SELECT WATER SOLUTIONS, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report, as well as the historical consolidated financial statements and notes thereto included in our 2019 Form 10-K. This discussion and analysis contains forward-looking statements based upon our current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors as described under "Cautionary Note Regarding Forward-Looking Statements." We assume no obligation to update any of these forward-looking statements.
This discussion relates to the three months ended
Overview
We are a leading provider of comprehensive water-management solutions to the oil and gas industry inthe United States ("U.S."). We also develop, manufacture and deliver a full suite of chemical products for use in oil and gas well completion and production operations. Through a combination of organic growth and acquisitions over the last decade, we have developed a leading position in the relatively new water solutions industry. We believe we are the only company in the oilfield services industry that combines comprehensive water-management services with related chemical products. Furthermore, we are one of the few large oilfield services companies whose primary focus is on the management of water and water logistics in the oil and gas development industry. Accordingly, as an industry leader in the water solutions industry, we place the utmost importance on safe, environmentally responsible management of oilfield water throughout the lifecycle of a well. Additionally, we believe that responsibly managing water resources through our operations to help conserve and protect the environment in the communities in which we operate is paramount to our continued success. In many regions of the country, there has been growing concern about the volumes of water required for new oil and gas well completions. Working with our customers and local communities, we strive to be an industry leader in the development of cost-effective alternatives to fresh water. Specifically, we offer services that enable our E&P customers to treat and reuse produced water, thereby reducing the demand for fresh water while also reducing the volumes of saltwater that must be disposed by injection. In many areas, we have also acquired sources of non-potable water such as brackish water or municipal or industrial effluent. We work with our customers to optimize their fluid systems to economically enable the use of these alternative sources. We also work with our E&P customers to reduce the environmental footprint of their operations through the use of temporary hose and permanent pipeline systems. These solutions reduce the demand for trucking operations, thereby reducing diesel emissions, increasing safety and decreasing traffic congestion in nearby communities.
Industry Overview
Significant challenges that emerged during theCurrent Quarter , and which are expected to continue into the foreseeable future, have had and will continue to have a negative impact on our results of operations. The novel coronavirus ("COVID-19") outbreak, characterized as a pandemic by theWorld Health Organization onMarch 11, 2020 , has caused significant disruptions in global oil demand as well as international andU.S. economies and financial markets. Additionally, the failure ofSaudi Arabia andRussia to reach a decision to cut production of oil and gas along with theOrganization of the Petroleum Exporting Countries ("OPEC"), andSaudi Arabia's subsequent decision to reduce the prices at which it sells oil and increase production, combined with the continued outbreak of COVID-19, contributed to a sharp drop in prices for oil in theCurrent Quarter . While an agreement to cut production was reached inApril 2020 , oil prices have remained low, and global oil demand is expected to remain challenged at least until the COVID-19 outbreak can be contained. As a result of these market disruptions, oil prices have declined significantly and ourCurrent Quarter results have been negatively impacted. With the significant recent
drop
in oil prices, the activity
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levels of our customers and the demand for our services will certainly decrease
materially in the near-term; however, at this time, we believe it is too soon to
determine the depth or magnitude of the declines.
We believe the ongoing effects of COVID-19 on our operations have had, and will
continue to have, a material negative impact on our financial results, and such
negative impact may continue well beyond the containment of such outbreak until
oil demand and prices, recover. We cannot assure you that our assumptions used
to estimate our future financial results will be correct given the unpredictable
nature of the current market environment after the rapid decline in the demand
for oil and demand for our services. As a consequence, our ability to accurately
forecast our activity and profitability is uncertain.
