CYPRESS ENVIRONMENTAL PARTNERS, L.P. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains a discussion of our business, including a general overview of our properties, our results of operations, our liquidity and capital resources, and our quantitative and qualitative disclosures about market risk. The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs, and expected performance. The forward-looking statements are dependent upon events, risks, and uncertainties that may be outside our control, including among other things, the risk factors discussed in "Item 1A. Risk Factors" of this Annual Report on Form 10-K. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, market prices for oil and natural gas, production volumes, estimates of proved reserves, capital expenditures, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in this Annual Report on Form 10-K, all of which are difficult to predict. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed may not occur. See "Cautionary Remarks Regarding Forward-Looking Statements" in the front of this Annual Report on Form 10-K. Overview We are a growth-oriented master limited partnership formed inSeptember 2013 . We offer essential services that help protect the environment and ensure sustainability. We provide a wide range of environmental services including independent inspection, integrity, and support services for pipeline and energy infrastructure owners and operators and public utilities. We also provide water pipelines, hydrocarbon recovery, disposal, and water treatment services. The Inspection Services segment comprises the operations of our TIR Entities and the Pipeline & Process Services segment comprises the operations of CBI. We also provide water treatment and other water and environmental services toU.S. onshore oil and natural gas producers and trucking companies through our Environmental Services segment. We operate nine (eight wholly-owned) water treatment facilities, all of which are in theBakken Shale region of theWilliston Basin inNorth Dakota . We also have a management agreement in place to provide staffing and management services to one 25%-owned water treatment facility in theBakken Shale region. In all of our business segments, we work closely with our customers to help them comply with increasingly complex and strict environmental and safety rules and regulations applicable to production and pipeline operations, assisting in reducing their operating costs. How We Generate Revenue The Inspection Services segment generates revenue primarily by providing essential environmental services, including inspection and integrity services on a variety of infrastructure assets such as midstream pipelines, gathering systems, and distribution systems. Services include nondestructive examination, in-line inspection support, pig tracking, survey, data gathering, and supervision of third-party contractors. Our revenues in this segment are driven primarily by the number of inspectors that perform services for our customers and the fees that we charge for those services, which depend on the type, skills, technology, equipment, and number of inspectors used on a particular project, the nature of the project, and the duration of the project. The number of inspectors engaged on projects is driven by the type of project, prevailing market rates, the age and condition of customers' assets including pipelines, gas plants, compression stations, storage facilities, and gathering and distribution systems including the legal and regulatory requirements relating to the inspection and maintenance of those assets. We also bill our customers for per diem charges, mileage, and other reimbursement items. Revenue and costs in this segment are subject to seasonal variations and interim activity may not be indicative of yearly activity, considering many of our customers develop yearly operating budgets and enter into contracts with us during the winter season for work to be performed during the remainder of the year. Additionally, inspection work throughoutthe United States during the winter months (especially in the northern states) may be hampered or delayed due to inclement weather. 46 The Pipeline & Process Services segment generates revenue primarily by providing essential environmental services including hydrostatic testing, chemical cleaning, water transfer and recycling, pumping, pigging, flushing, filling, dehydration, caliper runs, in-line inspection tool run support, nitrogen purging, and drying services to energy companies and pipeline construction companies. We perform services on newly-constructed and existing pipelines and related infrastructure. We generally charge our customers in this segment on a fixed-bid basis, depending on the size and length of the pipeline being tested, the complexity of services provided, and the utilization of our work force and equipment. Our results in this segment are driven primarily by the number of projects we are awarded and the nature and duration of the projects. Revenue and costs in this segment may be subject to seasonal variations and interim activity may not be indicative of yearly activity, considering that many of our customers develop yearly operating budgets and enter into contracts with us during the winter season for work to be performed during the remainder of the year. Additionally, field work during the winter months may be hampered or delayed due to inclement weather. The Environmental Services segment owns and operates nine (9) water treatment facilities with ten (10)EPA Class II injection wells in the Bakken shale region of theWilliston Basin inNorth Dakota . We wholly-own eight of these water treatment facilities and we own a 25% interest in the other facility. These water treatment facilities are connected to thirteen (13) pipeline gathering systems, including two (2) that we developed and own. We specialize in the treatment, recovery, separation, and disposal of waste byproducts generated during the lifecycle of an oil and natural gas well to protect the environment and our drinking water. All of the water treatment facilities utilize specialized equipment and remote monitoring to minimize the facilities' downtime and increase the facilities' efficiency for peak utilization. Revenue is generated on a fixed-fee per barrel basis for receiving, separating, filtering, recovering, processing, and injecting produced and flowback water. We also sell recovered oil, receive fees for pipeline transportation of water, and receive fees from a partially-owned water treatment facility for management and staffing services.
How We Evaluate Our Operations
Our management uses a variety of financial and operating metrics to analyze our performance. We view these metrics as significant factors in assessing our operating results and profitability. These metrics include:
? inspector headcount in our Inspection Services segment;
? gross margin percentages in our Inspection Services segment;
? field personnel headcount and utilization in our Pipeline & Process Services
segment;
? volume of water treated and residual oil recovered in our Environmental
Services segment; ? operating expenses; ? segment gross margin; ? safety metrics; ? Adjusted EBITDA;
? maintenance capital expenditures; and
? distributable cash flow. Inspector Headcount The amount of revenue we generate in our Inspection Services segment depends primarily on the number of inspectors that perform services for our customers. The number of inspectors engaged on projects is driven by the type of project, prevailing market rates, the age and condition of customers' midstream pipelines, gathering systems, miscellaneous infrastructure, distribution systems, and the legal and regulatory requirements relating to the inspection and maintenance of those assets.
Field Personnel Headcount and Utilization
The amount of revenue we generate in our Pipeline & Process Services segment depends primarily on the number of bids we win for hydrostatic testing and other integrity services and the fees that we charge for those services, which depend on the type and number of field personnel used on a particular project, the type of equipment used and the fees charged for the utilization of that equipment, and the nature and the duration of the project. The number of field personnel engaged on projects is driven by the type of project, the size and length of the pipeline being inspected, the complexity of services provided, and the utilization of our work force and equipment. The employees of the Pipeline & Process Services segment are full-time employees, and therefore primarily represent fixed costs (in contrast to the employees of the Inspection Services segment who perform work in the field, most of whom only earn wages when they are performing work for a customer and whose wages are therefore primarily
variable costs).
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Water Treatment and Residual Oil Volumes
The amount of revenue we generate in the Environmental Segment depends primarily on the volume of produced water and flowback water that we treat and dispose for our customers pursuant to published or negotiated rates, as well as the volume of residual oil that we sell pursuant to rates that are determined based on the quality of the oil sold and prevailing oil prices. Most of the revenue generated from water delivered to our facilities by truck is generated pursuant to contracts that are short-term in nature. Most of the revenue generated from water delivered to our facilities by pipeline is generated pursuant to contracts that are several years in duration, but do contain cancellation terms. The volumes of water processed at our water treatment facilities are driven by water volumes generated from existing oil wells during their useful lives and development drilling and production volumes from new wells located near our facilities. Producers' willingness to engage in new drilling is determined by a number of factors, the most important of which are the prevailing and projected prices of oil, natural gas, and natural gas liquids, the cost to drill and operate a well, the availability and cost of capital, and environmental and governmental regulations. We generally expect the level of drilling to positively correlate with long-term trends in prices of oil, natural gas, and natural gas liquids.
Approximately 3%, 6%, and 5% of our Environmental Services segment revenue in 2020, 2019, and 2018, respectively, was derived from sales of residual oil recovered during the water treatment process. Our ability to recover residual oil is dependent upon the oil content in the water we treat, which is, among other things, a function of water type, chemistry, source, and temperature. Generally, where outside temperatures are lower, oil separation is more difficult. Thus, our residual oil recovery during the winter season is lower than our recovery during the summer season. Additionally, residual oil content will decrease if, among other things, producers begin recovering higher levels of residual oil in saltwater prior to delivering such saltwater to us for treatment. Operating Expenses
The primary components of our operating expenses include cost of services, general and administrative expense, and depreciation, amortization and accretion.
Costs of services. Employee-related costs and reimbursable expenses are the primary cost of services components in the Inspection Services segment. Employee-related costs, equipment rentals, supplies, and depreciation on fixed assets are the primary cost of services components in the Pipeline & Process Services segment. These expenses fluctuate based on the number, type, and location of projects on which we are engaged at any given time. Repair and maintenance costs, employee-related costs, residual oil disposal costs, and utility expenses are the primary cost of services components in the Environmental Services segment. Certain of these expenses remain relatively stable with fluctuations in the volume of water processed (although certain expenses, such as utilities, vary based on the volume of water processed). Maintenance expenses fluctuate depending on the timing of maintenance work.
General and administrative. General and administrative expenses include compensation and related costs of employees performing general and administrative functions, general office expenses, insurance, legal and other professional fees, software, travel and promotion, and other expenses.
