The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto in "Item 8. Financial Statements and Supplementary Data". This discussion and analysis contains forward-looking statements based on our current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors as described under "Cautionary Note Regarding Forward-Looking Statements" and "Item 1A. Risk Factors." We assume no obligation to update any of these forward-looking statements.
Overview
We are a leading provider of comprehensive water-management solutions to the oil and gas industry in theU.S. We also develop, manufacture and deliver a full suite of chemical products for use in oil and gas well completion and production operations. Through a combination of organic growth and acquisitions over the last decade, we have developed a leading position in the relatively new water solutions industry. We believe we are the only company in the oilfield services industry that combines comprehensive water-management services with related chemical products. Furthermore, we are one of the few large oilfield services companies whose primary focus is on the management of water and water logistics in the oil and gas development industry. Accordingly, as an industry leader in the water solutions industry, we place the utmost importance on safe, environmentally responsible management of oilfield water throughout the lifecycle of a well. Additionally, we believe that responsibly managing water resources through our operations to help conserve and protect the environment in the communities in which we operate is paramount to our continued success. In many regions of the country, there has been growing concern about the increasing volumes of water required for new oil and gas well completions. Working with our customers and local communities, we strive to be an industry leader in the development of cost-effective alternatives to fresh water. Specifically, we offer services that enable our E&P customers to treat and reuse produced water, thereby reducing the demand for fresh water while also reducing the volumes of saltwater that must be disposed by injection. In many areas, we have also acquired sources of non-potable water such as brackish water or municipal or industrial effluent. We work with our customers to optimize their fluid systems to economically enable the use of these alternative sources. We also work with our E&P customers to reduce the environmental footprint of their operations through the use of temporary hose and permanent pipeline systems. These solutions reduce the demand for trucking operations, thereby reducing diesel emissions, increasing safety and decreasing traffic congestion in nearby communities. Recent Trends and Outlook Demand for our services depends substantially on drilling, completion and production activity by E&P companies, which, in turn, depends largely upon the current and anticipated profitability of developing oil and natural gas reserves in theU.S. Beginning in 2017 and through 2018, our clients steadily increased their spending as oil prices increased 28% from$50.80 per barrel on average in 2017 to$65.23 per barrel in 2018 and natural gas prices increased 6% from$2.99 per mmbtu on average in 2017 to$3.17 per mmbtu in 2018 according to theU.S. Energy Information Administration ("EIA"). In conjunction,U.S. rig count increased 18% and new well completions increased by 24% in 2018 relative to 2017, according to Baker Hughes Company and the EIA, respectively . However, beginning in the fourth quarter of 2018 and through 2019, we experienced a pullback in spending by our customers relative to previous trends. This decline was driven partly by a 13% decline in oil prices to$56.98 per barrel and a 19% decline in natural gas prices to$2.57 per mmbtu on average in 2019 and resulted in a 9% decline in rig count during 2019. Recent volatility in oil and gas prices and pressure from investors have led many of our customers to implement a more disciplined capital spending strategy. In addition to the commodity price declines seen in 2019, we saw a notable change in the priorities of our customers and their investors over the course of the year. Beginning in 2019, many of our customers increasingly prioritized spending within their cash flows and capital budgets, debt reduction and returning capital to shareholders, rather than production growth. While these trends have resulted in a limitation of recent growth 60
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opportunities, we believe that ultimately, this transition will result in a healthier overall industry and a more stable long-term operating environment over time. This shift in priorities has led to an increased industry focus on optimizing operational efficiencies and decreasing costs, which consequently resulted in significant pricing pressure on the service industry throughout 2019. In recent quarters, our customers have benefitted from enhanced operational efficiencies in both the drilling and completions processes. On the drilling side, our customers have benefited from improved economics driven by technologies that reduce the number of days required to drill a well and therefore the associated cost of drilling wells. Our customers have incorporated newer drilling rig technologies, meaning each rig can drill more wells in a given period. Additionally, drilling rigs have also incorporated new technology that greatly reduces the time it takes to move from one well location to the next. At the same time, E&P companies are evolving in their lifecycles away from single well drilling for appraisal purposes or to hold acreage positions, to larger-scale development plans incorporating multi-well pad development. This allows them to drill multiple wells from the same pad or location, improving cost efficiencies and reducing cycle times. Similar trends have occurred on the completions side, utilizing improving subsurface techniques and technologies to exploit unconventional resources. These improvements have targeted increasing the exposure of each wellbore to the reservoir by drilling longer horizontal lateral sections of the wellbore. To complete the well, hydraulic fracturing is applied in stages along the wellbore to break up the resource so that oil and gas can be produced. As wellbores have increased in length, the number of stages has also increased, while at the same time, the average time to complete each stage has been significantly reduced. Further, E&P companies have improved production from each stage while reducing their costs through efficiencies. Given the expected returns that E&P companies have reported for new well development activities due to improved rig efficiencies and increasing well completion complexity and intensity, we expect these industry trends to continue in today's commodity price environment. We anticipate that the recent downward trends in commodity prices, recent shift in customer priorities and continued improvements in operational efficiencies will result in our customers further reducing their capital budgets in 2020 relative to 2019. While these industry trends are not without their challenges, we believe in the long term, there will be a bifurcation of the market between traditional commoditized or over-leveraged service companies and those like Select that are well capitalized with the scale, expertise and technological innovations to effectively service today's more efficient and technology-reliant oilfield landscape. In order to continue to advance our strategy, mitigate pricing pressures and continue to differentiate the advantages of our product offerings, we have made acquisitions and significant investments in our business to provide more comprehensive solutions offerings including technology, water infrastructure, chemicals manufacturing capabilities as well as expanding our water treatment capabilities. We prioritized executing these acquisitions and investments within cash flow and at the same time steadily improving our balance sheet over the course of recent years. We believe our investments in automation technology will allow us to continue to improve our own operational efficiencies, while providing a more efficient, safer solution to our customers and improving our ability to decrease our cost of labor and protect our margins. Additionally, as the larger operators continue to focus on their long-term through-cycle development planning, we believe our continued investments in infrastructure and proprietary chemical capabilities allow us to provide more efficient, comprehensive solutions to our customers and continue to differentiate our capabilities relative to our smaller, single service, regional competitors. Another area of strategic focus is investing in longer-lived infrastructure assets in areas we believe will experience consistently high levels of completion activity. We have successfully executed these types of investments in the Bakken, through our fixed infrastructure investments inNorth Dakota and in thePermian Basin , through our GRR Acquisition in theNorthern Delaware Basin and ourNorthern Delaware Basin pipeline project. Additionally, as market opportunities continue to grow for treating and reusing produced water for new well completions, we are exploring opportunities to develop and expand our production-related services, including our existing produced water gathering infrastructure and SWDs, to help manage rapidly growing produced water volumes. 61 Table of Contents Within our Oilfield Chemicals segment, the recent addition of friction reducer manufacturing capabilities inMidland has saved us freight and logistics costs relative to shipping this high-volume product out of ourTyler, Texas production facility and increased our overall production capacity. We continue to make investments to drive operational efficiencies to continue to reduce unnecessary logistics and freight costs, making us more competitive and more nimble to our customers. Additionally, our knowledge and expertise related to treatment, recycling and fracturing fluid chemistry allow us to provide our customers with environmentally sound solutions across a range of various water attributes. The quality of water used for a well completion directly impacts the completion chemicals that are used in the fracturing fluid system and the trend of increased use of produced water will continue to require additional chemical treatment solutions. We believe our recent acquisition of Baker Hughes Company's well chemical services business ("WCS") expanded upon our strong position in water treatment. WCS provides advanced water treatment solutions, specialized stimulation flow assurance and integrity additives and pre-, during and post-treatment monitoring service in theU.S. As a leading provider of chlorine dioxide generators, proprietary dry scale additives and specialty chemical deployment services in theU.S. , we are now positioned to serve a much larger customer base with multiple water treatment and disinfection service offerings.