The magnitude and duration of the COVID-19 pandemic is also uncertain. As a
consequence, we cannot estimate the impact on our business, financial condition
or near- or longer-term financial or operational results with reasonable
certainty, but at this time, we expect a net loss for 2020. We are taking
further actions to maintain our liquidity, including decreasing operating
expenses by reducing headcount, reducing salaries, closing yard locations,
reducing third party expenses and streamlining operations, as well as reducing
capital expenditures. We are also deferring employer payroll tax payments for
the remainder of 2020, in accordance with the provisions of the CARES Act, and
may take advantage of future legislation passed by the United States Congress in
response to COVID-19. In this environment, the duration of which remains
uncertain, the Company has planned for a range of scenarios and has taken a
number of actions. To protect our workforce in the wake of COVID-19, we have
taken steps to keep our people safe by supporting those affected, mandating that
as many employees and contractors as possible work from home, and monitoring and
consistently communicating with those who cannot do so and are required tobe at work. Based on our current cash position, lack of bank debt and these ongoing actions, we believe that we will be able to maintain sufficient liquidity to satisfy our obligations and remain in compliance with our existing debt covenants for the next twelve months, prior to giving effect to any financing that may occur. During theCurrent Quarter , the average spot price of West Texas Intermediate ("WTI") (Cushing) crude oil was$45.34 versus an average price of$54.82 for the Prior Quarter. The WTI price closed at$20.51 onMarch 31, 2020 , which was nearly 55% lower than the average price for theCurrent Quarter , illustrating the significant decline and volatility of the price of oil and gas prices in theCurrent Quarter . The averageHenry Hub natural gas spot price during theCurrent Quarter was$1.91 versus an average of$2.92 for the Prior Quarter. The significant decline in oil and gas prices in theCurrent Quarter relative to the Prior Quarter, as well as the more recent oil pricing volatility driven by market dislocation, has been driven largely by increased supply from OPEC+ and decreased demand due to the COVID-19 pandemic, as well as increased utilization of existing storage capacity, which may result in our E&P customers being forced to shut-in production. Additionally, both debt and equity capital markets, and in particular the IPO market, do not appear favorably disposed towards investing in the oil and gas industry at this time. In light of these factors, combined with the downward revisions made to many of our customers' respective annual capital budgets and financial outlooks, we do not anticipate large incremental sums of capital entering the market to create higher demand for our services for the remainder of 2020, which will likely lead to decreased activity for us. Additionally, this lack of available capital in the current market environment will make it challenging for distressed oil and gas companies to resolve their debt covenant and liquidity challenges in the near-term, potentially resulting in a number of restructuring activities, including bankruptcies, in the industry. Outside of the macroeconomic challenges, from an operational standpoint, many of the recent trends still apply to ongoing unconventional oil and gas development. For example, while we believe leading-edge lateral lengths and proppant use are plateauing, the average operator continues to catch up to this leading edge and many smaller operators with less robust completion designs may be challenged in this environment. The continued trend towards multi-well pad development, executed within a limited time frame, has increased the overall complexity of well completions, while increasing frac efficiency and the use of lower cost in-basin sand, all of which has decreased total costs for our customers. 40
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This multi-well pad development, combined with recent upstream acreage consolidation and the emerging trends around the reuse applications of produced water, particularly in thePermian Basin , provides significant opportunity for companies like us that can deliver increasingly complex solutions for our E&P customers across the full completion and production life of wells over the long-term. However, we note the continued efficiency gains in the well completions process can limit the days we spend on the wellsite and therefore negatively impact the total revenue opportunity. The trend of increased use of produced water may require additional chemical treatment solutions, which we are well positioned to provide given our water treatment capabilities, our recent WCS acquisition and our knowledge base within our Oilfield Chemicals segment. Additionally, this trend supports more complex "on the fly" solutions that treat, proportion, and blend various streams of water and chemicals at the wellsite. This complexity favors service companies able to provide advanced technology solutions that are able to economically compete with alternative historical solutions. Regardless of these operational trends, the current environment is one of the most challenging in decades for the oilfield services industry due to the large imbalance between oil supply and demand. Many operators may prioritize decreasing their activity levels or pursuing near-term cost savings rather than long-term efficiencies, which could negatively impact the demand and pricing for our services. While we enjoy an advantaged position relative to many other oilfield services companies due to our cash position and absence of debt on the balance sheet at the end of theCurrent Quarter , our full year 2020 financial results are likely to be materially worse than those of recent years.
Our Segments
Our services are offered through three reportable segments: (i) Water Services; (ii) Water Infrastructure; and (iii) Oilfield Chemicals.
Water Services. The Water Services segment consists of the Company's services
businesses including water transfer, flowback and well testing, fluids hauling,
? water containment and water network automation, primarily serving E&P
companies. Additionally, this segment includes the operations of our
accommodations and rentals business.
Water Infrastructure. The Water Infrastructure segment consists of the
Company's infrastructure assets and ongoing infrastructure development
? projects, including operations associated with our water sourcing and pipeline
infrastructure, our water recycling solutions and infrastructure, and our
produced water gathering systems and salt water disposal wells, primarily
serving E&P companies. ? Oilfield Chemicals. The Oilfield Chemicals segment, provides technical solutions and expertise related to chemical applications in the oil and gas industry. We also have significant capabilities in supplying logistics for chemical applications. We develop, manufacture and provide a full suite of chemicals used in hydraulic fracturing, stimulation, cementing, production, pipelines and well completions, including polymer slurries, crosslinkers, friction reducers, biocides, scale inhibitors corrosion inhibitors, buffers, breakers and other chemical technologies. With the range of chemicals and application expertise our customers range from pressure pumpers to major integrated and independentU.S. and international oil and gas producers. This segment also utilizes its chemical experience and lab testing capabilities to customize tailored water treatment solutions designed to maximize the effectiveness of and optimize the efficiencies of the fracturing fluid system in conjunction with the quality of water used in well completions.