Depreciation, amortization and accretion. Depreciation, amortization and accretion expense primarily consists of the decrease in value of assets as a result of using the assets over their estimated useful life. Depreciation and amortization are recorded on a straight-line basis. We estimate that our assets have useful lives ranging from 3 to 39 years. The fixed assets of our Environmental Services segment constituted approximately 72% of the net book value of our consolidated fixed assets as ofDecember 31, 2020 .
Segment Gross Margin, Adjusted EBITDA, and Distributable Cash Flow
We view segment gross margin as one of our primary management tools, and we track this item on a regular basis, both as an absolute amount and as a percentage of revenue. We also track Adjusted EBITDA, defined as net income or loss exclusive of (i) interest expense, (ii) depreciation, amortization, and accretion expense, (iii) income tax expense or benefit, (iv) equity-based compensation expense, and (v) certain other unusual or nonrecurring items. We use distributable cash flow, defined as Adjusted EBITDA less cash interest paid, cash taxes paid, maintenance capital expenditures, and distributions on preferred equity, as an additional measure to analyze our performance. Adjusted EBITDA and distributable cash flow do not reflect changes in working capital balances, which could be significant, as headcounts of the Inspection Services segment vary from period to period. Adjusted EBITDA and distributable cash flow are non-GAAP, supplemental financial measures used by management and by external users of our financial statements, such as investors, lenders, and analysts, to assess:
? our operating performance as compared to those of other providers of similar
services, without regard to financing methods, historical cost basis, or
capital structure;
? the ability of our assets to generate sufficient cash flow to support our
indebtedness and make distributions to our partners; and
? our ability to incur and service debt and fund capital expenditures.
Adjusted EBITDA and distributable cash flow are not financial measures presented
in accordance with GAAP. We believe that the presentation of these non-GAAP
financial measures provide useful information to investors in assessing our
financial condition and results of operations. Net income (loss) is the GAAP
measure most directly comparable to Adjusted EBITDA. The GAAP measure most
directly comparable to distributable cash flow is net cash provided by operating
activities. Our non-GAAP financial measures should not be considered as
alternatives to the most directly comparable GAAP financial measures. Each of
these non-GAAP financial measures has important limitations as an analytical
tool because it excludes some, but not all, of the items that affect the most
directly comparable GAAP financial measure. You should not consider Adjusted
EBITDA or distributable cash flow in isolation or as a substitute for analysis
of our results as reported under GAAP. Because Adjusted EBITDA and distributable
cash flow 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.
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For a further discussion of the non-GAAP financial measures of Adjusted EBITDA
and reconciliation of that measure to their most comparable financial measures
calculated and presented in accordance with GAAP, please read "Item 6 - Selected
Financial Data - Non-GAAP Financial Measures."
Overview and Outlook
Overall
Our 2020 results were the worst in our short history following our best year
that included record results in 2019. The financial results in 2020 were
adversely affected by the significant decline in oil prices during the year,
which was driven in part by increased supply from Russia , Saudi Arabia , and
other oil-producing nations as a result of a price war and in part by a
significant decrease in demand as a result of the COVID-19 pandemic. The
combination of these events led many of our customers to cancel planned
construction projects and defer regular maintenance projects whenever
possible. The effects of these events placed significant financial pressures on
a vast majority of our customers to reduce costs, which led to some of our
customers to aggressively pursue pricing concessions. We value our long-term
customer relationships and worked closely with them to address this reality
which, in turn, required us to modify what pay we could offer to our valued
inspectors. Despite the COVID-19 pandemic, we have continued our field
operations without any significant disruption in our service to our customers.
Previously, OPEC started a price war for market share in November 2014 that led
to a downturn that lasted through 2017. The industry, our customers, and we
benefitted from the rebound in 2018 and 2019. In the years leading into 2020,
many companies had been active in constructing new energy infrastructure, such
as pipelines, gas plants, compression stations, pumping stations, and storage
facilities, which afforded us the opportunity to provide our inspection and
integrity services on these projects. The commodity price decline in 2020 led
our customers to change their budgets and plans, and to decrease their spending
on capital expenditures. This, in turn, had an impact on regular maintenance
work and the construction of new pipelines, gathering systems, and related
energy infrastructure. Lower exploration and production activity also affected
the midstream industry and led to delays and cancellations of projects. The
volatility in crude oil prices is illustrated in the chart below, which shows
the average monthly spot price for West Texas Intermediate crude oil from 2018
through 2020.
[[Image Removed]]
Recognizing the impact of the COVID-19 pandemic, we took swift and decisive actions to reduce overhead and other costs through a combination of salary reductions, reductions in force, furloughs, hiring freezes, and other cost-cutting measures. We elected to defer some discretionary capital expenditures and we remain focused on opportunities to reduce our working capital needs. In early 2021, we took additional actions to further reduce our costs with some additional layoffs and furloughs. We believe the actions we have taken have significantly lowered our general and administrative costs to weather the storm. While reducing various costs, we have also made investments in personnel in our account management and business development teams, to position ourselves to take advantage of the market's eventual recovery. As ofDecember 31, 2020 , we had long-term debt, net of cash and cash equivalents, of$44.1 million . We explored the possibility of aFederal Reserve Main Street lending facility. We had too many employees to avail ourselves of any of the federal government's Paycheck Protection Program forgivable loans. InMarch 2021 , we entered into an amendment to our existing credit facility that extended the maturity date toMay 2022 , reduced the total capacity from$110.0 million to$75.0 million , and made the leverage ratio covenant temporarily less restrictive during 2021. See further discussion regarding our credit facility below in the "Our Credit Agreement" section as part of "Management's Discussion and Analysis of Financial Condition and Liquidity". In light of the adverse market conditions, we made the difficult decision inJuly 2020 to temporarily suspend payment of common unit distributions. This has enabled us to retain more cash to manage our working capital and financing requirements during these challenging market conditions. Our credit facility, as amended inMarch 2021 , contains significant restrictions on our ability to pay cash distributions to common and preferred unitholders. As a result, we expect to use cash generated from operations for working capital to finance revenue growth and to pay down debt. The vaccination process for COVID-19 is currently underway, which has likely been a leading factor in the recent recovery in demand for crude oil. The price of crude oil has increased in early 2021, with the average daily spot price for West Texas Intermediate crude oil increasing to$52.01 inJanuary 2021 and$65.36 onMarch 15, 2021 . We expect this increase in crude oil prices to lead customers to increase their maintenance and capital spending plans. This should provide more opportunity to provide inspection, integrity, and water treatment services. We continue to focus on winning new customers while supporting our existing clients.
Sales and business development remain our top priority, and we are bidding on
many projects with both existing and prospective new customers. The near-term
recovery remains fragile, as market participants evaluate the risks associated
with new variants of the coronavirus. Our customers are evaluating these
changing circumstances as they prepare their capital expansion and maintenance
budgets. Historically, as commodity prices increase, customers begin to increase
their spending, which increases our opportunities to provide our services.
Although higher commodity prices typically benefit our business, we typically
experience a lag between when commodity prices increase and when our customers
begin to increase their spending for inspection, integrity, and water treatment
services. We believe there will be significant long-term demand for our
services, and we continue our efforts to diversify our customer base. We have
continued to invest in talent in the areas of account management and business
development. We strive to position ourselves as a stable and reliable provider
of high-quality services to our customer base.
In 2020 we made the strategic decision to aggressively pursue new inspection
markets to diversify our inspection business to markets not tied to commodity
prices. We have the expertise and systems to offer inspection services into new
markets including municipal water, sewer, bridges, electrical transmission,
marine coatings, and renewables (such as wind, solar, and hydroelectric). We
have been bidding inspection jobs in these new markets and many of our
inspectors and employees have the skills to offer these services to these new
markets. Over the long term, we hope to have the majority of our inspection
revenue coming from these new segments.
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We believe government regulation under the new administration will continue to grow with a focus on protecting the environment.The U.S. Pipeline and Hazardous Materials Safety Administration ("PHMSA") recently issued new rules that impose several new requirements on operators of onshore gas transmission systems and hazardous liquids pipelines. The new rules expand requirements to address risks to pipelines outside of environmentally sensitive and populated areas. In addition, the rules make changes to integrity management requirements, including emphasizing the use of in-line inspection technology. The new rules took effect onJuly 1, 2020 with various implementation phases over a period of years. We remain optimistic about the long-term demand for environmental services such as inspection services, integrity services, and water solutions, due to our nation's aging pipeline infrastructure, and we believe we continue to be well-positioned to capitalize on these opportunities. The following charts summarize the age of pipelines inthe United States , as developed from our independent research and government data: [[Image Removed]] [[Image Removed]] In 2018, Holdings completed two acquisitions to further broaden our collective suite of environmental services. One acquisition provided entry into the municipal water industry, whereby we can offer our traditional inspection services, including corrosion and nondestructive testing services, as well as in-line inspection ("ILI"). Holdings' next generation 5G ultra high-resolution magnetic flux leakage ("MFL") ILI technology called EcoVision™ UHD, is capable of helping pipeline owners and operators better manage the integrity of their pipeline assets in both the municipal water and energy industries. We believe Holdings is the only technology provider today capable of offering this service to the large and diverse municipal water industry that provides drinking water to our communities. Holdings has been investing in building tools to serve different size pipelines. At some point in the future, these businesses may be offered to the Partnership when appropriate. We do not expect to acquire either of these businesses in the near term, although we continue to use these affiliated business as cross-selling opportunities for our services.
