, although the Chinese government’s COVID-19 mitigation measures have recently been relaxed. Cost inflation, including labor cost inflation, continues through 2022 and into 2023. Therefore, we have qualified additional suppliers to provide materials, components and services for which supply lines have been impacted or for which delivery times have increased.
Market Conditions
Oil and Natural Gas Drilling and Completion Activity
Oil and natural gas prices remain volatile, with WTI crude oil pricing rising throughout 2021 to approximately $75/BBL at the end of December 2021. WTI crude oil pricing continued to increase in the first half of 2022 to over $100/BBL following Russia’s invasion of Ukraine. However, WTI crude oil pricing average decreased to approximately $83/BBL during the fourth quarter of 2022 reflecting an overall weaker macroeconomic environment and its potential impact on lowering demand. During 2022, to address the uncertain outlook in the global economic and oil markets, OPEC+ members agreed to a collective voluntary oil production reduction of 2MMBBL/D beginning in November 2022 through December 2023.
Natural gas pricing increased throughout 2021 to an average level of $3.89 per MMBtu and further increased to an average level of $6.45 per MMBtu during 2022. Realized natural gas prices for Canadian E&P customers are typically at a discount to U.S. Henry Hub pricing. 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, reflecting European demand for LNG sourced from the United States and other regions to diversify supply historically provided by Russia. At the end of September 2022, natural gas pricing reached a level of $6.40 per MMBtu, but declined to as low as $3.52 per MMBtu in December 2022 due to overall
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warm winter weather conditions and extended downtime at an LNG export facility, which decreased near-term demand and has led to robust levels of natural gas in storage. Natural gas pricing has continued to decline in early 2023, which may negatively impact drilling and completion activity in certain regions.
Sustained meaningful declines in commodity prices from current levels, 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.
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 2020, 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. The average U.S. land rig count and completion activity have continued to increase from lows reached in late 2020, with the U.S. land rig count averaging 760 during the fourth quarter of 2022, a 39% increase compared to the fourth quarter of 2021. The average land rig count in Canada for the fourth quarter of 2022 was 18% higher than in the same period in 2021. We expect Canadian rig counts and completion activity to continue to rise in 2023 compared to prior year levels. We expect average annual drilling and completion activity in the United States to exceed prior year levels, but to be below the levels reached during the fourth quarter of 2022.
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 usually lower than activity in the first quarter. As we experienced in the fourth quarter of 2022, our business can 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 and Canada 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
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our technology to compete against technological advances in traditional well completion techniques, and our ability to successfully compete with other providers of pinpoint stimulation products and services, including adjusting our pricing in certain markets to respond to customer demands and to competitors that may provide discounted pricing to our customers.
Increasing Well Complexity and Focus on Completion Optimization
In recent years, E&P companies have drilled longer horizontal wells and completed more hydraulic fracturing stages per well to maximize the volume of hydrocarbon recoveries per well. This trend towards longer and more complex wells has resulted in us selling more sliding sleeves or composite frac plugs per well on average, which increases our revenue opportunity per well completion and has 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. However, as the development of unconventional resources has matured, E&P companies have become increasingly focused on operational efficiencies and lowering the cost of the wells they drill and complete. This focus on cost has led to increased competition amongst oilfield services companies, limiting pricing power, and in some cases leading to E&P companies selecting products and services primarily based on cost as opposed to technical benefits.
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, perforating guns and related products through Repeat Precision, and from sales of our tracer diagnostics services, casing buoyancy systems, liner hanger systems and toe initiation sleeves products.
Product sales represented 68% and 70% of our revenues for the years ended December 31, 2022 and 2021, 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 32% and 30% of our revenues for the years ended December 31, 2022 and 2021, 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 some instances, lower the prices of our products and services. Our revenues are also impacted by well complexity, with wells with more stages resulting in longer jobs and increased revenue attributable to selling more sliding sleeves or composite frac plugs and the provision of our services.
The percentages of our revenues derived from sales in Canada and denominated in Canadian dollars were approximately 65% and 62% for the years ended December 31, 2022 and 2021, respectively. Our Canadian contracts are typically invoiced in Canadian dollars; therefore, 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 manufacture of product components and finished assemblies and costs related to our employees that perform quality control analysis, assemble and test our products. In addition, Repeat Precision operates manufacturing facilities with supporting personnel in Mexico, which has allowed us to reduce our costs for certain product categories. We review forecasted activity levels in our business and either directly procure or support our vendors in procuring the required raw materials with sufficient lead time to meet our business requirements. We obtain certain chemicals utilized in our tracer diagnostics services business from suppliers in China, which are subject to a 25% tariff, which increases our cost of sales. Prices for certain raw materials, including steel and chemicals and for purchased components and outsourced services, have increased in recent years due to inflation, exacerbated by the impacts resulting
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from Russia’s continuing invasion of Ukraine. Cost of sales for support services includes compensation and benefit-related expenses for employees who provide direct revenue generating services to customers in addition to the costs incurred by these employees for travel and subsistence while on site. Cost of sales includes other variable manufacturing costs, such as shrinkage, obsolescence, revaluation and scrap related to our existing inventory and costs related to the chemicals and laboratory analysis associated with our tracer diagnostics services.
Our SG&A expenses are comprised of compensation expense, which includes compensation and benefit-related expenses for our employees who are not directly involved in revenue generating activities, including those involved in our research and development activities, as well as our general operating costs. These general operating costs include, but are not limited to: rent and occupancy for our facilities, information technology infrastructure services, software licensing, advertising and marketing, third party research and development, risk insurance and professional service fees for audit, legal and other consulting services. Our SG&A expenses also include litigation expenses and provisions for doubtful accounts.
During 2021, we began to experience tight labor conditions which has led to increased employee turnover, delays in filling open positions and labor cost inflation, which impacts both our cost of sales and our SG&A expenses. This labor cost inflation, which continued through 2022 and into 2023, has resulted in increased salaries, hourly pay rates and benefit costs.
The percentage of our operating costs denominated in Canadian dollars (including cost of sales and SG&A expenses but excluding depreciation and amortization expense) approximated 27% and 25%, for the years ended December 31, 2022 and 2021, respectively.