Going forward, we may continue to pursue selected, accretive acquisitions of complementary assets, businesses and technologies, and believe we are well positioned to capture attractive opportunities due to our market position, customer and landowner relationships and industry experience and expertise.
Well Chemical Services Acquisition
OnSeptember 30, 2019 , we acquired WCS for$10.0 million , funded with cash on hand. WCS provides advanced water treatment solutions, specialized stimulation flow assurance and integrity additives and post-treatment monitoring service in theU.S. This acquisition expands the Company's service offerings in oilfield water treatment across the full life-cycle of water, from pre-fracturing treatment through reuse and recycling.
Pro Well Acquisition
OnNovember 20, 2018 , we completed our acquisition of the assets of Pro Well for an initial payment of$12.4 million , which was funded with cash on hand. DuringMarch 2019 , upon final settlement, the purchase price was revised to$11.8 million . This acquisition expanded our flowback footprint intoNew Mexico and added new strategic customers. The Pro Well assets acquired included$6.6 million of property, plant and equipment infrastructure that supports current operations. Rockwater Merger
OnNovember 1, 2017 , we completed our merger with Rockwater (the "Rockwater Merger"). Rockwater was a provider of comprehensive water-management solutions to the oil and gas industry in theU.S. andCanada . Rockwater and its subsidiaries provided water sourcing, transfer, testing, monitoring, treatment and storage; site and pit surveys; flowback and well testing; water reuse services; water testing; and fluids logistics. Rockwater also developed and manufactured a full suite of specialty chemicals used in well completions, and production chemicals used to enhance performance over the life of a well. The total consideration for the Rockwater Merger was$620.2 million .
Resource Water Acquisition
OnSeptember 15, 2017 , we completed our acquisition (the "Resource Water Acquisition") ofResource Water Transfer Services, L.P. and certain other affiliated assets (collectively, "Resource Water") for total consideration of$9.0 million . Resource Water provides water transfer services to E&P operators inWest Texas andEast Texas . Resource Water's assets include 24 miles of layflat hose as well as numerous pumps and ancillary equipment required to support water transfer operations. Resource Water has longstanding customer relationships across its operating regions, which are viewed as strategic to our water solutions business. 62 Table of Contents GRR Acquisition
OnMarch 10, 2017 , we completed the GRR Acquisition for total consideration of$59.6 million . The GRR Entities provide water and water-related services to E&P companies in thePermian Basin and own and have rights to a vast array of fresh, brackish and effluent water sources with access to significant volumes of water annually and water transport infrastructure, including over 1,000 miles of temporary and permanent pipeline infrastructure and related storage facilities and pumps, all located in theNorthern Delaware Basin portion of thePermian Basin . Our Segments
Our services are offered through three operating segments: (i) Water Services; (ii) Water Infrastructure; and (iii) Oilfield Chemicals.
Water Services. The Water Services segment consists of the Company's services
businesses including water transfer, flowback and well testing, fluids hauling,
? water containment, water treatment and water network automation, primarily
serving E&P companies. Additionally, this segment includes the operations of
our accommodations and rentals business, which were previously a part of the
former Wellsite Services segment.
Water Infrastructure. The Water Infrastructure segment consists of the
Company's infrastructure assets and ongoing infrastructure development
? projects, including operations associated with our water sourcing and
pipelines, produced water gathering systems and salt water disposal wells,
primarily serving E&P companies.
Oilfield Chemicals. The Oilfield Chemicals segment, operating as Rockwater,
provides technical solutions and expertise related to chemical applications in
the oil and gas industry. We also have significant capabilities in supplying
logistics for chemical applications. Rockwater develops, manufacturers and
provides a full suite of chemicals used in hydraulic fracturing, stimulation,
cementing, production, pipelines and well completions, including polymer
? slurries, crosslinkers, friction reducers, biocides, scale inhibitors corrosion
inhibitors, buffers, breakers and other chemical technologies. Our customer
interaction and expertise is spread along many facets of the industry from well
bore completion, to initial flowback and long-lived production. With the range
of chemicals and application expertise our customers range from pressure
pumpers to major integrated and independent
producers.
Rockwater also utilizes its chemical experience and lab testing capabilities to customize tailored water treatment solutions designed to maximize the effectiveness of and optimize the efficiencies of the fracturing fluid system in conjunction with the quality of water used in well completions. The results of our divested service lines that were previously a part of our former Wellsite Services segment including the operations of our Affirm subsidiary, our sand hauling operations and our Canadian operations are combined in the "Other" category. As ofDecember 31, 2019 , these operations have ceased, and we do not expect regular recurring revenue going forward from this segment.