Our parent company's ownership interests continue to remain fully aligned with
our unitholders, as our
Inspection Services Revenues of our Inspection Services segment decreased from$372.0 million in 2019 to$181.5 million in 2020, a decrease of 51%. Gross margins in this segment decreased from$40.5 million in 2019 to$19.8 million in 2020, a decrease of 51%. Revenues during 2019 benefited from the largest contract in the 18-year history of TIR, which was a single-source Inspection Services project inTexas . This project began in late 2018, peaked in 2019, and continued with declining headcounts into 2020. Our revenues during 2020 did not significantly benefit from any other large new projects. A portion of our revenue in this segment is associated with mileage and per diem allowances for our inspectors who leave their home to work remotely at the client's location. The majority of the time we are not entitled to a markup or profit margin on these items, and the gross margin percentages reflect this dynamic. 50
During 2020, the COVID-19 pandemic, combined with a significant decrease in crude oil prices resulting from reduced demand and an anticipated increase in supply fromSaudi Arabia andRussia , led many of our customers to change their budgets and plans. In our Inspection Services segment, most projects that were already in process continued, despite the COVID-19 pandemic. However, many customers announced reductions in their capital expansion budgets and deferrals of planned construction projects, and these changes reduced our revenue-generating opportunities. We expect customers to continue to conduct maintenance activities, many of which are government-mandated. However, many customers are deferring maintenance work when possible if they have the option to do so. We have many long-term customer relationships that go back over 18 years. We believe our reputation developed over this time will give us a competitive advantage during this challenging industry downturn when some of our competitors may not survive. We continue to bid on new work that could benefit us if we are successful in being awarded those inspection opportunities. The vast majority of our customers are under significant financial pressure to reduce costs and have been aggressively pursuing pricing concessions. We value our long-term customer relationships and work closely with our customers to address this reality, which in turn requires us to modify what pay we can offer to our valued inspectors. The net result of the actions has led to less working capital being required to operate the businesses.
We operate in a very large market, with more than 3,000 customer prospects who require federally and/or state-mandated inspection and integrity services. Today, we estimate that we serve less than 8% of the available market. We believe we have substantial opportunities for organic growth. Our focus remains on maintenance and integrity work on existing pipelines, as well as work on new projects. The majority of our clients are large public companies with long planning cycles that lead to healthy backlogs of new long-term projects and existing pipeline networks that also require inspection and integrity services. We believe that regulatory requirements, coupled with the aging pipeline infrastructure, mean that, regardless of commodity prices, our customers will require our inspection services. However, a prolonged downturn in oil and natural gas prices could lead to a downturn in demand for our services.
Pipeline and Process Services
Revenues of our Pipeline & Process Services segment decreased from$19.3 million in 2019 to$18.7 million in 2020, a decrease of 3%. Gross margins decreased from$5.9 million in 2019 to$5.0 million in 2020, a decrease of 16%. Revenues remained strong in 2020, due to increased success in winning bids for projects as a result of improved business development efforts. We believe we have positioned ourselves as a preferred provider for large hydrotesting projects with our customer base. Although market conditions were adverse in 2020 for our other businesses, hydrotesting is one of the last steps to be completed before a pipeline is placed into service, and during 2020, a number of pipeline construction projects that began prior to the COVID-19 pandemic continued. During late 2020, activity slowed down, and bid activity was lower in early 2021 than in years past. In early 2021, we implemented a cost reduction plan that included salary reductions, furloughs, and a reduction in workforce. In 2018, we opened a new office inOdessa, Texas to better serve the Permian basin market. In early 2019, we opened a new location in theHouston market. CBI continues to enjoy an excellent reputation in the industry. Although the planned reduction in capital expansion projects by many of our customers will reduce our revenue-generating opportunities, we believe we have developed a strong reputation over the last decade that will give us a competitive advantage when bidding on future work, not only with new construction projects, but also with integrity maintenance projects. We remain active in bidding for new projects and we believe this downturn may put some competitors out of business. Environmental Services
Revenues of our Environmental Services segment decreased from$10.3 million in 2019 to$5.8 million in 2020, a decrease of 44%. The decrease was primarily due to a decrease of 5.5 million barrels of water processed in 2020 compared to 2019. The decrease in volume resulted from a slowdown in exploration and production activity in the areas near our facilities. Gross margins in this segment decreased from$7.3 million in 2019 to$3.7 million in 2020, a decrease of 49%. The decrease in gross margin was due primarily to a$4.6 million decrease in revenue, partially offset by a$1.0 million decrease in cost of services. Low commodity prices, an excess of supply, and low demand have led to a significant reduction in activity by producers inNorth Dakota .Bakken Clearbrook oil pricing was under intense pressure during 2020, along with WTI oil prices. WTI oil prices, which were at$61.14 atDecember 31, 2019 , decreased in January andFebruary 2020 , decreased even more sharply in March andApril 2020 , gradually increased to$40 per barrel in early July, and begin increasing in December to$48.35 atDecember 31, 2020 . Pipeline capacity and storage constraints also adversely affected this market. Several prominent exploration and production customers elected to shut in their production instead of selling oil at the low market prices. According to a published rig count as ofDecember 31, 2020 , theWilliston basin of the Bakken totaled 11 rigs, down 82% from its peak in 2019 of 61 rigs. During late 2020, the largest customer of one of our highest-volume facilities notified us of its decision to build its own facility and began sending most of its water to that facility inFebruary 2021 . Although market conditions are adverse, we expect to continue to benefit from the fact that 99% of our water in 2020 was produced water from existing wells (rather than flowback water from new wells) and 66% of our water in 2020 was from pipelines. We also took steps to reduce our operating costs, including the temporary closure during the second quarter of 2020 of several of our facilities. We have since reopened these facilities after market conditions improved. We recently completed a new contract with a public energy company to connect its pipeline to one of our water treatment facilities. This facility began receiving volumes from the pipeline inOctober 2020 . We expect the increase in oil prices in early 2021 to lead to an increase in exploration and production activity in the Bakken. InJuly 2020 , in relation to an ongoing lawsuit challenging various federal authorizations for the Dakota Access Pipeline, a federal court ordered that the Dakota Access Pipeline be shut down and drained of oil byAugust 5, 2020 . The owners of the pipeline appealed the decision, and a federal appeals court stayed theJuly 2020 order to close the pipeline and ordered further briefing on the issue. The Dakota Access Pipeline transports approximately 40% of the crude oil that is produced in the Bakken region. Although most of the production from the wells that our facilities serve is not transported on the Dakota Access Pipeline, the closure of the pipeline would likely have an adverse effect on overall production in the Bakken, which would likely reduce the volume of water delivered to our facilities. In addition, the uncertainty associated with this litigation may reduce E&P companies' incentive to invest in new production
in
the Bakken.
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Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to select appropriate accounting policies and make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. See "Note 2 - Summary of Significant Accounting Policies" in the audited financial statements included in "Item 8 - Financial Statements and Supplementary Data" for descriptions of our major accounting policies and estimates. Certain of these accounting policies and estimates 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. The following discussions of critical accounting estimates, including any related discussion of contingencies, address all important accounting areas where the nature of accounting estimates or assumptions could be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.
Business Combinations and Intangible Assets Including Goodwill
We account for acquisitions of businesses using the acquisition method of accounting. Accordingly, assets acquired and liabilities assumed are recorded at their estimated fair values at the acquisition date. The excess of purchase price over fair value of net assets acquired, including the amount assigned to identifiable intangible assets, is recorded as goodwill. The results of operations of acquired businesses are included in the Consolidated Financial Statements from the acquisition date.