Results of Operations
The following table summarizes our results of operations for the years ended December 31, 2022 and 2021.
Year Ended December 31, Variance
Revenues
Cost of sales
Other income (expense)
Net income attributable to non-controlling interest 150 955 (805) (84.3) %
Year Ended December 31, 2022 compared to Year Ended December 31, 2021
Revenues
Revenues were $155.6 million for the year ended December 31, 2022 as compared to $118.5 million for the year ended December 31, 2021. This increase reflected higher product sales and services volumes in Canada and the United States as well as higher international services volumes, partially offset by a decrease in international product sales, for which individual orders can be larger and less frequent. We believe the overall increase in revenues largely resulted from higher drilling and completion activity in
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2022 as compared to 2021, particularly in North America, attributable primarily to higher oil and natural gas demand and more favorable commodity prices.Product sales for the year ended December 31, 2022 were $105.9 million as compared to $83.2 million for the year ended December 31, 2021. Our services revenue was $49.8 million for the year ended December 31, 2022 as compared to $35.3 million for the year ended December 31, 2021.
Cost of sales
Cost of sales was $95.2 million, or 61.2% of revenues, for the year ended December 31, 2022 as compared to $70.0 million, or 59.1% of revenues, for the year ended December 31, 2021. Cost of sales as a percentage of total revenues was higher between the years due to increased costs impacting our supply chain, including raw materials, purchased materials, labor costs and outsourced service activity as well as a decrease in international revenue as a percentage of our total revenue. Labor costs for 2021 were reduced due to the U.S. employee retention credit (“ERC”), which did not recur in 2022. See “Note 10. Commitments and Contingencies” of our consolidated financial statements. The decline was partially offset by increased revenues and higher utilization of manufacturing capacity and field service personnel. Cost of product sales was $68.4 million or 64.6% of product sales revenue and cost of services was $26.8 million or 53.9% of services revenue for the year ended December 31, 2022. For the year ended December 31, 2021, 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.
Selling, general and administrative expenses
Selling, general and administrative expenses were $58.3 million for the year ended December 31, 2022 as compared to $49.1 million for the year ended December 31, 2021. This overall increase in expense reflects increased compensation and benefit costs of $6.4 million primarily associated with the reinstatement of certain salaries in mid-2021, increased headcount, salary increases implemented during the first quarter of 2022, the restoration of employer matching contributions to employee retirement plans in January 2022 and a benefit of $2.3 million in 2021 associated with the ERC, which did not recur in 2022. See “Note 10. Commitments and Contingencies” of our consolidated financial statements. In addition, professional fees, primarily related to litigation matters, increased by $1.7 million and travel and entertainment increased by $0.8 million. The increases were partially offset by lower share-based compensation expense of $0.6 million.
Interest expense, net
Interest expense, net was $1.0 million for the year ended December 31, 2022 as compared to $0.7 million for the year ended December 31, 2021. The increase in interest expense, net reflects a $0.2 million write-off of deferred loan costs associated with the termination of the Prior Senior Secured Credit Facility, which was replaced by an ABL Facility.
Other income, net
Other income, net was $3.0 million for the year ended December 31, 2022 as compared to $2.1 million for the year ended December 31, 2021. The increase is primarily attributable to royalties earned on the use of our intellectual property and profit share associated with our technical services and assistance agreement with Special Oilfield Services Co., LLC (“SOS”).
Foreigncurrencyexchange (loss) gain
Foreign currency exchange loss was $(0.3) million for the year ended December 31, 2022 as compared to a gain of $0.3 million for the year ended December 31, 2021. The change was due to the movement in the foreign currency exchange rates between the periods, primarily the Canadian dollar relative to the U.S. dollar.
Income tax expense
Income tax expense was $0.4 million for the year ended December 31, 2022 as compared to $0.3 million for the year ended December 31, 2021.
Included in tax expense (benefit) for the year ended December 31, 2022 was a benefit of $(4.1) million related to changes in valuation allowance on deferred tax assets not expected to be realized, an expense of $0.4 million related to stock awards, a benefit of $(0.1) million related to the effects of taxes on foreign operations, and an expense of $0.6 million related to state taxes.
Included in tax expense (benefit) 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.
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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 and perforating gun 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 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 share-based compensation, is non-cash in nature. Adjusted EBITDA Less Share-Based Compensation is defined as Adjusted EBITDA, with the sole exception being that it does not add back 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,
Net benefit of ERC (3) — (1,908)
Foreign currency loss (gain) (4) 283 (283)
Adjusted EBITDA Less Share-Based Compensation $ 11,657 $ 4,873
_____________________
(1)Represents non-cash compensation charges related to share-based compensation granted to our officers, employees and directors.
(2)Represents non-capitalizable costs of professional services incurred in connection with our financings, legal proceedings and the evaluation of potential acquisitions.
(3)Represents ERC benefits recorded during 2021 less the effect on bonus and associated payroll burden accruals.
(4)Represents unrealized and realized foreign currency translation gains and losses primarily due to movement in the foreign exchange rates during the applicable periods.
(5)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.