How We Generate Revenue
We currently generate most of our revenue through our water-management services associated with hydraulic fracturing, provided through our Water Services and Water Infrastructure segments. We generate the majority of our revenue through customer agreements with fixed pricing terms and earn revenue when delivery
of
services is provided,
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generally at our customers' sites. While we have some long-term pricing arrangements, particularly in our Water Infrastructure segment, most of our water and water-related services are priced based on prevailing market conditions, giving due consideration to the specific requirements of the customer.
We also generate revenue by providing completion, specialty chemicals and production chemicals through our Oilfield Chemicals segment. We invoice the majority of our Oilfield Chemicals customers for services provided based on the quantity of chemicals used or pursuant to short-term contracts as the customers' needs arise.
Costs of Conducting Our Business
The principal expenses involved in conducting our business are labor costs, equipment costs (including depreciation, repair, rental and maintenance and leasing costs), raw materials and water sourcing costs and fuel costs. Our fixed costs are relatively low. Most of the costs of serving our customers are variable, i.e., they are only incurred when we provide water and water-related services, or chemicals and chemical-related services to our customers. Labor costs associated with our employees and contract labor represent the most significant costs of our business. We incurred labor and labor-related costs of$101.6 million and$138.8 million for theCurrent Quarter and Prior Quarter, respectively. The majority of our recurring labor costs are variable and are incurred only while we are providing our operational services. We also incur costs to employ personnel to sell and supervise our services and perform maintenance on our assets, which is not directly tied to our level of business activity. Additionally, we incur selling, general and administrative costs for compensation of our administrative personnel at our field sites and in our operational and corporate headquarters. In light of the challenging activity and pricing trends, management has taken direct action during theCurrent Quarter to reduce operating and equipment costs, as well as selling, general and administrative costs, in order to proactively manage these expenses as a percentage of revenue. We expect to continue pursuing meaningful direct actions to reduce our labor costs in the coming quarters. We incur significant equipment costs in connection with the operation of our business, including depreciation, repair and maintenance, rental and leasing costs. We incurred equipment costs of$47.3 million and$66.1 million for theCurrent Quarter and Prior Quarter, respectively. We incur significant transportation costs associated with our service lines, including fuel and freight. We incurred fuel and freight costs of$18.1 million and$22.3 million for theCurrent Quarter and Prior Quarter, respectively. Fuel prices impact our transportation costs, which affect the pricing and demand for our services and have an impact on our results of operations. We incur raw material costs in manufacturing our chemical products, as well as for water that we source for our customers. We incurred raw material costs of$70.1 million and$70.4 million for theCurrent Quarter and Prior Quarter, respectively.
How We Evaluate Our Operations
We use a variety of operational and financial metrics to assess our performance. Among other measures, management considers each of the following:
? Revenue;
? Gross Profit;
? Gross Margins;
? EBITDA; and
? Adjusted EBITDA.
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Revenue
We analyze our revenue and assess our performance by comparing actual monthly
revenue to our internal projections and across periods. We also assess
incremental changes in revenue compared to incremental changes in direct
operating costs, and selling, general and administrative expenses across our
reportable segments to identify potential areas for improvement, as well as to
determine whether segments are meeting management's expectations.
Gross Profit
To measure our financial performance, we analyze our gross profit, which we define as revenues less direct operating expenses (including depreciation and amortization expenses). We believe gross profit provides insight into profitability and true operating performance of our assets. We also compare gross profit to prior periods and across segments to identify trends as well as underperforming segments. Gross Margins Gross margins provide an important gauge of how effective we are at converting revenue into profits. This metric works in tandem with gross profit to ensure that we do not increase gross profit at the expense of lower margins, nor pursue higher gross margins exclusively at the expense of declining gross profits. We track gross margins by segment and service line and compare them across prior periods and across segments and service lines to identify trends as well as underperforming segments.
EBITDA and Adjusted EBITDA
We view EBITDA and Adjusted EBITDA as important indicators of performance. We define EBITDA as net income/(loss), plus interest expense, income taxes, and depreciation and amortization. We define Adjusted EBITDA as EBITDA plus/(minus) loss/(income) from discontinued operations, plus any impairment charges or asset write-offs pursuant to accounting principles generally accepted in theU.S. ("GAAP"), plus non-cash losses on the sale of assets or subsidiaries, non-recurring compensation expense, non-cash compensation expense, and non-recurring or unusual expenses or charges, including severance expenses, transaction costs, or facilities-related exit and disposal-related expenditures, plus/(minus) foreign currency losses/(gains) and plus any inventory write-downs. The adjustments to EBITDA are generally consistent with such adjustments described in our Credit Facility. See "-Note Regarding Non-GAAP Financial Measures-EBITDA and Adjusted EBITDA" for more information and a reconciliation of EBITDA and Adjusted EBITDA to net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP.