Impairments of Long-Lived Assets
Property and Equipment
We assess property and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Such indicators include, among others, the nature of the asset, the projected future economic benefit of the asset, changes in regulatory and political environments, and historical and future cash flow and profitability measurements. If the carrying value of an asset group exceeds the undiscounted cash flows estimated to be generated by the asset group, we recognize an impairment loss equal to the excess of carrying value of the asset group over its estimated fair value. Estimating the future cash flows and the fair value of an asset group involves management estimates on highly uncertain matters such as future commodity prices, the effects of inflation on operating expenses, and the outlook for national or regional market supply and demand for the services
we provide. In the Environmental Services segment, Property, Plant, and Equipment is grouped for impairment testing purposes at each water treatment facility, as these asset groups represent the lowest level at which cash flows are separately identifiable. Our estimates utilize judgments and assumptions such as undiscounted future cash flows, discounted future cash flows, estimated fair value of the asset group, and economic environment in which the asset is operated. Significant judgments and assumptions in these assessments include estimates of rates for water treatment services, volumes of water processed, expected capital costs, oil and gas drilling and producing volumes in the markets served, risks associated with the different zones into which water is processed, and our estimate of an applicable discount rate commensurate with the risk of the underlying cash flow estimates. An estimate as to the sensitivity to earnings for these periods had we used other assumptions in our impairment reviews and impairment calculations is not practicable, given the number of assumptions involved in the estimates. Unfavorable changes in our assumptions might have caused an unknown number of assets to become impaired. Additionally, further unfavorable changes in our assumptions in the future are reasonably possible, and therefore, it is possible that we may incur impairment charges in the future.
Identifiable Intangible Assets
Our recorded net identifiable intangible assets of$17.4 million and$20.1 million atDecember 31, 2020 and 2019, respectively, consist primarily of customer relationships and trademarks and trade names, amortized on a straight-line basis over estimated useful lives ranging from 5 - 20 years. Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which is the period over which the asset is expected to contribute directly or indirectly to our future cash flows. We have no indefinite-lived intangibles other than goodwill. The determination of the fair value of the intangible assets and the estimated useful lives are based on an analysis of all pertinent factors including (1) the use of widely-accepted valuation approaches, such as the income approach or the cost approach, (2) our expected use of the asset, (3) the expected useful life of related assets, (4) any legal, regulatory, or contractual provisions, including renewal or extension periods that would cause substantial costs or modifications to existing agreements, and (5) the effects of demand, competition, and other economic factors. Should any of the underlying assumptions indicate that the value of the intangible assets might be impaired, we may be required to reduce the carrying value and/or subsequent useful life of the asset. If the underlying assumptions governing the amortization of an intangible asset were later determined to have significantly changed, we may be required to adjust the amortization period of such asset to reflect any new estimate of its useful life. Any write-down of the value or unfavorable change in the useful life of an intangible asset would increase expense at that time.Goodwill We have$50.4 million of goodwill on our Consolidated Balance Sheet atDecember 31, 2020 . Of this amount,$40.3 million relates to the Inspection Services segment and$10.1 million relates to the Environmental Services segment.Goodwill is not amortized, but is subject to annual assessments onNovember 1 (or at other dates if events or changes in circumstances indicate that the carrying value of goodwill may be impaired) for impairment at a reporting unit level. The reporting units used to evaluate and measure goodwill for impairment are determined primarily by the manner in which the business is managed or operated. We have determined that our Inspection Services and Environmental Services operating segments are the appropriate reporting units for testing goodwill impairment. To perform a goodwill impairment assessment, we first evaluate qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit exceeds its carrying value. If this assessment reveals that it is more likely than not that the carrying value of a reporting unit exceeds its fair value, we then determine the estimated fair value of the reporting unit. If the carrying amount exceeds the reporting unit's fair value, we record a goodwill impairment charge for the excess (not exceeding the carrying value of the reporting unit's goodwill). 52
Crude oil prices decreased significantly in 2020, due in part to decreased demand as a result of the worldwide COVID-19 pandemic. This decline in oil prices led many of our customers to change their budgets and plans, which resulted in reduced spending on drilling, completions, and exploration. This has had an adverse effect on construction of new pipelines, gathering systems, and related energy infrastructure. Lower exploration and production activity has also adversely effected the midstream industry and has led to delays and cancellations of projects. It is also possible that our customers may elect to defer maintenance activities on their infrastructure. Such developments would reduce our opportunities to generate revenues. It is impossible at this time to determine what may occur, as customer plans will evolve over time. It is possible that the cumulative nature of these events could have a material adverse effect on our results of operations and financial position. Inspection Services We completed our annual goodwill impairment assessment as ofNovember 1, 2020 and concluded the$40.3 million of goodwill of the Inspection Services segment was not impaired. Our evaluations included various qualitative and corroborating quantitative factors, including current and projected earnings and current customer relationships and projects, and a comparison of our enterprise value to the sum of the estimated fair values of our business segments. The qualitative and supporting quantitative assessments on this reporting unit indicated that there was no need to conduct further quantitative testing for goodwill impairment. The use of different assumptions and estimates from the assumptions and estimates we used in our analyses could have resulted in the requirement to perform further quantitative goodwill impairment analyses. Environmental Services We completed our annual goodwill impairment assessment as ofNovember 1, 2020 and updated this analysis as ofDecember 31, 2020 and concluded that the remaining$10.1 million of goodwill of the Environmental Services segment was not impaired. We considered the decline in the price of crude oil and the fact that, during the third quarter of 2020, the largest customer of one of our highest-volume facilities notified us of its decision to build its own facility and to send most of its water to that facility beginning inFebruary 2021 . We considered these developments to be potential indicators of impairment and therefore performed quantitative goodwill impairment analyses. We estimated the fair value of the reporting unit utilizing the income approach (discounted cash flows) valuation method, which is a Level 3 measurement as defined in ASC 820, Fair Value Measurement. Significant inputs in the valuation included projections of future revenues, anticipated operating costs, and appropriate discount rates. Since the volume of water we receive at our facilities is heavily influenced by the extent of exploration and production in the areas near our facilities, and since exploration and production is in turn heavily influenced by crude oil prices, we estimated future revenues by reference to crude prices in the forward markets. We used a forward price curve that reflects a gradual increase in the West Texas Intermediate ("WTI") crude price each month, with the price remaining around$39-$47 per barrel throughJanuary 2022 and reaching$49-$53 per barrel inJanuary 2032 . We estimated future operating costs by reference to historical per-barrel costs and estimated future volumes. We estimated revenues and costs for a period of ten years and estimated a terminal value calculated as a multiple of the cash flows in the preceding year. We discounted these estimated future cash flows at a rate of 13.5%. We assumed that a hypothetical buyer would be a partnership that is not subject to income taxes and that could obtain savings in general and administrative expenses through synergies with its other operations. Based on these quantitative analyses, we concluded that the goodwill of the Environmental Services segment was not impaired. Our analysis indicated that the fair value of the reporting unit of the Environmental Services segment exceeded their book value by 16% atDecember 31, 2020 . The use of different assumptions and estimates from those we used in our analysis could have resulted in the need to record a goodwill impairment. Our estimates of fair value are sensitive to changes in a number of variables, many of which relate to broader macroeconomic conditions outside of our control. As a result, actual performance could be different from our expectations and assumptions. Estimates and assumptions used in determining fair value of the reporting units that are outside the control of management include commodity prices, interest rates, and cost of capital. Our water treatment facilities are concentrated in one basin, and changes in oil and gas production in that basin could have a significant impact on the profitability of the Environmental Services segment. While we believe we have made reasonable estimates and assumptions to estimate the fair values of our reporting units, it is reasonably possible that changes could occur that would require a goodwill impairment charge in the future. Such changes could include, among others, a slower recovery in demand for petroleum products than assumed in our projections, an increase in supply from other areas (or other factors) that result in reduced production inNorth Dakota , and increased pessimism among market participants, which could increase the discount rate on (and therefore decrease the value
of)
estimated future cash flows.
Revenue Recognition
Under Accounting Standards Codification ("ASC") 606 - Revenue from Contracts
with Customers, an entity should recognize revenue to depict the transfer of
promised goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for those
goods or services. Based on this accounting guidance, our revenue is earned and
recognized through the service offerings of our three reportable business
segments. Our sales contracts have terms of less than one year. As such, we have
used the practical expedient contained within the accounting guidance which
exempts us from the requirement to disclose the transaction price allocated to
remaining performance obligations if the performance obligation is part of a
contract with an original expected duration of one year or less. We apply
judgment in determining whether we are the principal or the agent in instances
where we utilize subcontractors to perform all or a portion of the work under
our contracts. Based on the criteria in ASC 606, we have determined we are
principal in all such circumstances.
In 2020 and 2019, we recognized $0.3 million and $0.2 million of revenue within
our Inspection Services segment, respectively, on services performed in previous
years. We had constrained recognition of this revenue until the expiration of a
contract provision that had given the customer the opportunity to reopen
negotiation of the fee paid for the services. As of December 31, 2020 , and
December 31, 2019 , we recognized a refund liability of $0.8 million and $0.7
million within our Inspection Services segment, respectively, for revenue
associated with such variable consideration. In addition, we have recorded other
refund liabilities of $0.8 million and $0.7 million at December 31, 2020 and
2019, respectively.
53
In the first quarter of 2018, we recognized$0.3 million of revenue within our Pipeline & Process Services segment associated with additional billings on a project that we completed in the fourth quarter of 2017 (we recognized the revenue upon receipt of customer acknowledgment of the additional fees).
Consolidated Results of Operations -
The Consolidated Results of Operations and Segment Operating Results sections generally discuss 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in the Consolidated Results of Operations and Segment Operating Results sections of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2019 .
