NINE ENERGY SERVICE, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Financial Data" in Item 6 of Part II and "Financial Statements and Supplementary Data" in Item 8 of Part II of this Annual Report. A discussion and analysis of our financial condition and results of operations for the year endedDecember 31, 2017 can be found in Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2018 , which was filed with theSEC onMarch 7, 2019 and is incorporated herein by reference. This discussion contains forward-looking statements based on our current expectations, estimates, and projections about our operations and the industry in which we operate. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of risks and uncertainties, including those described under "Risk Factors" in Item 1A of Part I of this Annual Report. We assume no obligation to update any of these forward-looking statements. Overview Company Description We are a leading North American onshore completion services provider that targets unconventional oil and gas resource development. We partner with our E&P customers across all major onshore basins in both theU.S. andCanada as well as abroad to design and deploy downhole solutions and technology to prepare horizontal, multistage wells for production. We focus on providing our customers with cost-effective and comprehensive completion solutions designed to maximize their production levels and operating efficiencies. We believe our success is a product of our culture, which is driven by our intense focus on performance and wellsite execution as well as our commitment to forward-leaning technologies that aid us in the development of smarter, customized applications that drive efficiencies. We provide (i) cementing services, which consist of blending high-grade cement and water with various solid and liquid additives to create a cement slurry that is pumped between the casing and the wellbore of the well, (ii) an innovative portfolio of completion tools, including those that provide pinpoint frac sleeve system technologies as well as a portfolio of completion technologies used for completing the toe stage of a horizontal well and fully-composite, dissolvable, and extended range frac plugs to isolate stages during plug and perf operations, (iii) wireline services, the majority of which consist of plug-and-perf completions, which is a multistage well completion technique for cased-hole wells that consists of deploying perforating guns and isolation tools to a specified depth, and (iv) coiled tubing services, which perform wellbore intervention operations utilizing a continuous steel pipe that is transported to the wellsite wound on a large spool in lengths of up to 30,000 feet and which provides a cost-effective solution for well work due to the ability to deploy efficiently and safely into a live well. Recent Significant Events Production Solutions Divestiture OnAugust 30, 2019 , we sold our Production Solutions segment for approximately$17.1 million in cash. In connection with this divestiture, we recorded a loss of$15.9 million during the year endedDecember 31, 2019 . For additional information on this divestiture, see Note 3 - Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of this Annual Report. Magnum Acquisition OnOctober 25, 2018 (the "Magnum Closing Date"), pursuant to the terms of a Securities Purchase Agreement datedOctober 15, 2018 (as amended onJune 7, 2019 , the "Magnum Purchase Agreement"), we acquired all of the equity interests of Magnum for approximately$334.5 million in upfront cash consideration, subject to customary adjustments, and 5.0 million shares of our common stock, which were issued to the sellers of Magnum in a private placement. For additional information on the Magnum Acquisition, see Note 3 - Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of this Annual Report. The Magnum Purchase Agreement also includes the potential for additional future payments in cash of (i) up to 60% of net income (before interest, taxes, and certain gains or losses) for the "E-Set" tools business in 2019 through 2026 and (ii) up to$25.0 million based on sales of certain dissolvable plug products in 2019. In 2019, we did not meet the sales requirement of certain dissolvable plug products during the year. For additional information, see Note 12 - Commitments and Contingencies included in Item 8 of Part II of this Annual Report. 35 -------------------------------------------------------------------------------- How We Generate Revenue and the Costs of Conducting Our Business We generate our revenues by providing completion services to E&P customers across all major onshore basins in both theU.S. andCanada as well as abroad. We primarily earn our revenues pursuant to work orders entered into with our customers on a job-by-job basis. We typically will enter into an MSA with each customer that provides a framework of general terms and conditions of our services that will govern any future transactions or jobs awarded to us. Each specific job is obtained through competitive bidding or as a result of negotiations with customers. The rate we charge is determined by location, complexity of the job, operating conditions, duration of the contract, and market conditions. In addition to MSAs, we have entered into a select number of longer-term contracts with certain customers relating to our wireline and cementing services, and we may enter into similar contracts from time to time to the extent beneficial to the operation of our business. These longer-term contracts address pricing and other details concerning our services, but each job is performed on a standalone basis. The principal expenses involved in conducting our business include labor costs, materials and freight, the costs of maintaining our equipment, and fuel costs. Our direct labor costs vary with the amount of equipment deployed and the utilization of that equipment. Another key component of labor costs relates to the ongoing training of our field service employees, which improves safety rates and reduces employee attrition. How We Evaluate Our Operations We evaluate our performance based on a number of financial and non-financial measures, including the following: • Revenue: We compare actual revenue achieved each month to the most recent projection for that month and to the annual plan for the month established at the beginning of the year. We monitor our revenue to analyze trends in the performance of our operations compared to historical revenue drivers or market metrics. We are particularly interested in identifying positive or negative trends and investigating to understand the root causes. • Adjusted Gross Profit (Excluding Depreciation and Amortization): Adjusted gross profit (excluding depreciation and amortization) is a key metric that we use to evaluate operating performance. We define adjusted gross profit (excluding
depreciation
and amortization) as revenues less direct and indirect costs of
revenues (excluding depreciation and amortization). Costs of
revenues include direct and indirect labor costs, costs of
materials, maintenance of equipment, fuel and transportation freight
costs, contract services, crew cost, and other miscellaneous
expenses. For additional information, see "Non-GAAP Financial
Measures" below.
• Adjusted EBITDA: We define Adjusted EBITDA as net income (loss)
before interest, taxes, and depreciation and amortization, further
adjusted for (i) property and equipment, goodwill, and/or intangible
asset impairment charges, (ii) transaction and integration costs
related to acquisitions and our IPO, (iii) loss or gain on equity
method investment, (iv) loss or gain on revaluation of contingent
liabilities, (v) loss or gain on the sale of subsidiaries, (vi)
restructuring charges, (vii) stock-based compensation expense,
(viii) loss or gain on sale of property and equipment, (ix) other
expenses or charges to exclude certain items which we believe are
not reflective of ongoing performance of our business, such as legal
expenses and settlement costs related to litigation outside the
ordinary course of business. For additional information, see
"Non-GAAP Financial Measures" below.