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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 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 ABL 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 (used in) provided by operating activities $ (1,423) $ 11,583
Purchases of property and equipment (1,035) (495)
Purchase and development of software and technology (96) (338)
Proceeds from sales of property and equipment 433 389
Distributions to non-controlling interest — (2,750)
Free cash flow less distributions to non-controlling interest $ (2,121) $ 8,389
Liquidity and Capital Resources
Our primary sources of liquidity are our existing cash and cash equivalents, cash flows from operations and potential borrowings under our ABL Facility and the Repeat Precision Promissory Note (as defined below). As of December 31, 2022, we had cash and cash equivalents of $16.2 million, and total outstanding indebtedness of $7.9 million primarily related to capital lease obligations, of which $1.4 million is due within 12 months. Our ABL Facility consists of an asset-based revolving credit facility in an aggregate principal amount of $35.0 million. Total borrowings are limited to a borrowing base calculated on the sum of cash in a specified pledged account, eligible accounts receivable and eligible inventory, provided it does not include the assets of Repeat Precision. At December 31, 2022, our borrowing base under the ABL Facility was $18.6 million, with no outstanding borrowings. We have cash-collateralized less than $0.1 million in letter of credit commitments. The amount available to be drawn under the ABL 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, 2022. In addition, Repeat Precision’s promissory note with Security State Bank & Trust, Fredericksburg (the “Repeat Precision Promissory Note”) has total aggregate borrowing capacity of $4.3 million. As of December 31, 2022, Repeat Precision has $56 thousand of outstanding indebtedness under its promissory note. We believe that our cash on hand, cash flows from operations and potential borrowings under our ABL Facility and the Repeat Precision Promissory Note 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 $4 million to $5 million in capital expenditures during 2023, which includes (i) upgrades to our tracer diagnostics deployment and sampling equipment and laboratory instrumentation, (ii) machining equipment and a potential new facility to increase perforating gun manufacturing capacity at Repeat Precision, (iii) upgrades to our manufacturing and field service equipment to support North American fracturing systems and well construction businesses, (iv) new computers and engineering workstations and (v) software development and implementation. Our capital expenditures, including the purchase and development of software and technology, for the years ended December 31, 2022 and 2021 were $1.1 million and $0.8 million, respectively.
To the extent we require additional liquidity to fund our capital requirements, including our capital lease obligations, 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 provide assurance 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
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financial performance and ability to manage costs, which is subject to general economic, financial and other factors that are beyond our control, including the continued impacts from the COVID-19 pandemic and Russia’s invasion of Ukraine. Accordingly, we cannot provide assurance 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 equity to finance such acquisitions, which could result in incremental expenses or dilution.
Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented (in thousands):
Year Ended December 31,
Net cash (used in) provided by operating activities $ (1,423) $ 11,583
Net cash used in investing activities (698) (444)
Net cash used in financing activities (2,742) (4,265)
Effect of exchange rate changes on cash and cash equivalents (1,071) (251)
Net change in cash and cash equivalents $ (5,934) $ 6,623
Operating Activities
Net cash (used in) provided by operating activities was $(1.4) million compared to $11.6 million for the years ended December 31, 2022 and 2021, respectively. The decrease in cash flow reflects additional investments in inventory and higher accounts receivable balances due to an increase in our operational activity, related to an increase in oil and gas market activity, as well as the timing of payments for goods and services through accounts payable. The 2022 results also reflect the payment of the 2021 annual incentive bonus of $3.2 million, payments related to cash-settled share-based compensation and the receipt of income tax refunds in 2021, which did not recur in 2022. This overall decrease in cash flow from operations was partially offset by a smaller net loss in 2022 as compared to 2021, and the receipt and utilization of prepaid chemicals which were acquired in 2021.
Investing Activities
Net cash used in investing activities was $0.7 million and $0.4 million for the years ended December 31, 2022 and 2021, respectively, with an increase in purchases of property and equipment partially offset by a decrease in the purchase and development of software and technology.
Financing Activities
Net cash used in financing activities for the years ended December 31, 2022 and 2021 was $2.7 million and $4.3 million, respectively. Our primary uses of funds during the year ended December 31, 2022 included total principal payments of $1.5 million related to our finance leases, payments of $0.4 million for treasury shares withheld to settle withholding tax requirements for equity-settled share-based compensation, and payments of $1.0 million for deferred costs related to our ABL Facility. 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 related to our finance leases of $1.3 million.
Material Cash Requirements
Our material cash requirements include the following contractual and other obligations.
Financing Arrangements
Our ABL Facility consists of a revolving credit facility in an aggregate principal amount of $35.0 million. Total borrowings available to the borrowers under the ABL Facility may be limited subject to a borrowing base calculated on the sum of cash in a specified pledged account, eligible accounts receivables and eligible inventory, provided it does not include the assets of Repeat Precision. At December 31, 2022, our borrowing base under the ABL Facility was $18.6 million and we had no outstanding indebtedness under the ABL Facility.
Repeat Precision also has an outstanding promissory note with an aggregate borrowing capacity of up to $4.3 million as of December 31, 2022, subject to a borrowing base. As of December 31, 2022, Repeat Precision had $56 thousand in outstanding indebtedness under the promissory note.
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See “Note 9. Debt” to our consolidated financial statements for additional details regarding our credit agreement and the promissory note.
Leases
We have operating and finance leases for facilities, vehicles, and equipment. As of December 31, 2022, we had lease payment obligations, including interest payments for finance leases of $14.6 million, with $3.3 million payable within 12 months. See “Note 14. Leases” to our consolidated financial statements for additional information on lease obligations and maturities.
Purchase Obligations
Our purchase obligations in the amount of $12.6 million primarily represent commitments to purchase goods or services to be utilized in the normal course of business, of which $9.8 million is expected to be incurred within 12 months and is not reflected in the accompanying consolidated balance sheets.
Tax Obligations
Our tax obligations of $0.3 million, of which $0.1 million is due within 12 months, include a mandatory one-time tax on accumulated earnings of foreign subsidiaries resulting from the 2017 Tax Act. The income tax payable related to the 2017 Tax Act is due in installments in varying percentages over the next three 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 for each of the years ended December 31, 2022 and 2021 as we have historically been successful in 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 $2.5 million and $1.8 million for the years ended December 31, 2022 and 2021, respectively. An increase of obsolescence expense by 10%, or $0.3 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 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. We also 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. 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. Historically, we have recorded impairments associated with property and equipment, identifiable intangible assets and goodwill. We believe that the estimates and assumptions used in our impairment assessments are reasonable. However, if market conditions change dramatically, 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, 2022 and 2021. We have applied valuation allowances to reduce our deferred tax assets as of December 31, 2022 and 2021, 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. See “Note 10. Commitments and Contingencies” of our consolidated financial statements for further information regarding our legal proceedings.
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”).
Smaller Reporting Company Status
We are 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
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have a public float of less than $250 million. As 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 the classification, including among other things, providing only two years of audited financial statements.
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.
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, 2022 and 2021, approximately 65% and 62%, 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 2022 and 2021. We do not currently intend to hedge our future exposure to the Argentine Peso or other foreign currencies.