Factors Impacting Comparability
The historical results of operations for the periods presented may not be comparable, either to each other or to our future results of operations, for the reason described below:
? We are party to an omnibus agreement with Holdings and other related parties.
Prior to
certain general and administrative services, including executive management
services and expenses associated with our being a publicly-traded entity (such
as audit, tax, and transfer agent fees, among others) in return for a fixed
annual fee. In an effort to simplify this arrangement so it would be easier for
investors to understand, in
Committee of the Board of Directors, we and Holdings agreed to terminate the
management fee provisions of the omnibus agreement effective
Beginning
and administrative expenses that Holdings previously incurred and charged to us
via the annual administrative fee are charged directly to us as they are
incurred and are now paid directly by the Partnership. Under our current cost
structure, these direct expenses have been lower than the annual administrative
fee that we previously paid, although we experience more variability in our
quarterly general and administrative expense now that we are incurring the
expenses directly than when we paid a consistent administrative fee each
quarter.
54
Consolidated Results of Operations
The following table compares the operating results of
2020 2019
(in thousands)
Revenues $ 205,996 $ 401,648
Costs of services 177,484 347,924
Gross margin 28,512 53,724
Operating costs and expense:
General and administrative 20,100 25,626
Depreciation, amortization and accretion 4,883 4,448
Gain on asset disposals, net (27 ) (25 )
Operating income 3,556 23,675
Other income (expense):
Interest expense, net (4,028 ) (5,330 )
Foreign currency gains 107 222
Other, net 541 1,111
Net income before income tax expense 176 19,678
Income tax expense 542 2,254
Net (loss) income (366 ) 17,424
Net income attributable to noncontrolling interests 1,049
1,410
Net (loss) income attributable to limited partners (1,415 ) 16,014
Net income attributable to preferred unitholder 4,133 4,133
Net (loss) income attributable to common unitholders
See the detailed discussion of elements of operating income (loss) by reportable segment below. See also Note 14 to our Consolidated Financial Statements included in "Item 8. - Financial Statement and Supplementary Data."
The following is a discussion of significant changes in the non-segment related corporate other income and expenses for the years endedDecember 31, 2020 and 2019. Interest expense. Interest expense primarily consists of interest on borrowings under our Credit Agreement, amortization of debt issuance costs, and unused commitment fees. Changes in interest expense resulted primarily from changes in the balance of outstanding debt and changes in interest rates. The interest rate on our Credit Agreement floats based on LIBOR, and changes in the LIBOR rate were the primary driver of changes in the interest rate during 2019 and 2020. In March andApril 2020 , in an abundance of caution, we borrowed a combined$39.1 million on the Credit Agreement to provide substantial liquidity to manage our business in light of the COVID-19 pandemic and the significant decline in the price of crude oil. In January, May, June, andSeptember 2020 , we repaid a combined$52.0 million on the Credit Agreement. The average debt balance outstanding and average interest rates are summarized in the table below: Average Debt Balance Outstanding Year Ended (in Average December 31 thousands) Interest Rate 2020$ 80,763 4.03 % 2019$ 81,400 5.78 % 55 Foreign currency gains (losses). Our Canadian subsidiary has certain intercompany payables to ourU.S. -based subsidiaries. Such intercompany payables and receivables among our consolidated subsidiaries are eliminated in our Consolidated Balance Sheets. We report currency translation adjustments on these intercompany payables and receivables within foreign currency gains (losses) in our Consolidated Statements of Operations. The net foreign currency gains during 2020 and 2019 resulted from the appreciation of the Canadian dollar relative to theU.S. dollar. Other, net. Other income in 2019 includes a gain of$1.3 million of the settlement of litigation with a former subcontractor. Other expense in 2019 includes a loss of$0.5 million on the sale of pre-petition accounts receivable from Pacific Gas and Electric Company, which is a customer that filed for bankruptcy protection in 2019. Other income in 2020 and 2019 also includes royalty income, interest income, and income associated with our 25% interest in a water treatment facility that we account for under the equity method. Income tax expense. We qualify as a partnership for income tax purposes, and therefore we generally do not pay income tax; instead, each owner reports his or her share of our income or loss on his or her individual tax return. Our income tax provision relates primarily to (1) ourU.S. corporate subsidiaries that provide services to public utility customers, which do not appear to fit within the definition of qualified income as it is defined in the Internal Revenue Code, Regulations, and other guidance, which subjects this income toU.S. federal and state income taxes, (2) our Canadian subsidiary, which is subject to Canadian federal and provincial income taxes, and (3) certain other state income taxes, including theTexas franchise tax. Income tax expenses decreased from$2.3 million in 2019 to$0.5 million in 2020, primarily due a decrease in income of ourU.S. corporate subsidiary that provides services to public utility customers and a decrease in revenue that is subject to theTexas franchise tax in our Inspection Services and Pipeline
and Process Services segments.
As a publicly-traded partnership, we are subject to a statutory requirement that 90% of our total gross income represent "qualifying income" (as defined by the Internal Revenue Code, related Treasury Regulations, and Internal Revenue Service pronouncements), determined on a calendar-year basis. Income generated by taxable corporate subsidiaries is excluded from this calculation. In 2020, substantially all our gross income, which consisted of$139.0 million of revenue (exclusive of the income generated by our taxable corporate subsidiaries), represented "qualifying income". Certain inspection services are not qualifying income and we therefore have separate taxable entities that pay state and federal income tax on these earnings. Net income (loss) attributable to noncontrolling interests. We own a 51% interest in CBI and a 49% interest in CF Inspection. The accounts of these subsidiaries are included within our Consolidated Financial Statements. The portion of the net income (loss) of these entities that is attributable to outside owners is reported in net income (loss) attributable to noncontrolling interests in our Consolidated Statements of Operations. Changes in the net income (loss) attributable to noncontrolling interests from 2019 to 2020 related primarily to changes in the net income generated by CBI. Net income attributable to preferred unitholder. OnMay 29, 2018 , we issued and sold$43.5 million of preferred equity. The holder of the preferred units is entitled to an annual return of 9.5% on this investment. This return is reported in net income attributable to preferred unitholder in the Consolidated Statements of Operations. 56 Segment Operating Results Inspection Services
The following table summarizes the operating results of our Inspection Services
segment for the years ended
Years Ended December 31
% of % of
2020 Revenue 2019 Revenue Change % Change
(in thousands, except average revenue and inspector data)
Revenues $ 181,526 $ 371,994 $ (190,468 ) (51.2 )%
Costs of services 161,726 331,498 (169,772 ) (51.2 )%
Gross margin 19,800 10.9 % 40,496 10.9 % (20,696 ) (51.1 )%
General and administrative 15,282 8.4 % 19,086 5.1 % (3,804 ) (19.9 )% Depreciation, amortization and accretion 2,217 1.2 % 2,224 0.6 % (7 ) (0.3 )% Other - 1 0.0 % (1 ) (100.0 )% Operating income$ 2,301 1.3 %$ 19,185
5.2 %
Operating Data Average number of inspectors 730 1,485 (755 ) (50.8 )% Average revenue per inspector per week$ 4,769 $ 4,804 $ (35 ) (0.7 )% Revenue variance due to number of inspectors$ (187,758 ) Revenue variance due to average revenue per inspector$ (2,710 )
Revenue. Revenue decreased$190.5 million in 2020 compared to 2019, due to a decrease in the average number of inspectors engaged (a decrease of 755 inspectors accounting for$187.8 million of the revenue decrease) and a decrease in the average revenue billed per inspector (accounting for$2.7 million of the revenue decrease). Revenues during 2019 benefited from the largest contract in the 18-year history of TIR, which was a single-source inspection services project inTexas . This project began in the fourth quarter of 2018, peaked in the second quarter of 2019, and continued with declining headcounts into 2020. We generated$8.0 million and$62.9 million of revenue from this project in 2020 and 2019, respectively. Our revenues during 2020 did not significantly benefit from any other large new projects. During 2020, the COVID-19 pandemic, combined with a significant decrease in crude oil prices resulting from reduced demand and an anticipated increase in supply fromSaudi Arabia andRussia , led many of our customers to change their budgets and plans. Revenues of our subsidiary that serves public utility companies decreased by$19.1 million in 2020 compared to 2019, due in part to lower activity as a result of the COVID-19 pandemic. Revenues of our nondestructive examination service line decreased by$7.2 million in 2020 compared to 2019, due in part to lower activity as a result of the COVID-19 pandemic. The decrease in average revenue per inspector is due to changes in customer mix. Fluctuations in the average revenue per inspector are common, given that we charge different rates for different types of inspectors and different types of inspection services. In addition, certain of our customers pursued pricing concessions at the outset of the COVID-19 pandemic, which led us to reduce prices and to also reduce the compensation we could
offer to our valued inspectors. Costs of services. Costs of services decreased$169.8 million in 2020 compared to 2019, primarily related to a decrease in the average number of inspectors employed during the period. Gross margin. Gross margin decreased$20.7 million in 2020 compared to 2019, as a result of lower revenues. The gross margin percentage was 10.9% in both 2020 and 2019. Our gross margin percentage reflects the fact that we have certain revenue associated with mileage and per diem reimbursements for our inspectors travelling away from home that is typically not entitled to any profit margin or mark up. Gross margin in 2020 and 2019 benefited from the fact that we recognized$0.3 million and$0.2 million , respectively, of revenue on services performed in previous years. We had constrained recognition of this revenue until the expiration of a contract provision that had given the customer the opportunity to reopen negotiation of the fee paid for the services. General and administrative. General and administrative expenses decreased by$3.8 million in 2020 compared to 2019, due primarily to a decrease in employee compensation expense through a combination of salary reductions, reductions in workforce, furloughs, hiring freezes, and reductions in incentive compensation and sales commission expense. Legal fees increased by$0.4 million as a result of costs associated with FLSA employment litigation and certain other employment-related lawsuits and claims. We also recorded general and administrative expense of$0.5 million and$0.1 million in 2020 and 2019, respectively, related to the completed or proposed settlements of various litigation matters. Bad debt expense increased by$0.4 million primarily due to new information that changed our estimates regarding the likelihood of collecting accounts receivable from a former customer. Travel and advertising costs decreased by$0.6 million as a result of the pandemic and the resultant slowdown in travel. Expenses we incurred for costs that were previously incurred by Holdings pursuant to the Omnibus Agreement were lower during 2020 than the administrative fee charged by Holdings during 2019; however, the benefit of this reduced expense was partially offset by increased expense resulting from a reassessment of the allocation of shared expenses to the various segments, which resulted in less expense being charged to the Environmental Services segment and more expense being charged to the Inspection Services segment in 2020.