• Return on Invested Capital ("ROIC"): We define ROIC asafter-tax net
operating profit (loss), divided by average total capital. We define
after-tax net operating profit (loss) as net income (loss) plus (i)
property and equipment, goodwill, and/or intangible asset impairment
charges, (ii) transaction and integration costs related to
acquisitions and our IPO, (iii) interest expense (income), (iv)
restructuring charges, (v) loss or gain on the sale ofsubsidiaries,
and (vi) the provision or benefit for deferred income taxes. We
define total capital as book value of equity plus the book value of
debt less balance sheet cash and cash equivalents. We compute the
average of the current and prior year-end total capital for use in
this analysis. For additional information, see "Non-GAAP Financial
Measures" below.
• Safety: We measure safety by tracking the total recordable incident
rate ("TRIR"), which is reviewed on a monthly basis. TRIR is a
measure of the rate of recordable workplace injuries, defined below,
normalized and stated on the basis of 100 workers for an annual
period. The factor is derived by multiplying the number of
recordable injuries in a calendar year by 200,000 (i.e., the total
hours for 100 employees working 2,000 hours per year) and dividing
this value by the total hours actually worked in the year. A
recordable injury includes occupational death, nonfataloccupational
illness, and other occupational injuries that involve loss of
36-------------------------------------------------------------------------------- consciousness, restriction of work or motion, transfer to another job, or medical treatment other than first aid. Factors Affecting the Comparability of Our Results of Operations Our future results of operations may not be comparable to our historical results of operations for the periods presented, and our historical results of operations among the periods presented may not be comparable to each other, primarily due to the Magnum Acquisition and our divestiture of the Production Solutions segment. The historical results of operations for the year endedDecember 31, 2019 include activity related to the Magnum Acquisition whereas the historical results of operations for the year endedDecember 31, 2018 include activity related to the Magnum Acquisition only after the Magnum Closing Date (October 25, 2018 ). As a result, the historical results of operations for the year endedDecember 31, 2018 may not give an accurate indication of what our actual results would have been if the Magnum Acquisition had been completed at the beginning of the period presented, or of what our future results of operations are likely to be for the following reasons: • As a result of the Magnum Acquisition and the application of purchase accounting, these identifiable net assets have been adjusted to their estimated fair value as of October 25, 2018, the Magnum Closing Date. These adjusted valuations increase our operating expenses in periods after the Magnum Closing Date, primarily due to an increase in the amortization of intangible assets with definite lives. • Transaction and integration costs associated with the Magnum Acquisition increase operating expenses in periods after the Magnum Closing Date. • Our completion tools line constitutes a larger portion of our business, due in large part to the Magnum Acquisition. • We incurred significant indebtedness in connection with the consummation of the Magnum Acquisition, and our related interest expense is expected to be significantly higher than in prior periods For additional information on the Magnum Acquisition, see Note 3 - Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of this Annual Report on Form 10-K. Our historical results of operations included in this Annual Report include the impact of the divestiture of the Production Solutions segment onAugust 30, 2019 . Future results of operations will not include activity related to the Production Solutions segment. For additional information on the divestiture of the Production Solutions segment, see Note 3 - Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of this Annual Report on Form 10-K. Industry Trends and Outlook Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. During 2019, oil prices mostly ranged from$50 to$60 . At the beginning of 2019,OPEC members and some nonmembers, includingRussia , renewed pledges to reduce planned production in an effort to draw down a global oversupply and to rebalance supply and demand. These and other events provided support for an increase in oil prices during the first several months of 2019. As a result of a decrease in global demand for oil and natural gas due to the recent coronavirus outbreaks, inMarch 2020 , members ofOPEC andRussia considered extending their agreed oil production cuts and making additional oil production cuts. However, negotiations were unsuccessful;Saudi Arabia has announced a significant reduction in its export prices effective immediately andRussia has announced that all agreed oil production cuts between members ofOPEC andRussia will expire onApril 1, 2020 . Following these announcements, global oil and natural gas prices declined sharply and may continue to decline. We expect ongoing oil price volatility as output increases over the short term as a result of the events described above, the coronavirus outbreaks continue to develop, and changes in oil inventories, GDP growth, and actual demand growth are reported. Similarly, natural gas prices have decreased significantly throughout 2019 and are expected to continue to be volatile in 2020, causing many operators in the more gas-exposed regions to curtail activity in 2020. Significant factors that are likely to affect 2020 commodity prices include the extent to which members ofOPEC and other oil exporting nations continue to reduce oil export prices and increase production; the effect ofU.S. energy, monetary, and trade policies; the pace of economic growth in theU.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in theU.S. and globally; the outcome ofthe United States presidential election and subsequent energy and EPA policies; and overall North American natural gas supply and demand fundamentals, including the pace at which export capacity grows. 37 -------------------------------------------------------------------------------- On average, customer budgets for 2020 are likely to decrease as compared to 2019, which could adversely affect our business. With this overall reduction, there has been a strong commitment from E&P operators to stay within capital budgets, prompting many of them to scale back activity. Even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans. Additionally, if natural gas prices remain depressed in 2020, it could negatively affect activity and pricing in our gas-leveraged regions, specifically in the Marcellus andUtica . Operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price. Results of Operations Year Ended December 31, 2019 2018 Change (in thousands) Revenues Completion Solutions$ 774,665 $ 745,316 $ 29,349 Production Solutions 58,272 81,858 (23,586 ) 832,937$ 827,174 $ 5,763 Cost of revenues (exclusive of depreciation and amortization shown separately below) Completion Solutions 620,125 568,497 51,628 Production Solutions 49,854 70,801 (20,947 ) 669,979 639,298 30,681 Adjusted gross profit Completion Solutions 154,540 176,819 (22,279 ) Production Solutions 8,418 11,057 (2,639 ) 162,958 187,876 (24,918 ) General and administrative expenses 81,327 73,078 8,249 Depreciation 50,544 54,257 (3,713 ) Amortization of intangibles 18,367 9,558 8,809 Impairment of property and equipment 66,200 45,694 20,506 Impairment of goodwill 20,273 12,986 7,287 Impairment of intangibles 114,804 19,065 95,739 (Gain) loss on revaluation of contingent liabilities (21,187 ) 3,262 (24,449 ) Loss on sale of subsidiaries 15,896 - 15,896 (Gain) loss on sale of property and equipment (538 ) (1,731 ) 1,193 Loss from operations (182,728 ) (28,293 ) (154,435 ) Non-operating expenses 38,910 22,315 