Interest Rate Risk
We were primarily exposed to interest rate risk through our Prior Senior Secured Credit Facility and the Prior Amended Credit Agreement, which were terminated concurrent with our entry on May 3, 2022 into the replacement ABL Facility. At December 31, 2022, we had no outstanding indebtedness under our ABL Facility.
Borrowings under the ABL Facility may be made in U.S. dollars with interest calculated using either the “ABR”, the “Adjusted Daily Simple SOFR” or the “Adjusted Term SOFR Rate”, and in Canadian dollars with interest calculated using the “Canadian Prime Rate” or the “CDOR Rate” (each as defined in the Credit Agreement). Borrowings bear interest plus a margin that varies depending on our leverage ratio as follows: (i) for ABR based loans, between 1.40% and 2.40%, and (ii) for Adjusted Daily Simple SOFR, Adjusted Term SOFR Rate, Canadian Prime Rate, and CDOR Rate, between 2.40% and 3.40%. We must also pay a monthly commitment fee of 0.25% to 0.50% per year, based on unused commitments. The applicable interest rate at December 31, 2022 was 6.8%.
We are also subject to interest rate risk through our Repeat Precision Promissory Note. At December 31, 2022, we had $56 thousand outstanding indebtedness under the Repeat Precision Promissory Note. Borrowings under the Repeat Precision Promissory Note are made in U.S. dollars with interest calculated using the prime rate plus a 1.0% margin over the index. The applicable interest rate at December 31, 2022 was 8.5%.
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, 2022 and 2021 51
Notes to Consolidated Financial Statements 56
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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 sheets of NCS Multistage Holdings, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive loss, shareholders’ equity, and cash flows for the period ended December 31, 2022, 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, 2022 and 2021, and the results of itsoperations and itscash flows for each of the two years in the period ended December 31, 2022, 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 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 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 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 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 audits 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 audits provide a reasonable basis for our opinion.
Critical audit matters
Critical audit matters are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. We determined that there are no critical audit matters.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2021.
Houston, Texas
March 7, 2023
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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 2,815 3,290
Noncurrent assets
Identifiable intangibles, net 5,076 5,744
Deferred income taxes, net 46 236
Liabilities and Stockholders’ Equity
Current liabilities
Current maturities of long-term debt 1,489 1,483
Noncurrent liabilities
Long-term debt, less current maturities 6,437 6,335
Operating lease liabilities, long-term 3,680 3,779
Deferred income taxes, net 199 114
Commitments and contingencies (Note 10)
Stockholders’ equity
Accumulated other comprehensive loss (85,617) (82,094)
Total liabilities and stockholders' equity $ 138,599 $ 142,325
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
Selling, general and administrative expenses 58,338 49,094
Other income (expense)
Foreign currency exchange (loss) gain (283) 283
Loss before income tax (601) (3,516)
Net income attributable to non-controlling interest 150 955
Net loss attributable to NCS Multistage Holdings, Inc. $ (1,102) $ (4,734)
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 (3,523) (314)
Comprehensive income attributable to non-controlling interest 150 955
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 — — — — 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)
Share-based compensation — — — — 3,453 — — — — — 3,453
Net (loss) income — — — — — — (1,102) — — 150 (952)
Vesting of restricted stock — — 37,043 — — — — — — — —
Shares withheld — — — — — — — (8,943) (383) — (383)
Currency translation adjustment — — — — — (3,523) — — — — (3,523)
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
Depreciation and amortization 4,319 4,501
Amortization of deferred loan cost 231 281
Write-off of deferred loan costs 196 —
Provision for inventory obsolescence 2,542 1,754
Deferred income tax expense 266 96
Gain on sale of property and equipment (361) (378)
Provision for doubtful accounts (61) (129)
Proceeds from note receivable 590 281
Changes in operating assets and liabilities:
Accounts receivable—trade (4,860) (2,558)
Prepaid expenses and other assets 1,347 (437)
Income taxes receivable/payable 364 3,673
Net cash (used in) provided by operating activities (1,423) 11,583
Cash flows from investing activities
Purchases of property and equipment (1,035) (495)
Purchase and development of software and technology (96) (338)
Proceeds from sales of property and equipment 433 389
Net cash used in investing activities (698) (444)
Cash flows from financing activities
Payments on finance leases (1,463) (1,318)
Payments of line of credit borrowings (11,724) (360)
Treasury shares withheld (383) (197)
Distribution to non-controlling interest — (2,750)
Payment of deferred loan cost related to ABL facility (952) —
Net cash used in financing activities (2,742) (4,265)
Effect of exchange rate changes on cash and cash equivalents (1,071) (251)
Net change in cash and cash equivalents (5,934) 6,623
Cash and cash equivalents beginning of period 22,168 15,545
Cash and cash equivalents end of period $ 16,234 $ 22,168
Supplemental cash flow information
Cash paid for interest, net of amounts capitalized $ 557 $ 423
Cash paid for income taxes (net of refunds) (303) (3,528)
Noncash investing and financing activities
Assets obtained in exchange for new finance lease liabilities 1,788 3,712
Assets obtained in exchange for new operating lease liabilities 1,450 2,000
The accompanying notes are an integral part of these consolidated financial statements.
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NCS MULTISTAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 construction, well completions and field development strategies. We offer our products and services primarily to exploration and production companies for use both in onshore and offshore 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 with operations in the United States and Mexico, because NCS has a controlling voting interest. The other party’s ownership is presented separately as a non-controlling interest. As a smaller reporting company (“SRC”), we applied certain reduced reporting requirements permitted by the Securities and Exchange Commission (“SEC”), including among other things, providing only two years of audited financial statements.
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 to disclose 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”) caused unprecedented declines in economic activity, energy demand and oil and natural gas prices in 2020. The continuing impacts of the COVID-19 pandemic are contributing to occasional supply chain disruptions, particularly in China, and cost inflation, including labor cost inflation. As the impact of the pandemic continues to evolve, estimates and assumptions about future events and their efforts cannot be determined with certainty and therefore require judgment. 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 our significant foreign subsidiaries have been translated into USD at average exchange rates prevailing during the period. Assets and liabilities have been translated at the exchange rates on the 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, 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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NCS MULTISTAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, net of any customer paid freight, 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. 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 short-term 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.