Depreciation, amortization, and accretion. Depreciation, amortization, and accretion expense in 2020 was similar to depreciation, amortization and accretion expense during 2019.
57
Operating income. Operating income decreased by $16.9 million in 2020 compared
to 2019, due primarily to the decrease in gross margin, partially offset by a
decrease in general and administrative expenses.
Pipeline & Process Services
The following table summarizes the results of the Pipeline & Process Services
segment for the years ended
Year Ended December 31
% of % of
2020 Revenue 2019 Revenue Change % Change
(in thousands, except average revenue and inspector data)
Revenue $ 18,716 $ 19,337 $ (621 ) (3.2 )%
Costs of services 13,743 13,397
346 2.6 %
Gross margin 4,973 26.6 % 5,940 30.7 % (967 ) (16.3 )%
General and
administrative 2,308 12.3 % 2,500 12.9 % (192 ) (7.7 )%
Depreciation,
amortization and
accretion 558 3.0 % 574 3.0 % (16 ) (2.8 )%
Gain on asset
disposals, net (32 ) (0.2 )% (26 ) (0.1 )% (6 ) 23.1 %
Operating income $ 2,139 11.4 % $ 2,892 15.0 % $ (753 ) (26.0 )%
Operating Data
Average number of
field personnel 28 28 - 0.0 %
Average revenue per
field personnel perweek$ 12,819 $ 13,245
$ (424 ) (3.2 )% Revenue variance due to number of field personnel $ - Revenue variance due to average revenue per field personnel$ (621 ) Revenue. Revenue decreased$0.6 million in 2020 compared to 2019. Our Pipeline & Process Services segment generates more of its revenues from a smaller number of larger-scale projects than does our Inspection Services segment. As a result, the revenues of the Pipeline & Process Services segment can be significantly influenced by the ability to win a relatively small number of bids for hydrotesting projects. In 2020, 64% of the revenues in the Pipeline & Process Services segment were generated from the 10 largest projects. Costs of services. Costs of services increased$0.3 million in 2020 compared to 2019. This increase was due in part to an increase in the utilization of contract labor as there was more overlap in the timing of projects in 2020 compared to 2019. In addition, one large project during 2020 generated a significantly lower margin than normal, due in part to unplanned delays that were not within our control.
Gross margin. Gross margin decreased$1.0 million in 2020 compared to 2019. The employees of the Pipeline & Process Services segment are full-time employees, and therefore primarily represent fixed costs (in contrast to the employees of the Inspection Services segment who perform work in the field, most of whom only earn wages when they are performing work for a customer and whose wages are therefore primarily variable costs). Because these employees were less than fully utilized in 2020 than in 2019, the gross margin percentage was lower. In addition, the gross margin percentage decreased in 2020 compared to 2019 due to an increase in the utilization of contract labor and due to unplanned delays that were not within our control on one large project during 2020. General and administrative. General and administrative expenses primarily include compensation expense for office employees and general office expenses. These expenses decreased by$0.2 million in 2020 compared to 2019 due primarily to a decrease in incentive compensation expense resulting from the decrease in revenue of the business toward the latter part of 2020. Depreciation, amortization, and accretion. Depreciation, amortization, and accretion expense includes depreciation of property and equipment and amortization of intangible assets associated with customer relationships, trade names, and noncompete agreements. Depreciation, amortization, and accretion expense in 2020 was similar to depreciation, amortization, and accretion expense in 2019.
Operating income. Operating income decreased by
58
Environmental Services
The following table summarizes the operating results of our Environmental
Services segment for the years ended
Year Ended December 31
% of % of
2020 Revenue 2019 Revenue Change % Change
(in thousands, except per barrel data)
Revenues $ 5,754 $ 10,317 $ (4,563 ) (44.2 )%
Costs of services 2,015 3,029 (1,014 ) (33.5 )%
Gross margin 3,739 65.0 % 7,288 70.6 % (3,549 ) (48.7 )%
General and
administrative 1,802 31.3 % 2,995 29.0 % (1,193 ) (39.8 )%
Depreciation,
amortization and
accretion 1,648 28.6 % 1,632 15.8 % 16 1.0 %
Gain on asset
disposals, net 5 0.1 % - 5
Operating income $ 284 4.9 % $ 2,661 25.8 % $ (2,377 ) (89.3 )%
Operating Data
Total barrels of
water processed 7,932 13,416 (5,484 ) (40.9 )%
Average revenue per
barrel processed (a) $ 0.73 $ 0.77 $ (0.04 ) (5.2 )%
Revenue variance due
to barrels processed $ (4,246 )
Revenue variance due
to revenue per barrel $ (317 ) (a) Average revenue per barrel processed is calculated by dividing revenues
(which includes water treatment revenues, residual oil sales, and management
fees) by the total barrels of saltwater processed.
Revenue. Revenue of the Environmental Services segment decreased by $4.6 million
in 2020 compared to 2019. The decrease in revenues was due primarily to a
decrease of 5.5 million barrels in the volume of water processed and lower
prices on the sale of recovered crude oil. Low commodity prices, an excess of
supply, and low demand led to a significant reduction in activity by producers
in North Dakota . Bakken Clearbrook oil pricing was under intense pressure during
2020, along with WTI oil prices. WTI oil prices, which were at $61.14 at
December 31, 2019 , decreased in January and February 2020 , decreased even more
sharply in March and April 2020 , gradually increased to $40 per barrel in early
July, and begin increasing in December to $48.35 at December 31, 2020 . Pipeline
capacity and storage constraints also adversely affected this market. Several
prominent exploration and production customers elected to shut in their
production instead of selling oil at the low market prices. The average price
per barrel of recovered crude oil also decreased in 2020 compared to 2019.
Revenues from the sale of recovered crude oil represented 3% and 6% of the
revenue in the Environmental Services segment in 2020 and 2019, respectively.
Costs of services. Costs of services decreased by $1.0 million in 2020 compared
to 2019 due in part to a decrease of $0.5 million in variable costs (such as
chemical and utility expense) resulting from a decrease in volumes, a decrease
of $0.3 million in compensation expense as a result of salary reductions and
reductions in force, and a decrease of $0.2 million in repairs and maintenance
expense.
Gross margin. Gross margin decreased
General and administrative. General and administrative expenses include general overhead expenses such as employee compensation costs, insurance, property taxes, royalty expenses, and other miscellaneous expenses. These expenses decreased through a combination of salary reductions, reductions in workforce, furloughs, hiring freezes, reductions in incentive compensation expense, and other cost-cutting measures. Expenses we incurred for costs that were previously incurred by Holdings pursuant to the Omnibus Agreement were lower during 2020 than the administrative fee charged by Holdings during 2019. In addition, the decrease in general and administrative expenses was partially due to a reassessment of the allocation of shared expenses to the various segments, which resulted in less expense being charged to the Environmental Services segment and more expense being charged to the Inspection Services segment in 2020 than
in 2019.
Depreciation, amortization, and accretion. Depreciation, amortization, and accretion expenses include depreciation of property and equipment and amortization of intangible assets associated with customer relationships, trade names, and noncompete agreements. Depreciation, amortization, and accretion expense in 2020 was similar to depreciation, amortization, and accretion expense in 2019.