16,595 Loss before income taxes (221,638 ) (50,608 ) (171,030 ) Provision (benefit) for income taxes (3,887 ) 2,375 (6,262 ) Net loss$ (217,751 ) $ (52,983 ) $ (164,768 ) Revenues Revenue increased$5.8 million , or 1%, to$832.9 million in 2019. The increase is primarily related to an increase in completion tools revenue, due in large part to a full year of revenue attributed to the Magnum Acquisition in 2019, compared to approximately two months of revenue in 2018. The overall increase in revenue is partially offset with pricing pressure across 38 -------------------------------------------------------------------------------- other service offerings within the company. The Completion Solutions segment depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies onshore inNorth America . In turn, activity and capital spending are strongly influenced by current and expected oil and natural gas prices. During 2019, the average closing price of oil was$56.98 per barrel, and the average closing price of natural gas was$2.56 per MMBtu. During 2018, the average closing price per barrel of oil was$65.23 , and the average closing price of natural gas was$3.15 per MMBtu. The overall increase in revenue is also partially offset with a reduction in revenue attributed to the sale of the historical Production Solutions segment onAugust 30, 2019 . Additional information with respect to revenue by historical reportable segment is discussed below. Completion Solutions: Revenue increased$29.3 million , or 4%, to$774.7 million in 2019. The increase in 2019 was primarily related to an increase in completion tools revenue of$67.6 million , or 57%, as completion tool stages increased 37% and completion tools revenue by stage increased 18%, due in large part to a full year of revenue attributed to the Magnum Acquisition in 2019, compared to approximately two months of revenue in 2018. In addition, cementing revenue (including pump downs) increased$17.9 million , or 9%, as total cement jobs increased 9% year-over-year. The overall increase in revenue is partially offset by a decrease in coiled tubing revenue of$48.4 million , or 27%, in 2019 as total days worked decreased by 34% in comparison to 2018. In addition, wireline revenue decreased$8.1 million , or 3%, in 2019 primarily due to the pricing pressure from its customer base, as discussed above. Total completed wireline stages increased 11% year-over-year. Production Solutions: Revenue decreased$23.6 million , or 29%, to$58.3 million in 2019. The overall decrease in revenue was related to the fact that, given the segment was sold onAugust 30, 2019 , only eight months of revenue was recorded in 2019 compared to a full year of revenue in 2018. Cost of Revenues (Exclusive of Depreciation and Amortization) Cost of revenue increased$30.7 million , or 5%, to$670.0 million in 2019. The increase was primarily related to additional costs of$42.9 million for materials installed and consumed while performing services. The increase in these costs was due in large part to a full year of activity attributed to the Magnum Acquisition in 2019, compared to approximately two months of activity in 2018. The overall increase in cost of revenue was partially offset by a decrease of$11.0 million in employee-related costs, driven in part by the sale of the historical Production Solutions segment onAugust 30, 2019 , which reduced headcount year-over-year. Additional information with respect to cost of revenue by historical reportable segment is discussed below. Completion Solutions: Cost of revenue increased$51.6 million , or 9%, to$620.1 million in 2019 primarily related to additional costs of$46.7 million for materials installed and consumed while performing services,$2.5 million in facility costs, and$2.3 million in employee-related costs. The increase in these costs was due in large part to a full year of activity attributed to the Magnum Acquisition in 2019, compared to approximately two months of activity in 2018. In addition, the overall increase in 2019 was partly related to an increase in cost of revenue type integration costs of$3.1 million due mainly to the cost of inventory that was stepped up to fair value during purchase accounting for the Magnum Acquisition. Furthermore, the overall increase in cost of revenue was partly related to an increase in severance and other cost of revenue type restructuring charges of$2.3 million mainly associated with the 2019 wind-down of our wireline service offerings inCanada . The overall increase in cost of revenue in 2019 was partially offset by a decrease of$5.3 million in other costs, which was mainly driven by reductions in travel and meals and entertainment in comparison to 2018. Production Solutions: Cost of revenue decreased$20.9 million , or 30%, to$49.9 million in 2019. Employee-related costs decreased$13.3 million , costs related to materials consumed while performing services decreased$3.8 million , and other costs such as repairs and maintenance, insurance, and vehicle and expense, decreased$3.6 million in 2019. The primary driver behind the reduction of these costs of revenue related to the fact that, given the sale of the segment onAugust 30, 2019 , only eight months of activity was recorded in 2019 compared to a full year of activity in 2018. Adjusted Gross Profit Completion Solutions: Adjusted gross profit (excluding depreciation and amortization) decreased$22.3 million to$154.5 million in 2019 as a result of the factors described above under "Revenues" and "Cost of Revenues." Production Solutions: Adjusted gross profit (excluding depreciation and amortization) decreased$2.6 million to$8.4 million in 2019 as a result of the factors described above under "Revenues" and "Cost of Revenues." 39 -------------------------------------------------------------------------------- General and Administrative Expenses General and administrative expenses increased$8.2 million to$81.3 million in 2019. The increase was primarily related to an increase of$4.8 million in employee-related costs in comparison to 2018. The increase in these costs was due in large part to a full year of activity attributed to the Magnum Acquisition in 2019, compared to approximately two months of activity in 2018. The increase is also partly related to an increase in severance and other general and administrative type restructuring charges of$1.6 million mainly associated with the 2019 wind-down of our wireline service offerings inCanada , coupled with an increase in professional fees of$1.3 million , primarily related consulting costs. General and administrative expenses as a percentage of revenue was 9.8% for 2019, compared to 8.8% for 2018. (Gain) Loss on Revaluation of Contingent Liabilities We recorded a$21.2 million gain on the revaluation of contingent liabilities in 2019 in comparison to a$3.3 million loss on the revaluation of contingent liabilities recorded in 2018. The gain was primarily the result of the company not meeting the earnout requirements for the sale of certain dissolvable plug products in 2019 associated with the Magnum Acquisition, which contributed to the reduction in fair value of contingent liabilities year-over-year. (Gain) Loss on Sale of Subsidiaries We recorded a$15.9 million loss on the sale of subsidiaries in 2019 associated with the sale of the historical Production Solutions segment. We did not record a loss on the sale of subsidiaries in 2018. Depreciation Depreciation expense decreased$3.7 million to$50.5 million in 2019. The overall decrease was primarily within service offerings in the historical Production Solutions segment as we recorded a property and equipment impairment charge recorded in the fourth quarter of 2018. Furthermore, any remaining property and equipment associated with the historical Production Solutions segment was sold onAugust 30, 2019 . The overall decrease in depreciation expense was partially offset with an increase in depreciation expense associated with certain service offerings the Completion Solutions segment, which increased