How We Generate Revenue
We currently generate most of our revenue through our water-management services associated with hydraulic fracturing, provided through our Water Services and Water Infrastructure segments. We generate the majority of our revenue through customer agreements with fixed pricing terms and earn revenue when delivery of services is provided, generally at our customers' sites. While we have some long-term pricing arrangements, particularly in our Water Infrastructure segment, most of our water and water-related services are priced based on prevailing market conditions, giving due consideration to the specific requirements of the customer. 63
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We also generate revenue by providing completion, specialty chemicals and production chemicals through our Oilfield Chemicals segment. We invoice the majority of our Oilfield Chemicals customers for services provided based on the quantity of chemicals used or pursuant to short-term contracts as the customers' needs arise.
Costs of Conducting Our Business
The principal expenses involved in conducting our business are labor costs, equipment costs (including depreciation, repair, rental and maintenance and leasing costs), raw materials and water sourcing costs and fuel costs. Our fixed costs are relatively low. Most of the costs of serving our customers are variable, i.e., they are only incurred when we provide water and water-related services, or chemicals and chemical-related services to our customers. Labor costs associated with our employees and contract labor represent the most significant costs of our business. We incurred labor and labor-related costs of$477.9 million ,$545.0 million and$279.9 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. Our labor costs for the year endedDecember 31, 2017 included$12.5 million of non-recurring costs related to a payout on our phantom equity units and IPO bonuses. The majority of our recurring labor costs are variable and are incurred only while we are providing operational services. We also incur costs to employ personnel to sell and supervise our services and perform maintenance on our assets, which is not directly tied to our level of business activity. Additionally, we incur selling, general and administrative costs for compensation of our administrative personnel at our field sites and in our operational and corporate headquarters. In light of the challenging activity and pricing trends, management has taken direct action during the year endedDecember 31, 2019 to reduce operating and equipment costs, as well as selling, general and administrative costs, in order to proactively manage these expenses as a percentage of revenue. We incur significant equipment costs in connection with the operation of our business, including depreciation, repair and maintenance, rental and leasing costs. We incurred equipment costs of$244.1 million ,$282.5 million and$161.6 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. We incur significant transportation costs, associated with our service lines, including fuel and freight. We incurred fuel and freight costs of$81.3 million ,$97.0 million and$40.2 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively. Fuel prices impact our transportation costs, which affect the pricing and demand for our services and have an impact on our results of operations. We incur raw material costs in manufacturing our chemical products, as well as for water that we source for our customers. We incurred raw material costs of$274.1 million ,$283.2 million and$89.9 million for the years endedDecember 31, 2019 , 2018 and 2017, respectively.
Public Company Costs
General and administrative expenses related to being a publicly traded company include: Exchange Act reporting expenses; expenses associated with compliance with Sarbanes-Oxley; expenses associated with maintaining our listing on the NYSE; incremental independent auditor fees; incremental legal fees; investor relations expenses; registrar and transfer agent fees; incremental director and officer liability insurance costs; and director compensation. We expect that general and administrative expenses related to being a publicly traded company will remain generally consistent with costs incurred during 2019. Costs incurred by us for corporate and other overhead expenses will be reimbursed bySES Holdings pursuant to the SES Holdings LLC Agreement.
How We Evaluate Our Operations
We use a variety of operational and financial metrics to assess our performance. Among other measures, management considers each of the following:
? Revenue; ? Gross Profit; 64 Table of Contents ? Gross Margins; ? EBITDA; and ? Adjusted EBITDA. Revenue We analyze our revenue and assess our performance by comparing actual monthly revenue to our internal projections and across periods. We also assess incremental changes in revenue compared to incremental changes in direct operating costs, and selling, general and administrative expenses across our operating segments to identify potential areas for improvement, as well as to determine whether segments are meeting management's expectations.
Gross Profit
To measure our financial performance, we analyze our gross profit which we define as revenues less direct operating expenses (including depreciation and amortization expenses). We believe gross profit provides insight into profitability and true operating performance of our assets. We also compare gross profit to prior periods and across segments to identify trends as well as underperforming segments. Gross Margins Gross margins provide an important gauge of how effective we are at converting revenue into profits. This metric works in tandem with gross profit to ensure that we do not increase gross profit at the expense of lower margins, nor pursue higher gross margins exclusively at the expense of declining gross profits. We track gross margins by segment and service line, and compare them across prior periods and across segments and service lines to identify trends as well as underperforming segments.
EBITDA and Adjusted EBITDA
We view EBITDA and Adjusted EBITDA as important indicators of performance. We define EBITDA as net income/(loss), plus interest expense, income taxes, and depreciation and amortization. We define Adjusted EBITDA as EBITDA plus/(minus) loss/(income) from discontinued operations, plus any impairment charges or asset write-offs pursuant to GAAP, plus non-cash losses on the sale of assets or subsidiaries, non-recurring compensation expense, non-cash compensation expense, and non-recurring or unusual expenses or charges, including severance expenses, transaction costs, or facilities-related exit and disposal-related expenditures, plus/(minus) foreign currency losses/(gains) and plus any inventory write-downs. The adjustments to EBITDA are generally consistent with such adjustments described in our Credit Facility. See "-Comparison of Non-GAAP Financial Measures" for more information and a reconciliation of EBITDA and Adjusted EBITDA to net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP.
Factors Affecting the Comparability of Our Results of Operations to Our Historical Results of Operations
Our future results of operations may not be comparable to our historical results of operations for the periods presented, primarily for the reasons described below.
Acquisition and Divestiture Activity
As described above, we are continuously evaluating potential investments, particularly in water infrastructure and other water-related services and technology. To the extent we consummate acquisitions, any incremental revenues or expenses from such transactions are not included in our historical results of operations. 65 Table of Contents
Well Chemical Services Acquisition
On
Pro Well Acquisition OnNovember 20, 2018 , we completed our acquisition of the assets of Pro Well. Our historical financial statements for periods prior toNovember 20, 2018 do not include the results of operations of Pro Well.