No single customer individually accounted for 10% or more of our consolidated revenue during 2022 or 2021, or comprised 10% or more of our trade accounts receivable balance as of December 31, 2022. One customer accounted for 11% of our trade accounts receivable balance as of December 31, 2021.
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NCS MULTISTAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2022, we have no amounts in our allowance for doubtful accounts. As of December 31, 2021, our allowance for doubtful accounts approximated $0.1 million.
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, 2022 and 2021. See “Note 6. Property and Equipment” and “Note 7. Goodwill and Identifiable Intangibles” included herewith for further information.
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 exceeds the related 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 exceeds the related 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. Alternatively, we could 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, 2022 and 2021. 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
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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 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 incurred related to an acquisition or business combination, other than those associated with the issuance of debt or equity securities, 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. Certain costs incurred in the development of internal-use software applications are capitalized, while 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.
Leases
We determine if a contract contains a lease at the inception of an arrangement. If so, we record a right of use (“ROU”) asset representing the right to use an underlying asset for the lease term and a lease liability representing an obligation to make lease payments arising from the lease on the consolidated balance sheet.
We have operating and finance leases for facilities, vehicles, and equipment. Some leases include one or more options to renew, with renewal terms that can extend the lease term from five to ten years with exercise of lease renewal options being at the sole discretion of NCS as lessee. Some leases may include an option to terminate the contract with notice. ROU assets and lease liabilities recorded pursuant to a lease agreement with a term exceeding 12 months are recognized at the lease commencement date based on the present value of lease payments over the lease term. To the extent our lease agreements do not provide an implicit interest rate, the current interest rate pursuant to our secured asset-based revolving credit facility (“ABL Facility”), adjusted on a monthly annual basis, is used as an incremental borrowing rate applied to the present value calculation at the lease commencement date unless the implicit rate is readily determinable. Lease expense for operating leases is recognized on a straight-line basis over the lease term.
Our lease agreements are from a lessee perspective and do not contain (i) any leases with variable lease payments (e.g., payments that depend on a percentage of sales of a lessee or payments that increase based upon an index such as a consumer price
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index), (ii) residual value guarantees probable of being paid, except leased fleet vehicles, or (iii) material restrictive covenants. Lease agreements with lease and non-lease components are generally accounted for separately when practical. For leases where the lease and non-lease component are comingled and the non-lease component is determined to be insignificant when compared to the lease component, the lease and non-lease components are treated as a single lease component for all asset classes.
As of December 31, 2022, we have no significant leases where we are the lessor, and we do not have any additional significant operating or finance leases that have not yet commenced which create significant rights or obligations for NCS. For additional information, see “Note 9. Debt” and “Note 14. Leases.”
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.
Share-Based Compensation
We account for our stock-based compensation awards in accordance with ASC 718, Compensation—Stock Compensation. 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.
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.
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Earnings Per Share
Basic income (loss) 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 and unvested RSUs and PSUs, reduced by the number of shares purchased by us at cost, when such amounts are dilutive to the income per share calculation.
Research and Development
Research and development costs are incurred both through the utilization of our employees to create and develop new ideas and products as well as through engaging third parties to perform development activities under our coordination and management. We incurred approximately $2.7 million and $2.1 million in research and development costs for the years ended December 31, 2022 and 2021, 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. We recorded, and subsequently received, customer reimbursable amounts of $1.7 million and $0.1 million during the years ended December 31, 2022 and 2021, respectively, which are treated as a reduction of research and development costs included in SG&A expenses.
Recent Accounting Pronouncements
Pronouncement Adopted in 2022
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 became effective for fiscal years beginning after December 15, 2021. We adopted ASU No. 2021-10 on a prospective basis on January 1, 2022, with no material impact on our consolidated financial statements.
Pronouncement Not Yet Effective
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 SEC filers, except for entities who are deemed SRCs. 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 have evaluated this guidance and determined the adoption on January 1, 2023 will not have a material impact on our consolidated financial statements.
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 17. 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 presents the current contract liabilities for the periods indicated (in thousands):
Revenue recognized (1,036)
Revenue recognized (1,983)
We currently do not have any contract assets or non-current contract liabilities. Our contract liability as of December 31, 2022 and 2021 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 $2.0 million and $1.0 million for the years ended December 31, 2022 and 2021, respectively.
Contracts with Multiple Performance Obligations
Substantially all of our product and services revenues are considered a single performance obligation. Our self-service product line, which is a small percentage of our revenue for the years ended December 31, 2022 and 2021 is comprised 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 are determined as (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, 2022 and 2021 (in thousands):
December 31, December 31,
Work in process 38 14
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Note 5. Other Current Receivables
Other current receivables consist of the following as of December 31, 2022 and 2021 (in thousands):
December 31, December 31,
Current income tax receivables $ 1,868 $ 2,226
Total other receivables, net $ 3,726 $ 4,726
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, 2022 and 2021 includes the U.S. employee retention credit (“ERC”) claims we have filed but for which we have not yet received renumeration. The other receivables balance also includes $0.7 million for each year ended December 31, 2022 and 2021 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.
Note 6. Property and Equipment
Property and equipment by major asset class consist of the following as of December 31, 2022 and 2021 (in thousands):
December 31, December 31,
Less: Accumulated depreciation and amortization (18,844) (17,752)
Construction in progress 545 430
The following table presents the depreciation expense associated with the following income statement line items for the years ended December 31, 2022 and 2021 (in thousands):
Year Ended December 31,
Cost of sales
Selling, general and administrative expenses 1,678 1,742
The table above includes depreciation expense associated with finance leases for buildings as well as vehicles for our transportation fleet. See “Note 14. 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, 2022 and 2021, respectively, and accordingly no impairment loss was recorded.
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Note 7. Goodwill and Identifiable Intangibles
The carrying amount of goodwill is summarized 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. If an impairment loss occurs, we separately disclose it in the consolidated statements of operations, as applicable. See “Note 2. Summary of Significant Accounting Policies - Impairments” for additional information.