capital expenditures year-over-year. Amortization of Intangibles Amortization of intangibles increased$8.8 million to$18.4 million in 2019, primarily due to a$10.3 million increase in amortization associated with intangible assets acquired as part of the Magnum Acquisition and the acquisition of Frac Technology AS, a Norwegian private limited company. The overall increase was partially offset by a reduction in amortization associated with intangible assets in the historical Production Solutions segment, which were fully impaired in the fourth quarter of 2018, as well as a reduction in amortization associated with certain service offerings in the Completion Solutions segment, where the intangible asset reached its full finite life. Impairment of Property and Equipment In 2019, we recorded a property and equipment impairment charge of$66.2 million in our Completion Solutions segment due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. In 2018, we recorded a property and equipment impairment charge of$45.7 million in our Production Solutions segment due to deteriorating market conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. Impairment ofGoodwill In 2019, we recorded a goodwill impairment charge of$20.3 million in our Completion Solutions segment due to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. In 2018, we recorded a goodwill impairment charge of$13.0 million , which represented a full write-off of goodwill in our Production Solutions segment due to deteriorating market conditions attributed to depressed commodity prices towards the 40 -------------------------------------------------------------------------------- end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. Impairment of Intangibles In 2019, we recorded intangible asset impairment charges of$107.7 million associated with indefinite-lived trade names and an intangible asset impairment charge of$7.1 million associated with definite-lived customer relationship intangible assets, all within our Completion Solutions segment. These intangible asset impairment charges were primarily due to the transitioning of certain Magnum trade names to our trade names. These intangible asset impairment charges are also partly attributed to a reduction of the need for coiled tubing during the drill-out phase of the overall completions process due to a recent decline in exploration and production capital budgets and activity, an over-supply of new coiled tubing units, and the introduction of dissolvable plug technology. In 2018, we recorded an intangible asset impairment charge of$9.3 million associated with indefinite-lived trade names and an intangible asset impairment charge of$9.8 million associated with definite-lived customer relationship intangible assets, all within our Production Solutions segment, and primarily due to deteriorating market conditions attributed to depressed commodity prices towards the end of the fourth quarter of 2018, coupled with customers focusing more on the completions business where there is more technological differentiation and value. Non-Operating Expenses Non-operating expenses increased$16.6 million to$38.9 million in 2019. The increase in comparison to 2018 was primarily related to an increase in interest expense related to higher indebtedness and an increased interest rate in conjunction with the Senior Notes, which were entered into in the fourth quarter of 2018 in connection with the Magnum Acquisition. Provision (Benefit) for Income Taxes Our effective tax rate was 1.8% for 2019 and (4.7)% for 2018. The valuation allowance against our deferred tax assets results in tax expense that does not directly correlate with changes in our income levels. Our tax benefit for 2019 is comprised of tax amortization and impairment of indefinite-lived intangible assets, which are excluded when calculating the amount of valuation allowance needed, offset by state jurisdictions where income is expected to exceed available net operating losses. Adjusted EBITDA Adjusted EBITDA decreased$28.0 million to$113.0 million for 2019. The Adjusted EBITDA decrease is primarily due to the changes in revenue and expenses discussed above. See "Non-GAAP Financial Measures" below for further explanation. Non-GAAP Financial Measures EBITDA and Adjusted EBITDA EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are used by management and external users of our financial statements, such as industry analysts, investors, lenders, and rating agencies. We define EBITDA as net income (loss) before interest, depreciation, amortization of intangibles, and provision (benefit) for income taxes. We define Adjusted EBITDA as EBITDA further adjusted for (i) property and equipment, goodwill, and/or intangible asset impairment charges, (ii) transaction and integration costs related to acquisitions and our IPO, (iii) loss or gain on equity investment method, (iv) loss or gain on revaluation of contingent liabilities, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges, (vii) stock-based compensation expense, (viii) loss or gain on sale of property and equipment, and (ix) other expenses or charges to exclude certain items which we believe are not reflective of ongoing performance of our business, such as legal expenses and settlement costs related to litigation outside the ordinary course of business. 41 -------------------------------------------------------------------------------- Management believes EBITDA and Adjusted EBITDA are useful because they allow us to more effectively evaluate our operating performance and compare the results of our operations from period to period without regard to our financing methods or capital structure. We exclude the items listed above from net income in arriving at these measures because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures, and the method by which the assets were acquired. These measures should not be considered as an alternative to, or more meaningful than, net income as determined in accordance with accounting principles generally accepted inthe United States of America ("GAAP") or as an indicator of our operating performance. Certain items excluded from these measures are significant components in understanding and assessing a company's financial performance, such as a company's cost of capital and tax structure, as well as the historic costs of depreciable assets, none of which are components of these measures. Our computations of these measures may not be comparable to other similarly titled measures of other companies. We believe that these are widely followed measures of operating performance. The following table presents a reconciliation of the non-GAAP financial measures of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss): Year Ended December 31, 2019 2018 (in thousands) EBITDA reconciliation: Net loss$ (217,751 ) $ (52,983 ) Interest expense 39,770 22,939 Interest income (860 ) (624 ) Depreciation 50,544 54,257 Amortization of intangibles 18,367 9,558 Provision (benefit) for income taxes (3,887 )
2,375
EBITDA$ (113,817 ) $
35,522
Adjusted EBITDA reconciliation: EBITDA$ (113,817 ) $
35,522
Impairment of property and equipment 66,200 45,694 Impairment of goodwill 20,273 12,986 Impairment of intangibles 114,804 19,065 Transaction and integration costs 13,047
10,327
Loss on equity method investment -
347
(Gain) loss on revaluation of contingent liabilities (21,187 ) 3,262 Loss on sale of subsidiaries
15,896 -
Restructuring charges 3,976
-
Stock-based compensation expense 14,057
13,221