Rockwater Merger
OnNovember 1, 2017 , we completed the Rockwater Merger whereby we acquired the business, assets and operations of Rockwater. Our historical financial statements for periods prior toNovember 1, 2017 do not include the results
of operations of Rockwater. Resource Water Acquisition
On
GRR Acquisition
On
Affirm Divestitures
We sold the Affirm crane and field services businesses on
Canadian Operations Divestitures
OnMarch 19, 2019 , we sold over half of our Canadian operations and onApril 1, 2019 , we sold and wound down the rest of the Canadian operations. Canadian operations accounted for$8.2 million and$48.6 million of revenue during 2019 and 2018, respectively. Following the divestitures, the divested Canadian operations were not included in the consolidated results of operations.
Sand Hauling Wind Down
During the year endedDecember 31, 2019 , we wound down our sand hauling operations and sold certain of our sand hauling property and equipment. Sand hauling accounted for$3.3 million and$37.0 million of revenue during 2019 and 2018, respectively.
Proceeds received from Divestitures and Wind Down
During the year ended
66 Table of Contents Results of Operations
The following tables set forth our results of operations for the periods presented, including revenue by segment.
Year Ended
Year ended December 31, Change 2019 2018 Dollars Percentage (in thousands) Revenue Water services$ 772,311 $ 896,783 $ (124,472) (13.9) % Water infrastructure 221,593 230,115 (8,522) (3.7) % Oilfield chemicals 268,614 259,791 8,823 3.4 % Other 29,071 142,241 (113,170) (79.6) % Total revenue 1,291,589 1,528,930 (237,341) (15.5) % Costs of revenue Water services 598,405 681,546 (83,141) (12.2) % Water infrastructure 166,962 160,072 6,890 4.3 % Oilfield chemicals 230,434 233,454 (3,020) (1.3) % Other 30,239 124,839 (94,600) (75.8) % Depreciation and amortization 116,809 130,537 (13,728) (10.5) % Total costs of revenue 1,142,849 1,330,448 (187,599) (14.1) % Gross profit 148,740 198,482 (49,742) (25.1) % Operating expenses
Selling, general and administrative 111,622 103,156
8,466 8.2 % Depreciation and amortization 3,860 3,176 684 21.5 % Impairment of goodwill 4,396 17,894 (13,498) NM
Impairment of property and equipment 3,715 6,657 (2,942) NM Impairment of cost-method investment - 2,000
(2,000) NM Lease abandonment costs 2,073 3,925 (1,852) (47.2) % Total operating expenses 125,666 136,808 (11,142) (8.1) % Income from operations 23,074 61,674 (38,600) (62.6) % Other income (expense) (Losses) gains on sales of property and equipment and divestitures, net (11,626) 3,804 (15,430) NM Interest expense, net (2,688) (5,311) 2,623 (49.4) % Foreign currency gain (loss), net 273 (1,292) 1,565 NM Other expense, net (2,948) (2,872) (76) NM Income before income tax expense 6,085 56,003
(49,918) (89.1) % Income tax expense (1,949) (1,704) (245) NM Net income$ 4,136 $ 54,299 $ (50,163) (92.4) % 67 Table of Contents Revenue Our revenue decreased$237.3 million , or 15.5%, to$1.3 billion for the year endedDecember 31, 2019 compared to$1.5 billion for the year endedDecember 31, 2018 . The decrease was primarily due to$124.5 million lower Water Services revenue and$8.5 million lower Water Infrastructure revenue, partially offset by$8.8 million higher Oilfield Chemicals revenue discussed below. Also impacting the change was$113.2 million lower revenue from the combined total of our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were fully divested and wound down during 2019. For the year endedDecember 31, 2019 , our Water Services, Water Infrastructure, Oilfield Chemicals and Other segments constituted 59.8%, 17.2%, 20.8% and 2.2% of our total revenue, respectively, compared to 58.7%, 15.0%, 17.0% and 9.3%, respectively, for the year endedDecember 31, 2018 . The revenue change by operating segment was as follows: Water Services. Revenue decreased$124.5 million , or 13.9%, to$772.3 million for the year endedDecember 31, 2019 compared to$896.8 million for the year endedDecember 31, 2018 . The decrease was primarily due to lower water transfer, fluids hauling, and flowback and well testing revenues attributable to reduced drilling and completions activity and pricing pressure. Water Infrastructure. Revenue decreased by$8.5 million , or 3.7%, to$221.6 million for the year endedDecember 31, 2019 compared to$230.1 million for the year endedDecember 31, 2018 primarily due to reduced activity on our Bakken pipeline system including non-pipeline related water sales and logistics, partially offset by increases in revenue from ourNew Mexico pipeline system. Oilfield Chemicals. Revenue increased$8.8 million , or 3.4%, to$268.6 million for the year endedDecember 31, 2019 compared to$259.8 million for the year endedDecember 31, 2018 , primarily due to three months of revenue from the WCS Acquisition. Also impacting the change were small increases in completion chemicals revenue, partially offset by small decreases in production chemicals revenue. Other. Other revenue decreased$113.2 million , or 79.6%, to$29.1 million for the year endedDecember 31, 2019 compared to$142.2 million for the year endedDecember 31, 2018 as our Affirm subsidiary, sand hauling operations and Canadian operations were divested and wound down during 2019.
Costs of Revenue
Costs of revenue decreased$187.6 million , or 14.1%, to$1.1 billion for the year endedDecember 31, 2019 compared to$1.3 billion for the year endedDecember 31, 2018 . The decrease was primarily due to$94.6 million lower costs from the combination of our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were divested and wound down during 2019. Also impacting the decrease was$83.1 million lower Water Services costs, primarily due to aligning our cost structure to lower activity levels, further discussed below. Water Services. Costs of revenue decreased$83.1 million , or 12.2%, to$598.4 million for the year endedDecember 31, 2019 compared to$681.5 million for the year endedDecember 31, 2018 . The decrease was primarily driven by reduced drilling and completions activity levels. Cost of revenue as a percent of revenue increased from 76.0% to 77.5% due to pricing pressures we could not fully offset with cost reductions. Water Infrastructure. Costs of revenue increased$6.9 million , or 4.3%, to$167.0 million for the year endedDecember 31, 2019 compared to$160.1 million for the year endedDecember 31, 2018 . Cost of revenue as a percent of revenue increased from 69.6% to 75.3% primarily due to a decline in contribution from our high-margin Bakken pipeline system, resulting in a shift to lower margin services. Oilfield Chemicals. Costs of revenue decreased$3.0 million , or 1.3%, to$230.4 million for the year endedDecember 31, 2019 compared to$233.5 million for the year endedDecember 31, 2018 . Cost of revenue as a percent of revenue decreased from 89.9% to 85.8% due primarily to freight cost-savings from ourMidland, Texas plant, improved inventory management and increased sales of higher-margin friction reducer products. 68
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Other. Other costs decreased
Depreciation and Amortization. Depreciation and amortization expense decreased$13.7 million , or 10.5%, to$116.8 million for the year endedDecember 31, 2019 compared to$130.5 million for the year endedDecember 31, 2018 primarily due to the divestitures discussed above.