Factors Affecting the Comparability of Our Results of Operations to Our Historical Results of Operations
Our future results of operations may not be comparable to our historical results of operations for the periods presented, primarily for the reasons described below and those described in "-Industry Overview" above.
Acquisition and Divestiture Activity
As described above, we are continuously evaluating potential investments, particularly in water infrastructure and other water-related services and technology. To the extent we consummate acquisitions, any incremental revenues or expenses from such transactions are not included in our historical results of operations.
Well Chemical Services Acquisition
On
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Affirm Divestitures
We sold the Affirm crane and field services businesses onFebruary 26, 2019 andJune 28, 2019 , respectively. Affirm accounted for$21.8 million of revenue during 2019. Following the two divestitures, the divested operations were not included in the consolidated results of operations.
Canadian Operations Divestitures
OnMarch 19, 2019 , we sold over half of our Canadian operations and onApril 1, 2019 , we sold and wound down the rest of the Canadian operations. Canadian operations accounted for$8.6 million of annual revenue during 2019. Following the divestitures, the divested Canadian operations were not included in the consolidated results of operations.
Sand Hauling Wind Down
During 2019, we wound down our sand hauling operations and sold certain of our sand hauling property and equipment. Sand hauling accounted for$3.3 million of annual revenue during 2019.
Proceeds received from Divestitures and Wind Down
During 2019, we received$30.1 million from divestitures and fixed asset sale activity in connection with the sale and wind down of our Affirm subsidiary and the sand hauling and Canadian operations. 44 Table of Contents Results of Operations
The following tables set forth our results of operations for the periods presented, including revenue by segment.
Current Quarter Compared to the Prior Quarter
Three months ended March 31, Change
2020 2019 Dollars Percentage
(in thousands)
Revenue
Water Services $ 149,511 $ 220,595 $ (71,084) (32.2) %
Water Infrastructure 57,762 53,616 4,146 7.7 %
Oilfield Chemicals 71,012 66,829 4,183 6.3 %
Other - 21,606 (21,606) (100.0) %
Total revenue 278,285 362,646 (84,361) (23.3) %
Costs of revenue
Water Services 129,114 163,121 (34,007) (20.8) %
Water Infrastructure 47,813 41,430 6,383 15.4 %
Oilfield Chemicals 59,876 59,527 349 0.6 %
Other 4 21,053 (21,049) (100.0) %Depreciation and amortization 26,182
31,518 (5,336) (16.9) % Total costs of revenue 262,989 316,649 (53,660) (16.9) % Gross profit 15,296 45,997 (30,701) (66.7) % Operating expenses
Selling, general and administrative 25,289 32,376 (7,087) (21.9) % Depreciation and amortization 685 1,000 (315) (31.5) % Impairment of goodwill and trademark 276,016 4,396 271,620 NM Impairment of property and equipment 3,184
519 2,665 NM
Lease abandonment costs 953 1,073 (120) (11.2) %
Total operating expenses 306,127 39,364 266,763 NM(Loss) income from operations (290,831) 6,633 (297,464) NM Other expense Losses on sales of property and equipment and divestitures, net (435) (4,491) 4,056 NM Interest expense, net (331) (1,093) 762 (69.7) % Foreign currency (loss) gain, net (46) 260 (306) NM Other income, net 259 269 (10) NM (Loss) income before income tax benefit (expense) (291,384) 1,578 (292,962) NM Income tax benefit (expense) 164 (178) 342 NM Net (loss) income$ (291,220) $ 1,400 $ (292,620) NM 45 Table of Contents Revenue Our revenue decreased$84.4 million , or 23.3%, to$278.3 million for theCurrent Quarter compared to$362.6 million for the Prior Quarter. The decrease was driven by a$71.1 million decline in Water Services revenue,$21.6 million lower revenue from the combination of our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were fully divested and wound down during 2019, partially offset by a$4.2 million increase in Oilfield Chemicals revenue and a$4.1 million increase in Water Infrastructure revenue as discussed below. For theCurrent Quarter , our Water Services, Water Infrastructure, Oilfield Chemicals and Other segments constituted 53.7%, 20.8%, 25.5% and 0.0% of our total revenue, respectively, compared to 60.8%, 14.8%, 18.4%, and 6.0%, respectively, for the Prior Quarter. The revenue changes by reportable segment are as follows: Water Services. Revenue decreased$71.1 million , or 32.2%, to$149.5 million for theCurrent Quarter compared to$220.6 million for the Prior Quarter. The decrease was primarily attributable to reduced pricing for our services coupled with reduced drilling and completions activity due to decreases in oil prices late in the quarter due toOPEC supply and the COVID-19 pandemic. Water Infrastructure. Revenue increased by$4.1 million , or 7.7%, to$57.8 million for theCurrent Quarter compared to$53.6 million for the Prior Quarter, primarily due to increased water sales in the Permian and the initiation of ourNorthern Delaware pipeline system inNew Mexico , partially offset by declines in water sourcing volumes in the MidCon. Oilfield Chemicals. Revenue increased$4.2 million , or 6.3%, to$71.0 million for theCurrent Quarter compared to$66.8 million for the Prior Quarter, due to the incremental revenue from the WCS acquisition, partially offset by lower completions revenue.