Loss on sale of property and equipment (538 ) (1,731 ) Legal fees and settlements (2) 307 2,358 Adjusted EBITDA$ 113,018 $ 141,051 (1) Amounts relate to the revaluation of contingent liabilities associated with our recent acquisitions. The impact is included in our Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 12 - Commitments and Contingencies included Item 8 of Part II of this Annual Report. (2) Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the FLSA and/or similar state laws. 42 -------------------------------------------------------------------------------- Return onInvested Capital ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax net operating profit (loss), divided by average total capital. We define after-tax net operating profit (loss) as net income (loss) plus (i) property and equipment, goodwill, and/or intangible asset impairment charges, (ii) transaction and integration costs related to acquisitions and our IPO, (iii) interest expense (income), (iv) restructuring charges, (v) loss or gain on the sale of subsidiaries, and (vi) the provision or benefit for deferred income taxes. We define total capital as book value of equity plus the book value of debt less balance sheet cash and cash equivalents. We then take the average of the current and prior year-end total capital for use in this analysis. Management believes ROIC is a meaningful measure because it quantifies how well we generate operating income relative to the capital we have invested in our business and illustrates the profitability of a business or project taking into account the capital invested. Management uses ROIC to assist them in capital resource allocation decisions and in evaluating business performance. Although ROIC is commonly used as a measure of capital efficiency, definitions of ROIC differ, and our computation of ROIC may not be comparable to other similarly titled measures of other companies. The following table provides an explanation of our calculation of ROIC for the years endedDecember 31, 2019 and 2018: Year Ended December 31, 2019 2018 (in thousands) Net loss$ (217,751 ) $ (52,983 ) Add back: Impairment of property and equipment 66,200 45,694 Impairment of goodwill 20,273 12,986 Impairment of intangibles 114,804 19,065 Transaction and integration costs 13,047 10,327 Interest expense 39,770 22,939 Interest income (860 ) (624 ) Restructuring charges 3,976 - Loss on sale of subsidiaries 15,896 -
Provision (benefit) for deferred income taxes (4,327 ) 898 After-tax net operating profit
$ 51,028 $ 58,302 Total capital as of prior year-end: Total stockholders' equity$ 594,823 $ 287,358 Total debt 435,000 242,235 Less cash and cash equivalents (63,615 ) (17,513 ) Total capital as of prior year-end$ 966,208 $ 512,080 Total capital as of year-end: Total stockholders' equity$ 389,877 $ 594,823 Total debt 400,000 435,000 Less cash and cash equivalents (92,989 ) (63,615 ) Total capital as of year-end$ 696,888 $ 966,208 Average total capital$ 831,548 $ 739,144 ROIC 6.1 % 7.9 % 43
--------------------------------------------------------------------------------
Adjusted Gross Profit (Excluding Depreciation and Amortization)
GAAP defines gross profit as revenues less cost of revenues and includes
depreciation and amortization in costs of revenues. We define adjusted gross
profit (excluding depreciation and amortization) as revenues less direct and
indirect costs of revenues (excluding depreciation and amortization). This
measure differs from the GAAP definition of gross profit because we do not
include the impact of depreciation and amortization, which represent non-cash
expenses.
Management uses adjusted gross profit (excluding depreciation and amortization)
to evaluate operating performance. We prepare adjusted gross profit (excluding
depreciation and amortization) to eliminate the impact of depreciation and
amortization because we do not consider depreciation and amortization indicative
of our core operating performance. Adjusted gross profit (excluding depreciation
and amortization) should not be considered as an alternative to gross profit
(loss), operating income (loss), or any other measure of financial performance
calculated and presented in accordance with GAAP. Adjusted gross profit
(excluding depreciation and amortization) may not be comparable to similarly
titled measures of other companies because other companies may not calculate
adjusted gross profit (excluding depreciation and amortization) or similarly
titled measures in the same manner as we do.
The following table presents a reconciliation of adjusted gross profit
(excluding depreciation and amortization) to GAAP gross profit (loss).
Year Ended December 31,
2019 2018
(in thousands)
Calculation of gross profit
Revenues $ 832,937 $ 827,174
Cost of revenues (exclusive of depreciation and
amortization shown separately below) 669,979 639,298
Depreciation (related to cost of revenues) 47,006 53,358 Amortization of intangibles 18,367 9,558 Gross profit$ 97,585 $ 124,960 Adjusted gross profit (excluding depreciation and amortization) reconciliation: Gross profit$ 97,585 $ 124,960 Depreciation (related to cost of revenues) 47,006
53,358
Amortization of intangibles 18,367 9,558 Adjusted gross profit (excluding depreciation and amortization)$ 162,958 $ 187,876 44
-------------------------------------------------------------------------------- Liquidity and Capital Resources Sources and Uses of Liquidity Historically, we have met our liquidity needs principally from cash flows from operating activities, external borrowings, proceeds from the IPO, and capital contributions (prior to the IPO). Our principal uses of cash are to fund capital expenditures and acquisitions, to service our outstanding debt, and to fund our working capital requirements. In 2018, we issued$400.0 million of Senior Notes to, together with cash on hand and borrowings under the 2018 ABL Credit Facility (as defined below), fund the Magnum Acquisition as well as fully repay and terminate the term loan borrowings and the outstanding revolving credit commitments under our prior credit facility. For additional information regarding the Senior Notes, see Note 9 - Debt Obligations included in Item 8 of Part II of this Annual Report. In the third quarter of 2019, we divested the Production Solutions segment for approximately$17.1 million in cash. We plan to use such proceeds to fund a portion of our 2020 capital expenditures. We continually monitor potential capital sources, including equity and debt financing, to meet our investment and target liquidity requirements. Our future success and growth will be highly dependent on our ability to continue to access outside sources of capital. In addition, our ability to satisfy our liquidity requirements depends on our future operating performance, which is affected by prevailing economic conditions, the level of drilling, completion and production activity for North American onshore oil and natural gas resources, and financial and business and other factors, many of which are beyond our control. Our total 2019 capital expenditure budget, excluding possible acquisitions, was between$60.0 million and$70.0 million , and the actual amount of capital expenditures incurred in 2019 was$62.1 million . Our capital expenditure budget for 2020, excluding possible acquisitions, is expected to be between$20.0 million and$25.0 million . The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures and the amount we ultimately spend will depend on a number of factors including expected industry activity levels and company initiatives. AtDecember 31, 2019 , we had$93.0 million of cash and cash equivalents and$99.2 million of availability under the 2018 ABL Credit Facility, which resulted in a total liquidity position of$192.2 million . Based on our current forecasts, we believe that borrowings under the 2018 ABL Credit Facility, together with cash flows from operations, should be sufficient to fund our capital requirements for at least the next twelve months from the issuance date of our consolidated financial statements. However, we can make no assurance regarding our ability to achieve our forecasts. Furthermore, depending on our financial performance, we may implement certain cost-cutting measures, as necessary, to continue to meet our liquidity and capital resource needs for at least the next twelve months from the issuance date of our consolidated financial statements. We can make no assurance regarding our ability to successfully implement such measures, or whether such measures would be sufficient to mitigate a decline in our financial performance. Although we do not budget for acquisitions, pursuing growth through acquisitions may continue to be a significant part of our business strategy. Our ability to make significant additional acquisitions for cash will require us to obtain additional equity or debt financing, which we may not be able to obtain on terms acceptable to us or at all. Senior Notes OnOctober 25, 2018 , we issued$400.0 million principal amount of Senior Notes. The proceeds from the Senior Notes, together with cash on hand and borrowings under the 2018 ABL Credit Facility (as defined below), were used to (i) fund a portion of the upfront cash purchase price of the Magnum Acquisition, (ii) repay all indebtedness under the credit facility entered into in conjunction with our IPO, and (iii) pay fees and expenses associated with the issuance of the Senior Notes, the Magnum Acquisition, and the 2018 ABL Credit Facility (as defined below). For additional information on the Senior Notes, see Note 9 - Debt Obligations included in Item 8 of Part II of this Annual Report. 