Gross Profit
Gross profit decreased by$49.7 million , to a gross profit of$148.7 million for the year endedDecember 31, 2019 compared to a gross profit of$198.5 million for the year endedDecember 31, 2018 primarily due to$41.3 million lower gross profit from Water Services and$15.4 million lower gross profit from Water Infrastructure due to factors discussed above. Also impacting the decrease was$18.6 million lower gross profit from the combined total of our Affirm subsidiary, sand hauling operations and Canadian operations, all of which were divested and wound down during 2019. These were partially offset by$11.8 million higher gross profit from Oilfield Chemicals and$13.7 million lower depreciation costs discussed above. Gross margin as a percent of revenue decreased 1.5% to 11.5% during the year endedDecember 31, 2019 , from 13.0% during the year endedDecember 31, 2018 .
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased$8.5 million , or 8.2%, to$111.6 million for the year endedDecember 31, 2019 compared to$103.2 million for the year endedDecember 31, 2018 . This was primarily due to a$5.1 million increase in non-cash equity incentive plan expenses as the incentive plan initiated in 2018 provides for a three year vesting period and there were more grants outstanding in 2019 than 2018. Also impacting the increase were increased costs associated with our recent divestitures, including severance expenses, professional fees and other transaction costs.
Impairment
During the year endedDecember 31, 2019 , we incurred$4.4 million of goodwill impairment in connection with divesting Affirm. Additionally, we incurred$3.7 million of impairment of property and equipment, primarily comprised of$1.1 million of pipelines with low utilization,$1.0 million of layflat hose considered obsolete,$0.9 million related to divesting Canadian fixed assets, and$0.6 million related to an owned facility for sale. During the year endedDecember 31, 2018 , we determined that$12.7 million of goodwill in our Oilfield Chemicals segment and$5.2 million of goodwill related to our Affirm subsidiary were impaired as the estimated fair values were not adequate to fully cover the associated carrying values. Additionally, we incurred a$2.0 million impairment to write down most of our basis in our cost-method investee. Further, we incurred$6.7 million of impairment of property and equipment comprised of$4.4 million of Canadian fixed asset write-downs due to an expectation of loss on asset disposals as well as$2.3 million of impairment of machinery and equipment in poor condition in our Water Infrastructure segment. Lease Abandonment Costs Lease abandonment costs were$2.1 million and$3.9 million for the years endedDecember 31, 2019 and 2018, respectively. Costs incurred in 2019 were comprised of Canadian lease terminations in connection with divesting and winding down Canadian and Affirm operations, two facility lease abandonments and accretion of expenses for previously abandoned facilities. Costs incurred during 2018 were primarily due to excess facility capacity stemming from the Rockwater Merger.
Net Interest Expense
Net interest expense decreased by$2.6 million , or 49.4%, to$2.7 million during the year endedDecember 31, 2019 compared to$5.3 million for the year endedDecember 31, 2018 , primarily due to lower average borrowings resulting from the repayment of all remaining borrowings on our credit facility since December
31, 2018. 69 Table of Contents Net Income Net income decreased by$50.2 million , or 92.4%, to net income of$4.1 million for the year endedDecember 31, 2019 compared to net income of$54.3 million for the year endedDecember 31, 2018 primarily due to$49.7 million lower gross profit stemming from lower revenue and divestitures discussed above,$15.4 million higher net losses on sales of property and equipment, largely related to the recent divestitures, and$8.5 million higher selling, general and administrative costs discussed above, partially offset by$18.4 million lower impairment costs,$2.6 million lower interest expense and$1.9 million lower lease abandonment costs discussed above.
Year Ended
Year ended December 31, Change 2018 2017 Dollars Percentage (in thousands) Revenue Water services$ 896,783 $ 418,869 $ 477,914 114.1 % Water infrastructure 230,115 163,328 66,787 40.9 % Oilfield chemicals 259,791 41,586 218,205 524.7 % Other 142,241 68,708 73,533 107.0 % Total revenue 1,528,930 692,491 836,439 120.8 % Costs of revenue Water services 681,546 317,262 364,284 114.8 % Water infrastructure 160,072 120,510 39,562 32.8 % Oilfield chemicals 233,454 37,024 196,430 530.5 % Other 124,839 58,270 66,569 114.2 % Depreciation and amortization 130,537 101,645 28,892 28.4 % Total costs of revenue 1,330,448 634,711 695,737 109.6 % Gross profit 198,482 57,780 140,702 243.5 % Operating expenses
Selling, general and administrative 103,156 82,403
20,753 25.2 % Depreciation and amortization 3,176 1,804 1,372 76.1 % Impairment of goodwill 17,894 - 17,894 NM
Impairment of property and equipment 6,657 - 6,657 NM Impairment of cost-method investment 2,000 -
2,000 NM Lease abandonment costs 3,925 3,572 353 9.9 % Total operating expenses 136,808 87,779 49,029 55.9 % Income from operations 61,674 (29,999) 91,673 305.6 % Other income (expense) Gains on sales of property and equipment, net 3,804 2,726 1,078 NM Interest expense, net (5,311) (6,629) 1,318 (19.9) % Foreign currency (loss) gain, net (1,292) 281 (1,573) NM Other expense, net (2,872) (2,357) (515) NM Income (loss) before income tax expense 56,003 (35,978)
91,981 255.7 % Income tax (expense) benefit (1,704) 851 (2,555) NM Net income (loss)$ 54,299 $ (35,127) $ 89,426 254.6 % Revenue Our revenue increased$836.4 million , or 120.8%, to$1.5 billion for the year endedDecember 31, 2018 compared to$692.5 million for the year endedDecember 31, 2017 . The increase was driven by a$477.9 million increase in our Water Services revenue, a$66.8 million increase in our Water Infrastructure revenue, a$218.2 million increase in our Oilfield Chemicals revenue and a$73.5 million increase in our Other segment revenue. For the year ended 70