As of December 31, 2022 and 2021, 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, 2022 and 2021, respectively.
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 $ (3,030) $ 5,028
Technology - not subject to amortization Indefinite 48 — 48
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
We did not incur costs to renew or extend the term of acquired intangible assets during the years ended December 31, 2022 and 2021, respectively. Substantially all identifiable intangibles as of December 31, 2022 and 2021 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 - Impairments” for additional information. There were no indicators of impairment identified during the years ended December 31, 2022 or 2021. Therefore, we did not record any impairment charges related to our identifiable intangibles for the years ended December 31, 2022 or 2021, respectively.
Total amortization expense, which is associated with SG&A expenses on the consolidated statements of operations, was $0.7 million for each of the years ended December 31, 2022 and 2021, respectively.
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The total weighted average amortization period for intangible assets is 13 years and estimated future amortization expense by year is as follows (in thousands):
Note 8. Accrued Expenses
Accrued expenses consist of the following as of December 31, 2022 and 2021 (in thousands):
December 31, December 31,
Accrued payroll and bonus $ 3,227 $ 4,208
Property and franchise taxes accrual 340 550
Accrued other miscellaneous liabilities 824 1,565
Note 9. Debt
Our long-term debt consists of the following as of December 31, 2022 and 2021 (in thousands):
December 31, December 31,
Prior Senior Secured Credit Facility $ — $ —
ABL Facility — —
Repeat Precision Promissory Note 56 —
The estimated fair value of total debt for the years ended December 31, 2022 and 2021 was $6.8 million and $7.5 million, respectively. At December 31, 2022, the fair value of the Repeat Precision Promissory Note (as defined below) approximated the carrying value due to a variable interest rate and the ability to repay the note at any time. The fair value of 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 financing arrangements.
Prior Senior Secured Credit Facility
On May 1, 2019, we entered into a Second Amended and Restated Credit Agreement (the “2019 Credit Agreement”) by and among NCS Multistage Holdings, Inc. (“NCSH”) with Pioneer Investment, Inc., as U.S. borrower (“Pioneer”), NCS Multistage Inc., as Canadian borrower (“NCS Canada”; together with Pioneer, the “Borrowers”), Pioneer Intermediate, Inc. (together with NCSH, the “Parent Guarantors”), the lenders party thereto, Wells Fargo Bank, National Association as administrative agent (the “Prior U.S. Agent”) in respect of the U.S. facility provided therein and Wells Fargo Bank, National Association, Canadian Branch, as administrative agent (the “Prior Canadian Agent”) in respect of the Canadian Facility provided therein. The 2019 Credit Agreement amended and restated our then-existing credit agreement in its entirety.
On August 6, 2020, we entered into Amendment No. 1 to the Second Amended and Restated Credit Agreement (the “2020 Amendment”; the 2019 Credit Agreement, as amended by the 2020 Amendment, the “Prior Amended Credit Agreement”) with the Borrowers, Pioneer Intermediate, Inc., certain subsidiaries of the Borrowers, the lenders party thereto, the Prior U.S. Agent and the Prior Canadian Agent. The facility provided pursuant to the Prior Amended Credit Agreement is referred to herein as the “Prior Senior Secured Credit Facility.”
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The Prior Senior Secured Credit Facility consisted of a senior secured revolving credit facility in an aggregate principal amount of $25.0 million made available to Pioneer. NCS Canada could borrow under the Prior Senior Secured Credit Facility, subject to a $15.0 million sublimit. Total borrowings available to the Borrowers under the Prior Senior Secured Credit Facility were limited subject to a borrowing base calculated on eligible receivables, which did not include receivables at Repeat Precision. As of December 31, 2021, we had no outstanding indebtedness under the Prior Senior Secured Credit Facility, and we utilized letter of credit commitments of less than $0.1 million.
Borrowings under the Prior Senior Secured Credit Facility could 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 Prior Amended Credit Agreement). Such advances bore interest at the Adjusted Base Rate or at the Eurocurrency Rate (each as defined in the Prior Amended Credit Agreement) plus an applicable interest margin between 2.75% and 3.75%, depending on our leverage ratio. We incurred interest expense related to the Prior Senior Secured Credit Facility, including commitment fees, of $47 thousand and $0.1 million for the years ended December 31, 2022 and 2021, respectively.
The obligations of the Borrowers under the Prior Senior Secured Credit Facility were 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 were 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.
We capitalized direct costs of $1.2 million in connection with the Prior Amended Credit Agreement, which we amortized over the term of the Prior Senior Secured Credit Facility using the straight-line method.
Concurrent with our entry into a replacement asset-based revolving credit facility on May 3, 2022, as further discussed below, the Prior Senior Secured Credit Facility and the Prior Amended Credit Agreement were terminated. Of the unamortized remaining deferred loan costs associated with the Prior Senior Secured Credit Facility totaling $0.3 million, we charged $0.2 million to interest expense, net during the second quarter of 2022, associated with the members of the lender group who did not continue with the new facility, and deferred $0.1 million, along with new deferred loan costs associated with the replacement facility, to be amortized over the term of the new facility.
ABL Facility
On May 3, 2022, we entered into a new ABL Facility under which credit availability is subject to a borrowing base calculation. The ABL Facility is governed by the Credit Agreement dated as of May 3, 2022, by and between NCSH, Pioneer, NCS Multistage, LLC, NCS Canada, the other loan parties thereto, the lenders party thereto, and JPMorgan Chase Bank, N.A., as administrative agent and as a lender under the facility provided therein (the “Credit Agreement”).
The ABL Facility consists of a revolving credit facility in an aggregate principal amount of $35.0 million made available to borrowers, of which up to $10.0 million may be made in Canadian dollars and $7.5 million may be made available for letters of credit. Total borrowings available to the borrowers under the ABL Facility may be limited subject to a borrowing base calculated on the sum of cash in a specified pledged account, eligible accounts receivables and eligible inventory, provided it does not include the assets of Repeat Precision. Our borrowing base under the ABL Facility at December 31, 2022 was $18.6 million. The ABL Facility will mature on May 3, 2027. As of December 31, 2022, we had no outstanding indebtedness under the ABL Facility.