2018 ABL Credit Facility OnOctober 25, 2018 , we entered into a credit agreement dated as ofOctober 25, 2018 (the "2018 ABL Credit Agreement"), that permits aggregate borrowings of up to$200.0 million , subject to a borrowing base, including a Canadian tranche with a sub-limit of up to$25.0 million and a sub-limit of$50.0 million for letters of credit (the "2018 ABL Credit Facility"). The 2018 ABL Credit Facility will mature onOctober 25, 2023 or, if earlier, on the date that is 180 days before the scheduled maturity date of the Senior Notes if they have not been redeemed or repurchased by such date. 45 -------------------------------------------------------------------------------- Loans to us and our domestic related subsidiaries (the "U.S. Credit Parties") under the 2018 ABL Credit Facility may be base rate loans or LIBOR loans; and loans toNine Energy Canada Inc. , a corporation organized under the laws ofAlberta, Canada , and its restricted subsidiaries (the "Canadian Credit Parties") under the Canadian tranche may be CDOR loans or Canadian prime rate loans. The applicable margin for base rate loans and Canadian prime rate loans vary from 0.75% to 1.25% and the applicable margin for LIBOR loans or CDOR loans vary from 1.75% to 2.25% in each depending on our leverage ratio. In addition, a commitment fee of 0.50% per annum will be charged on the average daily unused portion of the revolving commitments. The 2018 ABL Credit Agreement contains various affirmative and negative covenants, including financial reporting requirements and limitations on indebtedness, liens, mergers, consolidations, liquidations and dissolutions, sales of assets, dividends and other restricted payments, investments (including acquisitions) and transactions with affiliates. In addition, the 2018 ABL Credit Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is tested quarterly when the availability under the 2018 ABL Credit Facility drops below a certain threshold or a default has occurred until the availability exceeds such threshold for 30 consecutive days and such default is no longer outstanding. We were in compliance with all covenants under the 2018 ABL Credit Agreement as ofDecember 31, 2019 . All of the obligations under the 2018 ABL Credit Facility are secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property ofU.S. Credit Parties, excluding certain assets. The obligations under the Canadian tranche are further secured by first priority perfected security interests (subject to permitted liens) in substantially all of the personal property of Canadian Credit Parties excluding certain assets. The 2018 ABL Credit Facility is guaranteed by theU.S. Credit Parties, and the Canadian tranche is further guaranteed by the Canadian Credit Parties and theU.S. Credit Parties. AtDecember 31, 2019 , our availability under the 2018 ABL Credit Facility was approximately$99.2 million , net of an outstanding letter of credit of$0.2 million . During the second quarter of 2019, we repaid our outstanding revolver borrowings in full, and atDecember 31, 2019 , we had no outstanding revolver borrowings. Cash Flows Our cash flows for the years endedDecember 31, 2019 , and 2018 are presented below: Year Ended December 31, 2019 2018 (in thousands) Operating activities$ 101,305 $ 89,577 Investing activities (34,121 ) (389,765 ) Financing activities (37,905 ) 346,691 Impact of foreign exchange rate on cash 95 (401 )
Net change in cash and cash equivalents
Operating Activities Net cash provided by operating activities was$101.3 million in 2019 compared to$89.6 million in net cash provided by operating activities in 2018. The$11.7 million increase in net cash provided by operating activities was primarily a result of a$54.5 million increase in cash collections and other changes in working capital which provided an increased source of cash flow in 2019 in comparison to 2018. The overall increase in net cash provided by operating activities was partially offset by a$42.8 million decrease in cash flow provided by continuing operations, adjusted for any non-cash items, primarily due to a reduction in cash operating income driven by a deterioration in market conditions year-over-year. Investing Activities Net cash used in investing activities was$34.1 million in 2019 compared to$389.8 million in net cash used in investing activities in 2018. The$355.7 million decrease in net cash used in investing activities was primarily related to a$350.0 million reduction in cash flow used in acquisitions in 2019 compared to 2018, as well as$16.9 million in proceeds received from the sale of our Production Solutions segment in 2019. In addition, the decrease in net cash used was partly due to an increase of$4.7 million in proceeds received in 2019 from notes receivable payments as well as an increase of$1.5 million in 2019 in cash payments received from the proceeds from the sale of property and equipment. The overall decrease in net cash used in investing activities was partially offset by an increase of$18.5 million in cash purchases of property and equipment in 2019 compared to 2018. 46 -------------------------------------------------------------------------------- Financing Activities Net cash used in financing activities was$37.9 million in 2019 compared to$346.7 million in net cash provided by financing activities in 2018. The$384.6 million decrease in net cash provided by financing activities was primarily related to$171.8 million in proceeds received from the IPO and issuances of common stock in 2018 and$400.0 million in proceeds received from the Senior Notes in 2018 that did not recur in 2019. In addition, net cash provided by financing activities decreased$3.6 million in 2019 related to an increase in restricted stock vests and options exercised during the year. The overall decrease in net cash provided by financing activities was partially offset by a decrease in net payments made on prior term loans of$146.0 million in 2019 and a reduction of$16.3 million in deferred financing costs paid in 2019 compared to 2018. The overall decrease in net cash provided by financing activities was also partially offset by a reduction in net payments on revolving credit facilities in 2019 of$26.2 million . Contractual Obligations In the normal course of business, we enter into various contractual obligations that impact or could impact our liquidity. The table below contains our known contractual commitments atDecember 31, 2019 . Payments Due by Period for the Year Ended December 31, 2020 2021 2022 2023 2024 Thereafter Total (in thousands) Senior Notes(1) $ - $ - $ -$ 400,000 $ - $ -$ 400,000 2018 ABL Credit Facility(2) - - - - - - - Interest expense(3) 35,000 35,000 35,000 28,575 - - 133,575 Capital leases 1,253 1,253 1,099 66 - - 3,671 Operating leases 10,597 8,504 7,485 6,649
4,470 17,105 54,810
Total $ 46,850 $ 44,757 $ 43,584 $ 435,290 $ 4,470 $ 17,105 $ 592,056
(1) Includes principal only.