Other. Other revenue was zero for the
Costs of Revenue
Costs of revenue decreased$53.7 million , or 16.9%, to$263.0 million for theCurrent Quarter compared to$316.6 million for the Prior Quarter. The decrease was primarily due to a$34.0 million decline in Water Services costs and$21.0 million lower combined costs from our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were divested and wound down during 2019. Also contributing to the decline was a$5.3 million decrease in depreciation costs, partially offset by a$6.4 million increase in Water Infrastructure costs and a$0.3 million increase in Oilfield Chemicals costs as further discussed below. Water Services. Cost of revenue decreased$34.1 million , or 20.8% to$129.1 million for theCurrent Quarter compared to$163.1 million for the Prior Quarter. Cost of revenue decreased due to reduced customer drilling and completions activity levels in theCurrent Quarter . Costs as a percent of revenue increased from 73.9% to 86.4% due to reductions in revenue generating activity we could not fully offset with cost reductions as well as yard closure costs resulting from current market conditions. Water Infrastructure. Cost of revenue increased$6.4 million , or 15.4%, to$47.8 million for theCurrent Quarter compared to$41.4 million for the Prior Quarter. Cost of revenue as a percent of revenue increased from 77.3% to 82.8% primarily due to decreased pricing on non-pipeline water sources as well as the acceleration of certain prepaid expenses relating to water rights secured for a customer, due to the bankruptcy of such customer. Oilfield Chemicals. Costs of revenue increased$0.3 million , or 0.6%, to$59.9 million for theCurrent Quarter compared to$59.5 million for the Prior Quarter. Cost of revenue as a percent of revenue decreased from 89.1% to 84.3% due primarily to increased sales of higher-margin friction reducer products as well as incremental gross profits resulting from the WCS acquisition.
Other. Other costs decreased to less than
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Depreciation and Amortization. Depreciation and amortization expense decreased$5.3 million , or 16.9%, to$26.2 million for theCurrent Quarter compared to$31.5 million for the Prior Quarter, primarily due to a$4.1 million decrease in our Water Services segment and a$1.7 million decrease related to the divestitures discussed above.
Gross Profit
Gross profit decreased by$30.7 million , or 66.7%, to a gross profit of$15.3 million for theCurrent Quarter compared to a gross profit of$46.0 million for the Prior Quarter primarily due to a$37.1 million decrease in Water Services gross profit stemming from lower revenue,$2.2 million decrease to Water Infrastructure gross profit due to decreased pricing and certain non-recurring costs and$0.6 million lower gross profit from our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were divested and wound down during 2019. This was partially offset by a$3.8 million increase in Oilfield Chemicals gross profit and$5.3 million decrease in depreciation expense. Gross margin as a percent of revenue was 5.5% and 12.7% in theCurrent Quarter and Prior Quarter, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased$7.1 million , or 21.9%, to$25.3 million for theCurrent Quarter compared to$32.4 million for the Prior Quarter. This was comprised of$3.6 million lower equity-based compensation costs,$2.3 million lower incentive compensation costs,$1.3 million lower professional fees, and$1.6 million of other expense reductions from cost cutting measures in response to lower oil prices partially offset by a$1.7 million increase in bad debt expense.
Impairment
Goodwill and trademark impairment costs were$276.0 million and$4.4 million in theCurrent Quarter and Prior Quarter, respectively. During theCurrent Quarter , all of our goodwill was impaired due to the dramatic decline in oil prices and the uncertainty associated with the future recovery. We also recorded a$9.1 million partial impairment of our Rockwater trademark. During the Prior Quarter, we incurred$4.4 million of goodwill impairment in connection with divesting Affirm.
Impairment of property and equipment costs were
Lease Abandonment Costs
Lease abandonment costs were$1.0 million and$1.1 million in theCurrent Quarter and Prior Quarter, respectively. During theCurrent Quarter , lease abandonment costs primarily related to newly abandoned properties associated with realignment and combining activity on fewer leased properties. The Prior Quarter costs were primarily due to early lease terminations in connection with the wind-down and divestiture of Canadian operations.