Borrowings under the ABL Facility may be made in U.S. dollars with interest calculated using either the “ABR”, the “Adjusted Daily Simple SOFR” or the “Adjusted Term SOFR Rate”, and in Canadian dollars with interest calculated using the “Canadian Prime Rate” or the “CDOR Rate” (each as defined in the Credit Agreement). Borrowings bear interest plus a margin that varies depending on our leverage ratio as follows: (i) for ABR based loans, between 1.40% and 2.40%, and (ii) for Adjusted Daily Simple SOFR, Adjusted Term SOFR Rate, Canadian Prime Rate, and CDOR Rate, between 2.40% and 3.40%. We must also pay a monthly commitment fee of 0.25% to 0.50% per year, based on unused commitments. The applicable interest rate at December 31, 2022 was 6.8%. We incurred interest expense related to the ABL Facility, including commitment fees, of $0.1 million for the year ended December 31, 2022.
The obligations of the borrowers under the ABL Facility are guaranteed by NCSH and each of our U.S. and Canada subsidiaries (other than Repeat Precision), as well as each of our future direct and indirect subsidiaries organized under the laws of the United States or Canada (subject to certain exceptions), and are secured by substantially all of the assets of NCSH and its subsidiaries, in each case, subject to certain exceptions and permitted liens.
The Credit Agreement requires, as a condition to borrowing, that available cash on hand after borrowings does not exceed $10.0 million. The Credit Agreement also requires us to (i) maintain, for quarters during which liquidity is less than 20% of the aggregate revolving commitments, a fixed charge coverage ratio of at least 1.0 to 1.0 and (ii) to prepay advances to the extent that the
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outstanding loans and letter of credit amounts exceed the most recently calculated borrowing base. As of December 31, 2022, we were in compliance with these financial covenants. The Credit Agreement also contains customary affirmative and negative covenants, including, among other things, restrictions on the creation of liens, the incurrence of indebtedness, investments, dividends and other restricted payments, dispositions and transactions with affiliates.
The 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 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 Credit Agreement also have the right upon an event of default thereunder to terminate any commitments to provide further borrowings, or to provide additional financing in excess of the borrowing base limit, or to proceed against the collateral securing the ABL Facility.
We capitalized direct costs of $1.0 million in connection with the Credit Agreement, which are being amortized over the term of the ABL Facility using the straight-line method. Amortization of the deferred financing charges of $0.1 million was included in interest expense, net for the year ended December 31, 2022.
Repeat Precision Promissory Note
On February 16, 2018, Repeat Precision entered into a promissory note for an aggregate borrowing capacity of $4.3 million with Security State Bank & Trust, Fredericksburg (the “Repeat Precision Promissory Note”). The Repeat Precision Promissory Note was originally scheduled to mature on February 11, 2023, but has since been extended to August 10, 2024. The note bears interest at a variable interest rate based on prime plus 1.00%. The applicable interest rate at December 31, 2022 was 8.5%. The Repeat Precision Promissory Note is collateralized by certain equipment, inventory and receivables. 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, 2022, Repeat Precision had $56 thousand of outstanding indebtedness under the note. There was no outstanding indebtedness under the Repeat Precision Promissory Note at December 31, 2021. Repeat Precision’s indebtedness is guaranteed by Repeat Precision and its subsidiary and is not guaranteed by any other NCS entity.
Finance Leases
We lease assets under finance lease arrangements including an office and laboratory in Tulsa, Oklahoma, as well as facilities in Odessa, Texas. 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 14. 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 connection with our patent infringement jury verdict against Nine Energy Services, Inc. (“Nine”), the Western District of Texas, Waco Division (“Waco District Court”) entered final judgment in June 2022, and awarded NCS approximately $0.5 million in damages for Nine’s infringement of U.S. Patent No. 10,465,445 (“the ’445 Patent”). At a hearing in December 2022, the Waco District Court announced it would be awarding hundreds of thousands of dollars in supplemental damages, interest, and costs and ordered Nine to pay an ongoing royalty for the sale of infringing casing flotation devices for the life of the ’445 Patent. In addition, in August 2022 in connection with our patent infringement jury verdict against TCO AS, the jury awarded NCS approximately $1.9 million in damages for TCO AS’s infringement of the ’445 Patent. Once the Waco District Court enters final judgment in that case, NCS will seek an award of ongoing royalties for TCO AS’s continued post-judgment infringement, supplemental damages, interest, and costs. Both of these cases remain subject to appeal. Therefore, we have not recorded any potential gain contingencies associated with these matters in the accompanying consolidated statements of operations.
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 will have a material adverse effect on our financial position, results of operations or cash flows.
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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, subject to withholding tax of $0.1 million for each of the years ended December 31, 2022 and 2021. 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, 2022 and 2021, we have recorded tracer diagnostics services revenue of $1.2 million and $0.9 million, respectively, and other income, net totaling $0.7 million and $0.5 million, respectively, related to this agreement in the consolidated statements of operations. We collected the receivable related to 2021 in May 2022 and expect to collect the receivable related to 2022 during the second quarter of 2023.
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 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 reduced the employer’s portion of social security tax and permitted the deferral of the payment of certain employer payroll taxes incurred in 2020 until December 2021 and 2022.
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 was included in cost of sales and $2.3 million was included in general and administrative expenses in the accompanying consolidated statements of operations. The refundable tax credits included $0.5 million pertaining to Repeat Precision. Of the aggregate credits claimed during 2021, we received $2.1million in 2021 and $0.2 million in 2022. We have included $0.9 million and $1.1 million, respectively, in other current receivables on our consolidated balance sheets as of December 31,2022 and 2021. See “Note 5. Other Current Receivables.” All deferred employer payroll tax from 2020 has been timely remitted as of December 2022, as required.
Note 11. Stockholders’ Equity
Authorized and Outstanding Shares
At December 31, 2022 and 2021, we had 11,250,000 shares of common stock authorized to be issued. At December 31, 2022 and 2021, 2,408,474 and 2,380,374 shares of common stock were outstanding, respectively. At December 31, 2022 and 2021, the number of our authorized shares of preferred stock included 10,000,000 shares, with none outstanding.