(2) The amount presented in the table above represents the outstanding
principal borrowings under the 2018 ABL Credit Facility as of December 31, 2019
and does not include future commitment fees, amortization of deferred financing
costs, interest expense, or other fees. These outstanding principal borrowings
must be repaid prior to the maturity date, which is October 25, 2023 or, if
earlier, on the date that is 180 days before the scheduled maturity date of the
Senior Notes if they have not been redeemed or repurchased by such date. Any
future borrowings or repayments could change the total amount outstanding under
the 2018 ABL Credit Facility.
(3) Consists of fixed rate interest on the Senior Notes as of December 31,
2019.
In addition, at December 31, 2019 , we have recorded certain contingent
liabilities associated with recent acquisitions. For additional information, see
Note 12 - Commitments and Contingencies included in Item 8 of Part II of this
Annual Report.
Off-Balance Sheet Arrangements
At December 31, 2019 , we had a letter of credit of $0.2 million , which
represented an off-balance sheet arrangement as defined in Item 303(a)(4)(ii) of
Regulation S-K. As of December 31, 2019 , no liability has been recognized in our
Consolidated Balance Sheets for the letter of credit.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations
are based upon our financial statements, which have been prepared in accordance
with GAAP. The preparation of our financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. Certain accounting policies involve judgments and uncertainties
to such an extent that there is a reasonable likelihood that materially
different amounts could have been reported under different conditions, or if
different assumptions had been used. We evaluate our estimates and assumptions
on a regular basis. We base our estimates on historical experience and various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates and assumptions used in
preparation of our financial statements. We provide expanded discussion of our
more significant accounting policies, estimates, and judgments below. We believe
that
47
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most of these accounting policies reflect our more significant estimates and
assumptions used in preparation of our financial statements.
Emerging Growth Company Status
We are an "emerging growth company" as defined in the JOBS Act. Under Section
107 of the JOBS Act, as an emerging growth company, we are taking advantage of
an extended transition period for the adoption of new or revised financial
accounting standards, including the reduced reporting requirements and
exemptions, and the longer phase-in periods for the adoption of new or revised
financial accounting standards, until we are no longer an emerging growth
company. Our election to use the longer phase-in periods permitted by this
election may make it difficult to compare our financial statements to those of
non-emerging growth companies and other emerging growth companies that have
opted out of the longer phase-in periods under Section 107 of the JOBS Act and
who will comply with new or revised financial accounting standards. If we were
to subsequently elect instead to comply with these public company effective
dates, such election would be irrevocable pursuant to Section 107 of the JOBS
Act.
Revenue Recognition
For information about our revenue, see Note 4 - Revenue included in Item 8 of
Part II of this Annual Report.
Property and Equipment
Property and equipment is stated at cost and depreciated under the straight-line
method over the estimated useful lives of the asset. Equipment held under
capital leases is stated at the present value of its future minimum lease
payments and is depreciated under the straight-line method over the shorter of
the lease term or the estimated useful life of the asset. When assets are
retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts and any resulting gain or loss is recognized
within operating expenses. Normal repair and maintenance costs are charged to
operating expense as incurred. Significant renewals and betterments are
capitalized.
Valuation of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for impairment, future cash flows expected
to result from the use of the asset and its eventual disposal are estimated. If
the undiscounted future cash flows are less than the carrying amount of the
assets, there is an indication that the asset may be impaired. The amount of the
impairment is measured as the difference between the carrying value and the
Level 3 fair value of the asset. The Level 3 fair value is determined either
through the use of an external valuation, or by means of an analysis of
discounted future cash flows based on expected utilization. Determining fair
value requires the use of estimates and assumptions. Such estimates and
assumptions include revenue growth rates, operating profit margins, weighted
average costs of capital, terminal growth rates, future market share, the impact
of new product development, and future market conditions, among others. We
believe that the estimates and assumptions used in impairment assessments are
reasonable and appropriate. Impairment losses are reflected in "Income (loss)
from operations" in our Consolidated Statements of Income and Comprehensive
Income (Loss).
In the fourth quarter of 2019, we recorded a property and equipment impairment
charge of $66.2 million and a definite-lived customer relationship intangible
asset impairment charge of $7.1 million . These impairment charges represent the
difference between the carrying value and the estimated fair value of the
long-lived assets in our coiled tubing asset group within our Completion
Solutions segment and were due to a reduction of the need for coiled tubing
during the drill-out phase of the overall completions process due to a recent
decline in exploration and production capital budgets and activity, an
over-supply of new coiled tubing units, and the introduction of dissolvable plug
technology.
In the fourth quarter of 2018, we recorded a property and equipment impairment
charge of $45.7 million and a definite-lived customer relationship intangible
asset impairment charge of $9.8 million . These impairment charges represent the
difference between the carrying value and the estimated fair value of the
long-lived assets associated with our Production Solutions segment and were due
to deteriorating conditions attributed to depressed commodity prices towards the
end of the fourth quarter of 2018, coupled with customers focusing more on the
completions business where there is more technological differentiation and
value. On August 30, 2019 , we sold our Production Solutions segment to Brigade.
For additional information on these impairment charges, see Note 6 - Property
and Equipment included in Item 8 of Part II of this Annual Report.
For additional information on the Production Solutions divestiture, see Note 3 -
Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of
this Annual Report.
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Valuation of Goodwill and Intangible Assets
Goodwill has an indefinite useful life and is not subject to amortization.
Intangible assets with indefinite useful lives (specifically trademarks and
trade names) are also not subject to amortization. For goodwill and intangible
assets with indefinite useful lives, an assessment for impairment is performed
annually on December 31 or when there is an indication an impairment may have
occurred. Goodwill is reviewed for impairment by comparing the carrying value of
each of our reporting unit's net assets (including allocated goodwill) to the
Level 3 fair value of our reporting unit. The Level 3 fair value of our
reporting unit is determined by using the income approach (discounted cash flows
of forecasted income). Intangible assets with indefinite useful lives are
reviewed for impairment by comparing the carrying value of the intangible asset
to the Level 3 fair value of the intangible asset. The Level 3 fair value of
intangible assets with indefinite useful lives (specifically trademarks and
trade names) is estimated using the relief-from-royalty method of the income
approach. This approach is based on the assumption that in lieu of ownership, a
company would be willing to pay a royalty in order to exploit the related
benefits of this intangible asset. Determining fair value requires the use of
estimates and assumptions. Such estimates and assumptions include revenue growth
rates, operating profit margins, royalty rates, weighted average costs of
capital, terminal growth rates, future market share, the impact of new product
development, and future market conditions, among others. We believe that the
estimates and assumptions used in impairment assessments are reasonable and
appropriate. We recognize a goodwill impairment charge for the amount by which
the carrying value of goodwill exceeds our reporting unit's Level 3 fair value.