Net Interest Expense
Net interest expense decreased by$0.8 million , or 69.7%, to$0.3 million during theCurrent Quarter compared to$1.1 million in the Prior Quarter primarily due to lower average borrowings resulting from the repayment of all remaining borrowings on our credit facility since the Prior Quarter.
Net (Loss) Income
Net (loss) income decreased by$292.6 million , to a net loss of$291.2 million for theCurrent Quarter compared to net income of$1.4 million for the Prior Quarter primarily due to goodwill, trademark and fixed asset impairments and lower Water Services gross profit. This was partially offset by lower selling, general and administrative costs, lower depreciation costs, lower losses on sales of property and equipment and lower interest expense. 47
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Comparison of Non-GAAP Financial Measures
We view EBITDA and Adjusted EBITDA as important indicators of performance. We
define EBITDA as net income (loss), plus interest expense, income taxes, and
depreciation and amortization. We define Adjusted EBITDA as EBITDA plus/(minus)
loss/(income) from discontinued operations, plus any impairment charges or asset
write-offs pursuant to GAAP, plus non-cash losses on the sale of assets or
subsidiaries, non-recurring compensation expense, non-cash compensation expense,
and non-recurring or unusual expenses or charges, including severance expenses,
transaction costs, or facilities-related exit and disposal-related expenditures,
plus/(minus) foreign currency losses/(gains) and plus any inventory write-downs.
The adjustments to EBITDA are generally consistent with such adjustments
described in our Credit Facility. See "-Note Regarding Non-GAAP Financial
Measures-EBITDA and Adjusted EBITDA" for more information and a reconciliation
of EBITDA and Adjusted EBITDA to net income (loss), the most directly comparable
financial measure calculated and presented in accordance with GAAP.
Our board of directors, management and many investors use EBITDA and Adjusted
EBITDA to assess our financial performance because it allows them to compare our
operating performance on a consistent basis across periods by removing the
effects of our capital structure (such as varying levels of interest expense),
asset base (such as depreciation and amortization) and items outside the control
of our management team. We present EBITDA and Adjusted EBITDA because we believe
they provide useful information regarding the factors and trends affecting our
business in addition to measures calculated under GAAP.
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Note Regarding Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA
EBITDA and Adjusted EBITDA are not financial measures presented in accordance
with GAAP. We believe that the presentation of these non-GAAP financial measures
will provide useful information to investors in assessing our financial
performance and results of operations. Net income is the GAAP measure most
directly comparable to EBITDA and Adjusted EBITDA. Our non-GAAP financial
measures should not be considered as alternatives to the most directly
comparable GAAP financial measure. Each of these non-GAAP financial measures has
important limitations as an analytical tool due to exclusion of some but not all
items that affect the most directly comparable GAAP financial measures. One
should not consider EBITDA or Adjusted EBITDA in isolation or as substitutes for
an analysis of our results as reported under GAAP. Because EBITDA and Adjusted
EBITDA may be defined differently by other companies in our industry, our
definitions of these non-GAAP financial measures may not be comparable to
similarly titled measures of other companies, thereby diminishing their utility.
For further discussion, please see "Item 6. Selected Financial Data" in our 2019
Form 10-K.
The following table presents a reconciliation of EBITDA and Adjusted EBITDA to
our net (loss) income, which is the most directly comparable GAAP measure for
the periods presented:
Three months ended March 31,
2020 2019
(in thousands)
Net (loss) income $ (291,220) $ 1,400
Interest expense, net 331 1,093
Income tax (benefit) expense (164) 178
Depreciation and amortization 26,867 32,518
EBITDA (264,186) 35,189Impairment of goodwill and trademark(1) 276,016
4,396
Non-recurring severance expenses(1) 3,502
1,680
Impairment of property and equipment(1) 3,184 519 Yard closure costs related to consolidating operations(1) 1,950 - Non-cash loss on sale of assets or subsidiaries(3) 1,627
5,906
Lease abandonment costs(1) 953
1,073
Non-cash compensation expenses 574
4,179
Foreign currency loss (gain), net 46
(260)
Non-recurring transaction costs(2) 12
662
Inventory write-down - 75
Adjusted EBITDA $ 23,678 $ 53,419 For the
significant decline in the price of oil. For the Prior Quarter, these costs
were due to the dissolution of our divested service lines.
(2) For the Prior Quarter, these costs primarily related to the rebranding of our
Fluids Hauling business.
For the Prior Quarter, these costs primarily related to losses on (3) divestitures and related sales of property and equipment in connection with
the wind down of former service lines.