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December 31, 2018 , our Water Services, Water Infrastructure, Oilfield Chemicals and Other segments constituted 58.7%, 15.0%, 17.0% and 9.3% of our total revenue, respectively, compared to 60.5%, 23.6%, 6.0% and 9.9%, respectively, for the year endedDecember 31, 2017 . The revenue increase by operating segment was as follows: Water Services. Revenue increased$477.9 million , or 114.1%, to$896.8 million for the year endedDecember 31, 2018 compared to$418.9 million for the year endedDecember 31, 2017 . The increase was primarily attributable to the Rockwater Merger as well as an increase in the demand for our services as a result of a rise in well completion count of 25.4% and an increase in the twelve month averageU.S. land rig count of 18.4% during the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . Water Infrastructure. Revenue increased$66.8 million , or 40.9%, to$230.1 million for the year endedDecember 31, 2018 compared to$163.3 million for the year endedDecember 31, 2017 . The increase was primarily attributable to the Rockwater Merger as well as an increase in the demand for our services as a result of a rise in well completion count of 25.4% and an increase in the twelve month averageU.S. land rig count of 18.4% during the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . Oilfield Chemicals. Revenue from our Oilfield Chemicals segment of$259.8 million relates entirely to ourRockwater LLC operations acquired onNovember 1, 2017 . Revenue increased$218.2 million , or 524.7%, to$259.8 million for the year endedDecember 31, 2018 compared to$41.6 million for the year endedDecember 31, 2017 , primarily due to a full year of operations in 2018 versus two months of operations in 2017. Costs of Revenue Costs of revenue increased$695.7 million , or 109.6%, to$1.3 billion for the year endedDecember 31, 2018 compared to$634.7 million for the year endedDecember 31, 2017 . The increase was largely attributable to the Rockwater Merger, higher labor costs due to an increase in employee headcount and outside services and higher rentals and materials expense as a result of increased demand for our services due to the overall increase in drilling, completion and production activities. The cost of revenue increase by operating segment was as follows: Water Services. Costs of revenue increased$364.3 million , or 114.8%, to$681.5 million for the year endedDecember 31, 2018 compared to$317.3 million for the year endedDecember 31, 2017 . The increase was primarily due to a full year of Rockwater operations in 2018 versus two months of operations in 2017 as well as organic growth revenue due to higher demand for our services. Water Infrastructure. Costs of revenue increased$39.6 million , or 32.8%, to$160.1 million for the year endedDecember 31, 2018 compared to$120.5 million for the year endedDecember 31, 2017 . The increase was primarily due to a full year of Rockwater operations in 2018 versus two months of operations in 2017 as well as organic growth due to higher demand for our services. Oilfield Chemicals. Costs of revenue from our Oilfield Chemicals segment relates entirely to ourRockwater LLC operations acquired onNovember 1, 2017 . Costs of revenue increased$196.4 million , or 530.5%, to$233.5 million for the year endedDecember 31, 2018 compared to$37.0 million for the year endedDecember 31, 2017 , primarily due to a full year of operations in 2018 versus two months of operations in 2017. These costs primarily related to an increase in raw material costs incurred in manufacturing our chemical products. Depreciation and Amortization. Depreciation and amortization expense increased$28.9 million , or 28.4%, to$130.5 million for the year endedDecember 31, 2018 compared to$101.6 million for the year endedDecember 31, 2017 . The increase was primarily attributable to additional depreciation from assets acquired in the Rockwater Merger, which closed onNovember 1, 2017 .
Gross Profit
Gross profit increased by$140.7 million , to a gross profit of$198.5 million for the year endedDecember 31, 2018 compared to a gross profit of$57.8 million for the year endedDecember 31, 2017 as a result of factors described above. Gross profit as a percent of revenue increased 4.7% to 13.0% during the year endedDecember 31, 2018 , from 71 Table of Contents 8.3% during the year endedDecember 31, 2017 . The increase was primarily driven by lower depreciation expense as a percentage of revenues, impacted by higher utilization of fixed assets, and longer useful lives and increased salvage value estimates on certain fixed assets. Additionally, operational improvements and cost synergies achieved through the Rockwater Merger integration also contributed towards the improvement in gross profit. This was partially offset by the impact from a larger portion of consolidated revenue coming from the lower margin chemicals segment acquired in the Rockwater Merger.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased$20.8 million , or 25.2%, to$103.2 million for the year endedDecember 31, 2018 compared to$82.4 million for the year endedDecember 31, 2017 . The year endedDecember 31, 2017 included one-time charges of$12.5 million related to payouts on our phantom equity units and IPO bonuses. Excluding these one-time charges incurred during the year endedDecember 31, 2017 , selling, general and administrative expenses increased$33.3 million , or 47.6% for the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . This overall increase was primarily related to the Rockwater Merger and GRR Acquisition, which significantly increased our size. Trailing deal costs stemming from the Rockwater Merger and other acquisitions, as well as incremental costs to support our new status as a public company, also contributed to the increase.
Impairment
During the year endedDecember 31, 2018 , we determined that$12.7 million of goodwill in our Oilfield Chemicals segment and$5.2 million of goodwill related to our Affirm subsidiary in our Other segment were impaired as the estimated fair values were not adequate to fully cover the associated carrying values. Additionally, we determined that most of our basis in our cost-method investee was no longer fully recoverable, and as such, it was written down to its estimated fair value of$0.5 million . The impairment expense of$2.0 million is included in impairment of investment within the consolidated statements of operations. Additionally, during the year endedDecember 31, 2018 , the Company reviewed certain fluid disposal machinery and equipment used in our fluid hauling and disposal services that are included in our Water Infrastructure segment. Due to the condition of the equipment, the Company determined that long-lived assets with a carrying value of$2.3 million were no longer recoverable, so we recorded$2.3 million of impairment expense to write off these fixed assets. Finally, we determined that$4.4 million of Canadian fixed assets were impaired due to an expectation of loss on asset disposals. There was no impairment expense incurred during the year endedDecember 31, 2017 .