We recognize an indefinite-lived intangible asset impairment charge of the
amount by which the carrying value of the intangible asset exceeds the Level 3
fair value of the intangible asset. Any impairment losses are reflected in
"Income (loss) from operations" in our Consolidated Statements of Income and
Comprehensive Income (Loss).
Intangible assets with definite lives include technology, customer
relationships, and non-compete agreements. The Level 3 fair value of technology
and the Level 3 fair value of customer relationships are estimated using the
income approach, specifically the multi-period excess earnings method. The
multi-period excess earnings method consists of isolating the cash flows
attributed to the intangible asset, which are then discounted to present value
to calculate the Level 3 fair value of the intangible asset. The Level 3 fair
value of non-compete agreements is estimated using a with and without scenario
where cash flows are projected through the term of the non-compete agreement
assuming the non-compete agreement is in place and compared to cash flows
assuming the non-compete agreement is not in place.
Intangible assets with definite lives are amortized based on the estimated
consumption of the economic benefit over their estimated useful lives.
Intangible assets with definite lives are tested for impairment whenever events
or changes in circumstances indicate that their carrying amount may not be
recoverable.
In the fourth quarter of 2019, in connection with our annual goodwill impairment
test, we recorded a goodwill impairment charge of $20.3 million , in our coiled
tubing reporting unit within our Completion Solutions segment. In addition, in
the fourth quarter of 2019, in connection with our annual indefinite-lived
intangible asset impairment test, we recorded an intangible asset impairment
charge of $12.7 million associated with the indefinite-lived trade names in our
coiled tubing reporting unit and an intangible asset impairment charge of $95.0
million associated with the indefinite-lived trade names in our completion tools
reporting unit, both within our Completion Solutions segment. As described above
in "Critical Accounting Policies - Valuation of Long-Lived Assets" and also in
the fourth quarter of 2019, we recorded an intangible asset impairment charge of
$7.1 million associated with the definite-lived customer relationship intangible
assets in our coiled tubing asset group within our Completion Solutions segment.
In the fourth quarter of 2018, in connection with our annual goodwill impairment
test, we recorded a goodwill impairment charge of $13.0 million , which
represented a full write-off of goodwill attributed to our Production Solutions
segment. In addition, in the fourth quarter of 2018, in connection with our
annual indefinite-lived intangible asset impairment test, we recorded an
intangible asset impairment charge of $9.3 million associated with
indefinite-lived trade names in our Production Solutions segment. As described
above in "Critical Accounting Policies - Valuation of Long-Lived Assets" and
also in the fourth quarter of 2018, we recorded an intangible asset impairment
charge of $9.8 million related to definite-lived customer relationship
intangible assets associated with our Production Solutions segment. On August
30, 2019 , we sold our Production Solutions segment to Brigade Energy Service LLC
("Brigade").
For additional information on goodwill and both indefinite-lived and
definite-lived intangible asset impairment charges, see Note 7 - Goodwill and
Intangible Assets included in Item 8 of Part II of this Annual Report.
For additional information on the Production Solutions divestiture, see Note 3 -
Divestitures, Acquisitions, and Combinations included in Item 8 of Part II of
this Annual Report.
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Recognition of Provisions for Contingencies
In the ordinary course of business, we are subject to various claims, suits, and
complaints. We, in consultation with internal and external advisors, will
provide for a contingent loss in the financial statements if it is probable that
a liability has been incurred at the date of the financial statements and the
amount can be reasonably estimated. If it is determined that the reasonable
estimate of the loss is a range and that there is no best estimate within the
range, provision will be made for the lower amount of the range. Legal costs are
expensed as incurred.
Stock-based Compensation
We account for awards of stock-based compensation at fair value on the date
granted to employees and recognize the compensation expense in the financial
statements over the requisite service period. Fair value of the stock-based
compensation was measured using the Black-Scholes model for all of the options
outstanding. These models require assumptions and estimates for inputs,
especially the estimate of the volatility in the value of the underlying share
price, that affect the resultant values and hence the amount of compensation
expense recognized. We determine the estimate of volatility periodically based
on the weighted averages for the stocks of comparable publicly traded companies.
Fair value of the stock-based compensation was measured using a Monte Carlo
simulation model for all of the performance share units outstanding. Forfeitures
are recorded as they occur. All stock-based compensation expense is recorded
using the straight-line method and is included in "General and administrative
expenses" in our Consolidated Statements of Income and Comprehensive Income
(Loss).
Determining Fair Market Value
Determining the appropriate fair value model and calculating the fair value of
options requires 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 involve inherent uncertainties and the application of management's
judgment. If factors change and different assumptions are used, our stock-based
compensation expense could be materially different in the future. We estimate
the fair value of each option grant using the Black-Scholes option-pricing
model. The Black-Scholes option pricing model requires estimates of key
assumptions based on both historical information and management judgment
regarding market factors and trends.
Expected Life - The expected term of stock options represents the period the
stock options are expected to remain outstanding and is based on the simplified
method, which is the weighted average vesting term plus the original contractual
term, divided by two.
Expected Volatility - Prior to our IPO, when our stock was not publicly traded,
we determined volatility based on an analysis of the PHLX Oil Service Index that
tracks publicly traded oilfield service stocks. Subsequent to our IPO and as a
publicly traded company, we develop our expected volatility based upon a
weighted average volatility of our peer group.
Risk-free Interest Rate - The risk-free interest rates for options granted are
based on the average of five year and seven year constant maturity Treasury bond
rates whose term is consistent with the expected term of an option from the date
of grant.
Expected Term - The expected term is based on the midpoint between the vesting
date and contractual term of an option. The expected term represents the period
that our stock-based awards are expected to be outstanding.
Expected Dividend Yield - We do not anticipate paying cash dividends on our
shares of common stock; therefore, the expected dividend yield is assumed to be
zero.
Recent Accounting Pronouncements
For additional information on recent accounting pronouncements, see Note 2 -
Significant Accounting Policies included in Item 8 of Part II of this Annual
Report.
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