EBITDA was($264.2) million for theCurrent Quarter compared to$35.2 million for the Prior Quarter. The$299.4 million decrease in EBITDA was primarily driven by a$271.6 million increase in goodwill and trademark impairment costs, a decrease of$37.1 million in Water Services gross profit offset by a$7.1 million decrease in selling, general and administrative costs and a$4.1 million decrease in loss on sale of property and equipment. Adjusted EBITDA was$23.7 million for theCurrent Quarter compared to$53.4 million for the Prior Quarter. The$29.7 million decrease is primarily attributable to the items discussed
above.
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Liquidity and Capital Resources
Overview
The impact of the COVID-19 pandemic and OPEC+ disputes on oil prices and production levels, as well as the uncertainty about the timing of a future recovery is expected to have a negative impact on financial results in the coming quarters. We are taking actions to manage costs and cash, including but not limited to significantly reducing headcount, cutting salaries, closing operational yards, reducing forecasted capital expenditures, streamlining operational and back office functions, selling excess equipment, deferring payroll tax payments for the rest of 2020 in accordance with the CARES Act and deferring applicable lease payments. Our primary sources of liquidity are cash on hand, borrowing capacity under our current Credit Agreement and cash flows from operations. Our primary uses of capital have been to maintain our asset base, implement technological advancements, make capital expenditures to support organic growth, fund acquisitions, and when appropriate, repurchase shares of Class A common stock in the open market. Depending on market conditions and other factors, we may also issue debt and equity securities if needed. As ofMarch 31, 2020 , we had no outstanding bank debt and a positive net cash position. We prioritize sustained positive free cash flow and a strong balance sheet, and evaluate potential acquisitions and investments in the context of those priorities, in addition to the economics of the opportunity. We believe this approach provides us with additional flexibility to evaluate larger investments as well as improved resilience in a sustained downturn versus many of our peers. We intend to finance most of our capital expenditures, contractual obligations and working capital needs with cash generated from operations and borrowings under our Credit Agreement. For a discussion of the Credit Agreement, see "-Credit Agreement" below. Although we cannot provide any assurance, we believe that our current cash balance, operating cash flow and available borrowings under our Credit Agreement will be sufficient to fund our operations for at least the next twelve months. As ofMarch 31, 2020 , cash and cash equivalents totaled$114.1 million and we had approximately$180.8 million of available borrowing capacity under our Credit Agreement. As ofMarch 31, 2020 , the borrowing base under the Credit Agreement was$200.6 million , we had no outstanding borrowings and the outstanding letters of credit totaled$19.8 million . As ofMay 4, 2020 , we had no outstanding borrowings, the borrowing base under the Credit Agreement was$192.2 million , the outstanding letters of credit totaled$15.6 million , and the available borrowing capacity under the Credit Agreement was$176.6 million .
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Three months ended March 31, Change
2020 2019 Dollars Percentage
(in thousands)
Net cash provided by operating activities $
46,711 $ 36,587
(5,485) (16,653) 11,168 (67.1) %
Net cash used in financing activities (6,291) (21,595) 15,304 (70.9) %
Subtotal 34,935 (1,661)
Effect of exchange rate changes on cash and cash equivalents (61) 107 (168) NM
Net increase (decrease) in cash and cash equivalents $ 34,874 $ (1,554) Analysis of Cash Flow Changes between the Three Months Ended
Operating Activities. Net cash provided by operating activities was
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related primarily to improved working capital management, including reductions in accounts receivable and other current assets.
Investing Activities. Net cash used in investing activities was$5.5 million for theCurrent Quarter , compared to$16.7 million for the Prior Quarter. The$11.2 million decrease in net cash used in investing activities was primarily due to a$25.2 million reduction in purchases of property and equipment and a$2.6 million increase in proceeds received from sales of property and equipment partially offset by a$15.9 million decrease of proceeds primarily related to the divestiture and wind down of our Affirm subsidiary and the sand hauling and Canadian operations as well as a$0.7 million working capital settlement in the Prior Quarter. Financing Activities. Net cash used in financing activities was$6.3 million for theCurrent Quarter compared to$21.6 million for the Prior Quarter. The decrease in cash used in financing activities was primarily due to$20.0 million of net debt repayments in the Prior Quarter compared to zero in theCurrent Quarter , partially offset by a$5.4 million increase in repurchases of shares of Class A Common Stock during theCurrent Quarter .
Credit Agreement
OnNovember 1, 2017 , in connection with the closing of the Rockwater merger (the "Closing"),SES Holdings andSelect LLC entered into a$300.0 million senior secured revolving credit facility (the "Credit Agreement"), by and amongSES Holdings , as parent,Select LLC , as borrower, certain ofSES Holdings' subsidiaries, as guarantors, each of the lenders party thereto andWells Fargo Bank, N.A ., as administrative agent, issuing lender and swingline lender (the "Administrative Agent"). The Credit Agreement has a sublimit of$40.0 million for letters of credit and a sublimit of$30.0 million for swingline loans. Subject to obtaining commitments from existing or new lenders, we have the option to increase the maximum amount under the Credit Agreement by$150.0 million during the first three years following the Closing.