Voting
The holders of common stock are entitled to one vote for each share of common stock held.
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 ABL Facility. No dividends were declared during the years ended December 31, 2022 and December 31, 2021.
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Note 12. Share-Based Compensation
Equity Incentive Plan
We maintain an equity incentive plan for the benefit of our employees, directors and other service providers: our 2017 Equity Incentive Plan (the “2017 Plan”).Our previous equity incentive plan, the 2012 Equity Incentive Plan (the “2012 Plan”), terminated on December 20, 2022, provided that any outstanding awards remain outstanding in accordance with the terms of the applicable award agreement. As of December 31, 2022, there remain 6,219 options outstanding, all of which are exercisable pursuant to the 2012 Plan.
The 2017 Plan provides for awards of stock options, stock appreciation rights, restricted stock awards, RSUs, stock awards and performance awards. Awards under the 2017 Plan may be granted to any employee, non-employee director, consultant or other personal service provider of NCS. The 2017 Plan is administered by a plan administrator, which is the Compensation, Nominating and Governance Committee or such other committee of the Board or the Board as a whole, in each case as determined by the Board. The 2017 Plan was initially established with the authorization for grants of up to 226,626 shares of authorized but unissued shares of common stock. During 2020, NCS increased the number of authorized shares by 325,000 shares of common stock, which increased the maximum aggregate number of shares available to be issued under the 2017 Plan to 551,626 shares. As of December 31, 2022, the total number of shares available for future issuance under the 2017 Plan is 243,354 shares.
Restricted Stock Units
In 2017, we began granting RSUs. We account for RSUs granted to employees at fair value, which we measure as the closing price of our common stock on the date of grant, and we recognize the compensation expense in the financial statements over the requisite service period. The RSUs granted to our employees generally vest over a period of three equal annual installments beginning on or around the anniversary of the date of grant. Beginning in 2019, the RSUs granted to the members of our Board generally vest on the one year anniversary of the grant date and settle either at vesting or, if the director has elected to defer the RSUs, the earlier of the termination of the director’s service for any reason or a change of control.
The following table summarizes RSU activity during the year ended December 31, 2022:
Number ofAwards WeightedAverageGrant DateFair Value
Vested (including 11,151 shares that have not been released) (45,991) 53.83
The total value of RSUs that vested and released was $1.6 million and $1.0 million during the years ended December 31, 2022 and 2021. For 2022 and 2021, the income tax benefit recognized for RSUs was $0.3 million and $0.2 million, respectively. As of December 31, 2022, there was $2.9 million of total unrecognized compensation cost related to RSUs, which we expect to recognize over a weighted average period of two years.
Equivalent Stock Unit Awards
In 2019, we began granting ESUs. When the ESUs are granted to employees, they are valued at fair value, which we measure as the closing price of our common stock on the date of grant. As the ESUs are settled in cash, we record a liability which is remeasured each reporting period at fair value based upon the closing price of our common stock until the awards are settled. The ESUs will generally vest and settle ratably in three equal annual installments beginning on or around the anniversary of the date of grant. The cash settled for any ESU will not exceed the maximum payout established by our Compensation, Nominating and Governance Committee of the Board.
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The following table summarizes ESU activity during the year ended December 31, 2022:
Number ofAwards WeightedAverageGrant DateFair Value
During the years ended December 31, 2022 and 2021, we paid $2.6 million and $1.8 million, respectively, upon settlement of the ESUs. As of December 31, 2022, the total liability for ESUs was $1.5 million.
Performance Stock Unit Awards
We have granted PSUs to certain executives on an annual basis since 2018. PSUs provide for the recipients to receive a grant of shares of common stock based upon the achievement of certain performance goals over a specified period established by the Compensation, Nominating, and Corporate Governance Committee. The number of PSUs ultimately issued is dependent upon our total shareholder return relative to our performance peer group (“relative TSR”) over a three-year performance period. Each PSU will settle for between zero and two shares of our common stock. For PSUs granted prior to 2021, the threshold performance level (25th percentile relative TSR) starts to earn PSUs, the mid-point performance level (50th percentile relative TSR) earns 65% of the target PSUs and the maximum performance level (90th percentile relative TSR) or greater earns 200% of the target PSUs. For PSU grants starting in 2021, the mid-point performance level (50th percentile relative TSR) earns 100% of the target PSUs and all other performance levels remain the same as prior years.
The PSUs grant date fair values in 2022 and 2021 were measured using a Monte Carlo simulation with the following assumptions and the resulting weighted-average grant date fair value per share:
Risk-free interest rate 4.4 % 1.6 % 0.3 %
Expected dividends — % — % — %
Weighted-average fair value per share $ 49.52 $ 71.28 $ 66.14
The following table summarizes PSU activity during the year ended December 31, 2022:
Number ofAwards WeightedAverageGrant DateFair Value
Vested — —
As of December 31, 2022, there was $2.4 million of total unrecognized compensation cost related to PSUs, which we expect to recognize over a weighted average period of two years.
Stock Options
Stock options granted under the 2012 Plan and the 2017 Plan generally vested annually in equal increments over three or five years and have a 10-year term. We estimated the fair value of each option grant using the Black-Scholes option-pricing model. The Black-Scholes option pricing model required estimates of key assumptions based on both historical information and management
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judgment regarding market factors and trends. Determining the appropriate fair value model and calculating the fair value of options required the input of highly subjective assumptions, including the expected volatility of the price of our stock, the risk-free rate, the expected term of the options and the expected dividend yield of our common stock. These estimates involved inherent uncertainties and the application of management’s judgment. If factors changed and different assumptions were used, our share-based compensation expense could have been materially different.
When we were a private company, we issued certain stock options that were to vest only in connection with a change of control (the “Liquidity Options”), which were amended to vest in three equal installments when we completed our initial public offering during the second quarter of 2017. All outstanding stock options were fully vested as of December 31, 2021. Therefore, no compensation cost has been recognized related to stock options for the year ended December 31, 2022.