Lease Abandonment Costs
In conjunction with the Rockwater Merger, we decided to close certain facilities that were deemed duplicative of our existing operational locations. As a result of costs related to certain facilities that are no longer in use, we recorded$3.9 million of lease abandonment costs during the year endedDecember 31, 2018 , approximately$2.2 million of which are directly attributable to the Rockwater Merger, as compared to$3.6 million of lease abandonment costs during the year endedDecember 31, 2017 . Net Interest Expense Net interest expense decreased by$1.3 million , or 19.9%, to$5.3 million during the year endedDecember 31, 2018 compared to$6.6 million for the year endedDecember 31, 2017 , due to paying down debt in 2018.
Net Income (Loss)
Net income of$54.3 million represented an increase of$89.4 million , or 254.6%, for the year endedDecember 31, 2018 compared to a net loss of$35.1 million for the year endedDecember 31, 2017 largely as a result of the factors described above.
Comparison of Non-GAAP Financial Measures
We view EBITDA and Adjusted EBITDA as important indicators of performance. We define EBITDA as net income (loss), plus interest expense, income taxes, and depreciation and amortization. We define Adjusted EBITDA, as 72
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EBITDA plus/(minus) loss/(income) from discontinued operations, plus any impairment charges or asset write-offs pursuant to GAAP, plus non-cash losses on the sale of assets or subsidiaries (excluding cash gains), non-recurring compensation expense, non-cash compensation expense, and non-recurring or unusual expenses or charges, including severance expenses, transaction costs, or facilities-related exit and disposal-related expenditures, plus/(minus) foreign currency losses/(gains) and plus any inventory write-downs. The adjustments to EBITDA are generally consistent with such adjustments described in our Credit Facility. See "-Note Regarding Non-GAAP Financial Measures-EBITDA and Adjusted EBITDA" for more information and a reconciliation of EBITDA and Adjusted EBITDA to net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP. Our board of directors, management and investors use EBITDA and Adjusted EBITDA to assess our financial performance because it allows them to compare our operating performance on a consistent basis across periods by removing the effects of our capital structure (such as varying levels of interest expense), asset base (such as depreciation and amortization) and items outside the control of our management team. We present EBITDA and Adjusted EBITDA because we believe they provide useful information regarding the factors and trends affecting our business in addition to measures calculated under GAAP.
Note Regarding Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA are not financial measures presented in accordance with GAAP. We believe that the presentation of these non-GAAP financial measures will provide useful information to investors in assessing our financial performance and results of operations. Net income is the GAAP measure most directly comparable to EBITDA and Adjusted EBITDA. Our non-GAAP financial measures should not be considered as alternatives to the most directly comparable GAAP financial measure. Each of these non-GAAP financial measures has important limitations as an analytical tool due to exclusion of some but not all items that affect the most directly comparable GAAP financial measures. You should not consider EBITDA or Adjusted EBITDA in isolation or as substitutes for an analysis of our results as reported under GAAP. Because EBITDA and Adjusted EBITDA may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility. For further discussion, please see "Item 6. Selected Financial Data." The following tables present a reconciliation of EBITDA and Adjusted EBITDA to our net income (loss), which is the most directly comparable GAAP measure for the periods presented: Year Ended December 31, 2019 2018 2017 (in thousands) Net income (loss)$ 4,136 $ 54,299 $ (35,127) Interest expense, net 2,688 5,311 6,629 Income tax expense 1,949 1,704 (851) Depreciation and amortization 120,669 133,713 103,449 EBITDA 129,442 195,027 74,100 Impairment of goodwill 4,396 17,894 -
Impairment of property and equipment 3,715 6,657
-
Impairment of cost-method investment - 2,000
-
Lease abandonment costs 2,073 3,925
3,572
Non-recurring severance expenses(1) 1,691 1,220
4,161
Non-recurring transaction costs(2) 4,697 7,809
10,179
Non-cash compensation expenses 15,485 10,371
7,691
Non-cash loss on sale of assets or subsidiaries(3) 21,679 3,775
1,740
Non-recurring phantom equity and IPO-related compensation - -
12,537
Foreign currency (gain) loss, net (273) 1,292
(281)
Inventory write-down 75 442
-
Non-recurring change in vacation policy(4) - 2,894
- Other non-recurring charges (248) 4,313 3,563 Adjusted EBITDA$ 182,732 $ 257,619 $ 117,262 73 Table of Contents
For 2019, these costs were due to severance payments in connection with the
dissolution of our former Wellsite Services segment. For 2018, these costs (1) are associated with severance incurred in connection with the retirement of
our former Chief Administrative Officer as well as the termination of certain
Canadian employees.
For 2019, these costs primarily related to the divestiture and wind down of
our Affirm subsidiary and the sand hauling and Canadian operations, as well (2) as rebranding Pro Well and our Fluids Hauling business, and additional
accruals relating to certain matters discussed in Item 3 - Legal Proceedings.
For 2018, these costs are primarily related to the Rockwater Merger.
For 2019, these costs primarily related to losses on divestitures and related
sales of property and equipment in connection with the wind down of the (3) former Wellsite Services segment, and losses from sales of property and
equipment in the normal course of business. For 2018 and 2017, losses were in
connection with sales of property and equipment.
(4) For 2018, these costs represent a one-time accrual to allow for carryover of
unused vacation. Previously, any unused vacation was forfeited at year-end.
EBITDA was$129.4 million for the year endedDecember 31, 2019 compared to$195.0 million for the year endedDecember 31, 2018 . Adjusted EBITDA was$182.7 million for the year endedDecember 31, 2019 compared to$257.6 million for the year endedDecember 31, 2018 . The decreases in EBITDA and Adjusted EBITDA resulted from a decrease in our revenues and gross profit, as discussed above. EBITDA was$195.0 million for the year endedDecember 31, 2018 compared to$74.1 million for the year endedDecember 31, 2017 . Adjusted EBITDA was$257.6 million for the year endedDecember 31, 2018 compared to$117.3 million for the year endedDecember 31, 2017 . The increases in EBITDA and Adjusted EBITDA resulted from an increase in our revenues and gross profit, as discussed above.