The maturity date of the Credit Agreement is the earlier of (a)
The Credit Agreement permits extensions of credit up to the lesser of$300.0 million and a borrowing base that is determined by calculating the amount equal to the sum of (i) 85.0% of the Eligible Billed Receivables (as defined in the Credit Agreement), plus (ii) 75.0% of Eligible Unbilled Receivables (as defined in the Credit Agreement), provided that this amount will not equal more than 35.0% of the borrowing base, plus (iii) the lesser of (A) the product of 70.0% multiplied by the value of Eligible Inventory (as defined in the Credit Agreement) at such time and (B) the product of 85.0% multiplied by the Net Recovery Percentage (as defined in the Credit Agreement) identified in the most recent Acceptable Appraisal of Inventory (as defined in the Credit Agreement), multiplied by the value of Eligible Inventory at such time, provided that this amount will not equal more than 30.0% of the borrowing base, minus (iv) the aggregate amount of Reserves (as defined in the Credit Agreement), if any, established by the Administrative Agent from time to time, including, if any, the amount of the Dilution Reserve (as defined in the Credit Agreement). The borrowing base is calculated on a monthly basis pursuant to a borrowing base certificate delivered bySelect LLC to the Administrative Agent. Borrowings under the Credit Agreement bear interest, atSelect LLC's election, at either the (a) one-, two-, three- or six-month LIBOR ("Eurocurrency Rate") or (b) the greatest of (i) the federal funds rate plus 0.5%, (ii) the one-month Eurocurrency Rate plus 1.0% and (iii) the Administrative Agent's prime rate (the "Base Rate"), in each case plus an applicable margin, and interest shall be payable monthly in arrears. The applicable margin for Eurocurrency Rate loans ranges from 1.50% to 2.00% and the applicable margin for Base Rate loans ranges from 0.50% to 1.00%, in each case, depending onSelect LLC's average excess availability under the Credit Agreement. During the continuance of a bankruptcy event of default, automatically and during the continuance of any other default, upon the Administrative Agent's or the required lenders' election, all outstanding amounts under the Credit Agreement will bear interest at 2.00% plus the otherwise applicable interest rate. 51
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The obligations under the Credit Agreement are guaranteed bySES Holdings and certain subsidiaries ofSES Holdings andSelect LLC and secured by a security interest in substantially all of the personal property assets ofSES Holdings ,Select LLC and their domestic subsidiaries. The Credit Agreement contains certain customary representations and warranties, affirmative and negative covenants and events of default. If an event of default occurs and is continuing, the lenders may declare all amounts outstanding under the Credit Agreement to be immediately due and payable. In addition, the Credit Agreement restrictsSES Holdings' and Select LLC's ability to make distributions on, or redeem or repurchase, its equity interests, except for certain distributions, including distributions of cash so long as, both at the time of the distribution and after giving effect to the distribution, no default exists under the Credit Agreement and either (a) excess availability at all times during the preceding 30 consecutive days, on a pro forma basis and after giving effect to such distribution, is not less than the greater of (1) 25.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (2)$37.5 million or (b) ifSES Holdings' fixed charge coverage ratio is at least 1.0 to 1.0 on a pro forma basis, and excess availability at all times during the preceding 30 consecutive days, on a pro forma basis and after giving effect to such distribution, is not less than the greater of (1) 20.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (2)$30.0 million . Additionally, the Credit Agreement generally permitsSelect LLC to make distributions to allowSelect Inc. to make payments required under the existing Tax Receivable Agreements. The Credit Agreement also requiresSES Holdings to maintain a fixed charge coverage ratio of at least 1.0 to 1.0 at any time availability under the Credit Agreement is less than the greater of (i) 10.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (ii)$15.0 million and continuing through and including the first day after such time that availability under the Credit Agreement has equaled or exceeded the greater of (i) 10.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (ii)$15.0 million for 60 consecutive calendar days.
We were in compliance with all debt covenants as of
Contractual Obligations
Our contractual obligations include, among other things, our Credit Agreement and operating leases. Refer to Note 5-Leases in our 2019 Form 10-K filed onFebruary 25, 2020 for operating lease obligations as ofDecember 31, 2019 and Note 9-Debt in Part I, Item 1 of this Quarterly Report for an update to our contractual obligations as ofMarch 31, 2020 .
Critical Accounting Policies and Estimates
There were no changes to our critical accounting policies from those disclosed
in our 2019 Form 10-K filed on
Recent Accounting Pronouncements
For information regarding new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements, please refer to Note 2-Significant Accounting Policies in Part I, Item 1 of this Quarterly Report.
Off-Balance-Sheet Arrangements
As of
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