Operating income. Operating income decreased by
59
Liquidity and Capital Resources
The working capital needs of the Inspection Services segment are substantial, driven by payroll costs and reimbursable expenses paid to our inspectors on a weekly basis. Please read "Risk Factors - Risks Related to Our Business - The working capital needs of the Inspection Services segment are substantial", which could require us to seek additional financing that we may not be able to obtain on satisfactory terms, or at all. Consequently, our ability to develop and maintain sources of funds to meet our capital requirements is critical to our ability to meet our growth objectives. We expect that our future capital needs will be funded by future borrowings and the issuance of debt and equity securities. However, we may not be able to raise additional funds on desired or favorable terms or at all.
At
?
(
? available borrowings under our Credit Agreement; and
? issuance of equity securities through our at-the-market equity program. We had outstanding borrowings of$62.6 million atDecember 31, 2020 (inclusive of finance lease obligations). At each quarter end, our borrowing capacity is limited by a leverage ratio in the Credit Agreement. The leverage ratio is calculated as the debt outstanding (inclusive of finance leases) divided by trailing-twelve-month EBITDA (as defined in the Credit Agreement). The maximum leverage ratio is 6.0 atDecember 31, 2020 andMarch 31, 2021 , 5.3 atJune 30, 2021 , 4.5 atSeptember 30, 2021 , and 4.0 atDecember 31, 2021 . AtDecember 31, 2020 , our leverage ratio was 5.8. As amended inMarch 2021 , the Credit Agreement has a maximum borrowing capacity of$75.0 million . In 2020, in light of the current market conditions, we made the difficult decision to temporarily suspend payment of common unit distributions. This has enabled us to retain more cash to manage our financing needs during these challenging market conditions. As amended inMarch 2021 , the Credit Agreement contains significant limitations on our ability to pay cash distributions. We may only pay the following cash distributions:
? distributions to common and preferred unitholders, to the extent of income
taxes estimated to be payable by these unitholders resulting from allocations
of our earnings;
? distributions to the preferred unitholder up to
leverage ratio is 4.0 or lower; and
? distributions to the noncontrolling interest owners of CBI and CF Inspection.
The Credit Agreement matures on
At-the-Market Equity Program
InApril 2019 , we established an at-the-market equity program ("ATM Program"), which will allow us to offer and sell common units from time to time, to or through the sales agent under the ATM Program. The maximum amount we may sell varies based on changes in the market value of the units. Currently, the maximum amount we may sell is$10 million . We are under no obligation to sell any common units under this program. As of the date of this filing, we have not sold any common units under the ATM Program and, as such, have not received any net proceeds or paid any compensation to the sales agent under the ATM Program.
Employee Unit Purchase Plan InNovember 2020 , we established an employee unit purchase plan ("EUPP"), which will allow us to offer and sell up to 500,000 common units. Employees can elect to have up to 10 percent of their annual base pay withheld to purchase common units, subject to terms and limitations of the EUPP. The purchase price of the common units is 95% of the volume weighted average of the closing sales prices of our common units on the ten immediately preceding trading days at the end of each offering period. There have been no common unit issuances under the EUPP. 60 Common Unit Distributions
The following table summarizes the distributions on common and subordinated units declared and paid since our initial public offering:
Total
Per Unit Cash Cash Distributions to
Payment Date Distributions Total Cash Distributions Affiliates (a)
(in thousands)
Total 2014 Distributions $ 1.104646 $ 13,064 $ 8,296
Total 2015 Distributions 1.625652 19,232 12,284
Total 2016 Distributions 1.625652 19,258 12,414
Total 2017 Distributions 1.036413 12,310 7,928
Total 2018 Distributions 0.840000 10,019 6,413
February 14, 2019 0.210000 2,510 1,606
May 15, 2019 0.210000 2,531 1,622
August 14, 2019 0.210000 2,534 1,624
November 14, 2019 0.210000 2,534 1,627
Total 2019 Distributions 0.840000 10,109 6,479
February 14, 2020 0.210000 2,534 1,627
May 15, 2020 0.210000 2,564 1,641
Total 2020 Distributions 0.420000 5,098 3,268
Total Distributions (since IPO)$ 7.492363 $
89,090 $ 57,082
(a) Approximately 64% of the Partnership's outstanding common units at December
31, 2020 were held by affiliates.
Preferred Unit Distributions
OnMay 29, 2018 we issued and sold in a private placement 5,769,231 Series A Preferred Units representing limited partner interests in the Partnership (the "Preferred Units") for a cash purchase price of$7.54 per Preferred Unit, resulting in gross proceeds to the Partnership of$43.5 million . The purchaser of the Preferred Units is entitled to receive quarterly distributions that represent an annual return of 9.5% (which amounts to$4.1 million per year). Of this 9.5% annual return, we have the option to pay 7.0% in kind (in the form of issuing additional Preferred Units) for the first twelve quarters after the initial sale of the Preferred Units. Under the terms of our modified credit facility, we are restricted from paying any cash distributions unless our gross leverage is less than four times our trailing-twelve-month EBITDA (as defined in the Credit Agreement). The Preferred Units rank senior to our common units, and we must pay distributions on the Preferred Units (including any arrearages) before paying distributions on our common units. 61 The following table summarizes the distributions paid to our preferred unitholder: Payment Date Cash Distributions (in thousands) November 14, 2018 (a) $ 1,412 Total 2018 Distributions 1,412 February 14, 2019 1,033 May 15, 2019 1,033 August 14, 2019 1,033 November 14, 2019 1,034 Total 2019 Distributions 4,133 February 14, 2020 1,033 May 15, 2020 1,033 August 14, 2020 1,033 November 14, 2020 1,034 Total 2020 Distributions 4,133 Total Distributions $ 9,678
(a) This distribution relates to the period from
unit issuance) through September 30, 2018 .
CBI
CBI's company agreement generally requires CBI to make an annual distribution to
its members equal to or greater than the amount of CBI's taxable income
multiplied by the maximum federal income tax rate. In 2020, CBI declared and
paid distributions of $2.8 million , of which $1.4 million was distributed to us
and the remainder of which was distributed to noncontrolling interest owners. In
2018, CBI declared and paid distributions of $2.0 million , of which $1.0 million
was distributed to us and the remainder of which was distributed to
noncontrolling interest owners.
Cash Flows
The following table sets forth a summary of the net cash provided by (used in) operating, investing, and financing activities for the periods identified.
Year Ended December 31
2020 2019
(in thousands)
Net cash provided by operating activities
Net cash used in investing activities (1,654 ) (1,933 ) Net cash used in financing activities (23,977 ) (15,930 ) Effect of exchange rates on cash 2 4
Net increase in cash and cash equivalents
Operating activities. In 2020, we generated net operating cash inflows of$27.9 million , consisting of a net loss of$0.4 million plus non-cash expenses of$7.7 million and net changes in working capital of$20.6 million . Non-cash expenses included depreciation, amortization, and accretion, and equity-based compensation expense, among others. The net change in working capital includes a net decrease of$33.6 million in accounts receivable, partially offset by a net increase of$0.9 million in prepaid expenses and other, and by a net decrease of$12.2 million in current liabilities. During periods of revenue growth, changes in working capital typically reduce operating cash flows, based on the fact that we pay our employees before we collect accounts receivable from our customers. During 2020, we experienced a decrease in inspectors in our Inspection Services segment, which reduced the need to expend cash for working capital. 62 In 2019, we generated operating cash flows of$18.2 million . Prior to consideration of changes in working capital, operating cash flows in 2019 were$23.5 million , consisting of net income of$17.4 million plus non-operating-cash expenses of$6.1 million (non-cash expenses include depreciation and amortization, equity-based compensation, foreign currency gains/losses, gain on litigation settlement, and loss on sale of accounts receivable, among others). In 2019, changes in working capital reduced operating cash flows by$5.3 million . During periods of revenue growth, changes in working capital typically reduce operating cash flows, based on the fact that we pay our employees before we collect our accounts receivable from our customers. Investing activities. In 2020, net cash outflows from investing activities were$1.7 million , which included costs associated with a new software system for payroll and human resources management, field equipment for our Inspection Services and Pipeline & Process Services segments, and facility improvements for our Environmental Services segment. In 2019, cash outflows for investing activities consisted of capital expenditures of$2.0 million , which were partially offset by less than$0.1 million in proceeds from fixed asset disposals. Capital expenditures in 2019 included the purchase of equipment (primarily for our nondestructive examination business) and costs associated with a new software system for payroll and human resources management that we implemented in early 2020. Financing activities. In 2020, financing cash outflows primarily consisted of$12.9 million of net repayments on our revolving credit facility. In March andApril 2020 , in an abundance of caution, we borrowed a combined$39.1 million on the Credit Agreement to provide substantial liquidity to manage our business in light of the COVID-19 pandemic and the significant decline in the price of crude oil. In January, May, June andSeptember 2020 , we repaid a combined$52.0 million on the Credit Agreement. Financing cash outflows also included$5.1 million of distributions to common unitholders,$4.1 million of distributions to preferred unitholders, and$1.4 million of distributions to noncontrolling interests. In 2019, cash outflows from financing activities included$1.2 million of net payments on our revolving credit facility. Financing cash outflows for 2020 also included$10.1 million of common unit distributions and$4.1 million of preferred unit distributions. Working Capital Our working capital (defined as current assets less current liabilities) was$30.3 million atDecember 31, 2020 . Our Inspection Services and Pipeline & Process Services segments have substantial working capital needs, as we generally pay our field personnel on a weekly basis, but typically receive payment from our customers 45 to 90 days after the services have been performed. A substantial portion of our inspection services revenue is associated with mileage and per diem expense reimbursement for our inspectors that work away from their home on our clients' assets. We generally do not receive any markup or profit margin on these amounts. Several customers are re-visiting their policies and considering deploying more local inspectors. If this occurs, this will reduce our working capital requirements. Please read "Risk Factors - Risks Related to Our Business - The working capital needs of the Inspection Services segment are substantial, which could require us to seek additional financing that we may not be able to obtain on satisfactory terms, or at all." Capital Requirements We generally have small capital expenditure requirements compared to many other master limited partnerships. Our Inspection Services segment does not generally require significant capital expenditures, other than the purchase of nondestructive examination technology. Our inspectors provide their own four wheel drive vehicles and receive mileage reimbursement. Our Pipeline & Process Services segment has both maintenance and growth capital needs for equipment and vehicles in order to perform hydrostatic testing and other integrity procedures. Our Environmental Services Segment has minimal capital expenditure requirements for the maintenance of existing water treatment facilities. We do not plan on investing in any growth capital in this segment. Our partnership agreement requires that we categorize our capital expenditures as either maintenance capital expenditures or expansion capital expenditures.
? Maintenance capital expenditures are those cash expenditures that will enable
us to maintain our operating capacity or operating income over the long-term.
Maintenance capital expenditures include expenditures to maintain equipment
reliability, integrity, and safety, as well as to address environmental laws
and regulations. Maintenance capital expenditures, inclusive of finance lease
obligation payments, were
2020 and 2019, respectively (cash basis).
63
? Expansion capital expenditures are those capital expenditures that we expect
will increase our operating capacity or operating income over the long-term.
Expansion capital expenditures include the acquisition of assets or businesses
and the construction or development of additional water treatment capacity, to
the extent such expenditures are expected to expand our long-term operating
capacity or operating income. Expansion capital expenditures were
and$1.5 million in 2020 and 2019, respectively (cash basis).
Future expansion capital expenditures may vary significantly from period to period based on the investment opportunities available. We expect to fund future capital expenditures from cash flows generated from our operations, borrowings under our Credit Agreement, the issuance of additional partnership units, or debt offerings. As we expand into new inspection markets such as municipal water, municipal sewer, electrical transmission, bridges, among others, we should be able to use a lot of our NDE equipment. However, we will need to invest in additional growth capital for attractive opportunities to enter these new markets. Credit Agreement We are party to a credit agreement (the "Credit Agreement") with a syndicate of seven banks, withDeutsche Bank Trust Company Americas ("DB") serving as the Administrative Agent. DB has served as our agent since 2013. The obligations under the Credit Agreement are secured by a first priority lien on substantially all of our assets. The Credit Agreement has been amended several times since inception and most recently inMay 2018 and again inMarch 2021 . Both recent amendments reduced the borrowing capacity following two industry downturns. After theMarch 2021 amendment, the Credit Agreement has a total capacity of$75.0 million and matures onMay 31, 2022 . Outstanding borrowings atDecember 31, 2020 andDecember 31, 2019 were$62.0 million and$74.9 million , respectively, and are reported in our Consolidated Balance Sheets as long-term debt. Outstanding borrowings less cash and cash equivalents was$44.1 million as ofDecember 31, 2020 . The average debt balance outstanding in 2020 and 2019 was$80.8 million and$81.4 million , respectively. In March andApril 2020 , in an abundance of caution, we borrowed a combined$39.1 million on the Credit Agreement to provide substantial liquidity to manage our business in light of the COVID-19 pandemic and the significant decline in the price of crude oil. In January, May, June, andSeptember 2020 , we repaid a combined$52.0 million on the Credit Agreement. All borrowings under the Credit Agreement bear interest, at our option, on a leveraged-based grid pricing at (i) a base rate plus a margin of 2.00% to 3.75% per annum ("Base Rate Borrowings") or (ii) an adjusted LIBOR rate plus a margin of 3.00% to 4.75% per annum ("LIBOR Borrowings"). The applicable margin is determined based on our leverage ratio, as defined in the Credit Agreement. Under theMarch 2021 amendment, the applicable margins are 0.50% to 0.75% higher (depending on the leverage ratio) than they were prior to the amendment. Interest on Base Rate Borrowings is payable monthly. Interest on LIBOR Borrowings is paid upon maturity of the underlying LIBOR contract, but no less often than quarterly. Commitment fees are charged at a rate of 0.50% on any unused credit and are payable quarterly. Interest paid in 2020 and 2019 was$3.4 million and$4.8 million , respectively, including commitment fees. The interest rate on our borrowings ranged from 3.33% to 4.80% in 2020 and 4.70% to 6.02% in 2019. The Credit Agreement contains various customary covenants and restrictive provisions. The Credit Agreement also requires us to maintain certain financial covenants, including a leverage ratio and an interest coverage ratio. The interest coverage ratio is calculated as the trailing-twelve-month EBITDA (as defined in the Credit Agreement) divided by trailing-twelve-month pro forma interest expense (as defined in the Credit Agreement). The minimum interest coverage ratio is 3.0 at each quarter end. AtDecember 31, 2020 , our interest coverage ratio was 4.7. The leverage ratio is calculated as the gross debt outstanding (inclusive of finance leases) divided by trailing-twelve-month EBITDA (as defined in the Credit Agreement). The maximum leverage ratio is 6.0x atDecember 31, 2020 andMarch 31, 2021 , 5.3x atJune 30, 2021 , 4.5x atSeptember 30, 2021 , and 4.0x atDecember 31, 2021 . AtDecember 31, 2020 , our leverage ratio was 5.8. As ofDecember 31, 2020 , we were in compliance with all covenants of the Credit Agreement (as amended inMarch 2021 ). We currently are forecasting a sufficient level of EBITDA to remain in compliance with the financial covenants in the Credit Agreement throughout the term of the Credit Agreement. However, maintaining a sufficient level of EBITDA will be dependent on the level of activity in the markets we serve and on our ability to win awards for work from our customers, and may require us to sell common units through our at-the-market equity program to raise proceeds to repay debt and/or to delay reimbursements to affiliates on a short-term basis. It is reasonably possible that we could fail to meet one or both of the financial covenant ratios. If this were to occur, and if we were unable to obtain from the lenders a waiver of the covenant violation, we would be in default on the Credit Agreement. Upon the occurrence and during the continuation of an event of default, subject to the terms and conditions of the Credit Agreement, the lenders may declare any outstanding principal, together with any accrued and unpaid interest, to be immediately due and payable and may exercise the other remedies set forth or referred to in the Credit Agreement.
The Credit Agreement contains significant limitations on our ability to pay cash distributions. We may only pay the following cash distributions:
? distributions to common and preferred unitholders, to the extent of income
taxes estimated to be payable by these unitholders resulting from allocations
of our earnings;
? distributions to the preferred unitholder up to
leverage ratio is 4.0 or lower; and
? distributions to the noncontrolling interest owners of CBI and CF Inspection.
In addition, the Credit Agreement restricts our ability to redeem or repurchase our equity interests.
The Credit Agreement requires us to make payments to reduce the outstanding balance if, for any consecutive period of five business days, our cash on hand (less amounts expected to be paid in the following five business days) exceeds$10.0 million . We incurred certain debt issuance costs at the inception of the Credit Agreement, which we were amortizing on a straight-line basis over the original term of the Credit Agreement. Upon amending the Credit Agreement inMay 2018 , we wrote off$0.1 million of these debt issuance costs and reported this expense within debt issuance cost write-off in our Consolidated Statement of Operations for 2018, which represented the portion of the unamortized debt issuance costs attributable to lenders who were no longer participating in the credit facility subsequent to the amendment. The remaining debt issuance costs associated with the inception of the Credit Agreement, along with$1.3 million of debt issuance costs associated with theMay 2018 amendment, were being amortized on a straight-line basis over the remaining term of the Credit Agreement. Debt issuance costs total$0.2 million and$0.8 million atDecember 31, 2020 andDecember 31, 2019 , respectively, and are reported as debt issuance costs, net on the Consolidated Balance Sheets. In 2021, we incurred$1.0 million of debt issuance costs related to theMarch 2021 amendment to the Credit Agreement.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet or hedging arrangements.
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