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash on hand and borrowing capacity under our current Credit Agreement and cash flows from operations. Our primary uses of capital have been to maintain our asset base, implement technological advancements, make capital expenditures to support organic growth, fund acquisitions, and when appropriate, repurchase shares of Class A common stock in the open market. Depending on market conditions and other factors, we may also issue debt and equity securities if needed. As ofDecember 31, 2019 , we had no outstanding bank debt and a positive net cash position. We prioritize sustained positive free cash flow and a strong balance sheet, and evaluate potential acquisitions and investments in the context of those priorities, in addition to the economics of the opportunity. We believe this approach provides us with additional flexibility to evaluate larger investments as well as improved resilience in a sustained downturn versus many of our peers. We intend to finance most of our capital expenditures, contractual obligations and working capital needs with cash generated from operations and borrowings under our Credit Agreement. For a discussion of the Credit Agreement, see "-Credit Agreement" below. Although we cannot provide any assurance, we believe that our operating cash flow and available borrowings under our Credit Agreement will be sufficient to fund our operations for at least the next twelve months. As ofDecember 31, 2019 , cash and cash equivalents totaled$79.3 million and we had approximately$194.7 million of available borrowing capacity under our Credit Agreement. As ofDecember 31, 2019 , the borrowing base under the Credit Agreement was$214.6 million , and we had no outstanding borrowings and outstanding letters of credit of$19.9 million . As ofFebruary 24, 2020 , we had no outstanding borrowings, the borrowing base under the Credit 74
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Agreement was
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Cash Flow Changes Between the Years Ended
Percentage Year Ended December 31, Dollar Change Change 2019 2018 (in thousands)
Net cash provided by operating activities $
203,948
(77,357) (168,361) 91,004 54.1 % Net cash used in financing activities (64,690) (49,293) (15,397) (31.2) % Subtotal$ 61,901 $ 14,755 Effect of exchange rate changes on cash and cash equivalents 130 (292) 422 NM Net increase in cash and cash equivalents $
62,031$ 14,463 Operating Activities. Net cash provided by operating activities was$203.9 million for the year endedDecember 31, 2019 , compared to net cash provided by operating activities of$232.4 million for the year endedDecember 31, 2018 . The$28.5 million decrease in net cash provided by operating activities was primarily attributable to a decrease in net income adjusted for non-cash charges including impairments and decreases in working capital during the year endedDecember 31, 2019 . These changes are primarily the result of decreased demand for our services. Investing Activities. Net cash used in investing activities was$77.4 million for the year endedDecember 31, 2019 , compared to$168.4 million for the year endedDecember 31, 2018 . The$91.0 million decrease in net cash used in investing activities was primarily due to a$55.2 million reduction in purchases of property and equipment, a$28.1 million increase of proceeds primarily related to the divestiture and wind down of our Affirm subsidiary and the sand hauling and Canadian operations and a$7.7 million reduction in acquisitions, net of cash acquired and working capital receipts. Financing Activities. Net cash used in financing activities was$64.7 million for the year endedDecember 31, 2019 , compared to net cash used in financing activities of$49.3 million for the year endedDecember 31, 2018 . The$15.4 million increase in net cash used in financing activities was primarily due to a$15.0 million increase in net debt repayments as well as a$2.0 million increase in repurchases of shares of Class A common stock during the year endedDecember 31, 2019 .
Cash Flow Changes Between the Years Ended
Percentage Year Ended December 31, Dollar Change Change 2018 2017 (in thousands)
Net cash provided by (used in) operating activities $
232,409
(168,361) (156,731) (11,630) (7.4) % Net cash (used in) provided by financing activities (49,293) 122,397 (171,690) (140.3) % Subtotal$ 14,755 $ (37,233) Effect of exchange rate changes on cash and cash equivalents (292) (34) (258) NM Net increase (decrease) in cash $
14,463$ (37,267) Operating Activities. Net cash provided by operating activities was$232.4 million for the year endedDecember 31, 2018 , compared to net cash used in operating activities of$2.9 million for the year endedDecember 31, 2017 . The$235.3 million increase in net cash provided by operating activities related primarily to increased net income 75
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adjusted for noncash items which was driven by a significant growth in revenue and improvement in gross margins resulting from recovering demand for our services as compared to the prior year period, improved working capital management, and a full year of contributions from the 2017 acquisitions.
Investing Activities. Net cash used in investing activities was$168.4 million for the year endedDecember 31, 2018 , compared to$156.7 million for the year endedDecember 31, 2017 . The$11.6 million increase in net cash used in investing activities was primarily due to an increase in cash used for capital expenditures of$66.6 million during the year endedDecember 31, 2018 to support the increased scale of operations following the Rockwater Merger which occurred onNovember 1, 2017 , partially offset by the$48.5 million decrease in cash used for acquisitions, primarily related to the GRR Acquisition inMarch 10, 2017 . Financing Activities. Net cash used in financing activities was$49.3 million for the year endedDecember 31, 2018 , compared to cash provided by financing activities of$122.4 million for the year endedDecember 31, 2017 . The$171.7 million increase in net cash used in financing activities was primarily due to the non-recurring nature of the$128.5 million in net proceeds received from the issuance of shares in our IPO onApril 26, 2017 , including the exercise of the over-allotment option, coupled with a net$28.0 million increase in net debt repayments of long-term debt during 2018. Also, impacting the increase in net cash used in financing activities was$15.7 million of common stock repurchases during the fourth quarter of 2018 related to our share repurchase program. Credit Agreement
OnNovember 1, 2017 , in connection with the closing of the Rockwater Merger (the "Closing"),SES Holdings andSelect LLC , entered into a$300.0 million senior secured revolving credit facility (the "Credit Agreement"), by and amongSES Holdings , as parent,Select LLC , as borrower, certain ofSES Holdings' subsidiaries, as guarantors, each of the lenders party thereto andWells Fargo Bank, N.A ., as administrative agent, issuing lender and swingline lender (the "Administrative Agent"). The Credit Agreement also has a sublimit of$40.0 million for letters of credit and a sublimit of$30.0 million for swingline loans. Subject to obtaining commitments from existing or new lenders, we have the option to increase the maximum amount under the Credit Agreement by$150.0 million during the first three years following the Closing.
The maturity date of the Credit Agreement is the earlier of (a)
The Credit Agreement permits extensions of credit up to the lesser of$300.0 million and a borrowing base that is determined by calculating the amount equal to the sum of (i) 85.0% of the Eligible Billed Receivables (as defined in the Credit Agreement), plus (ii) 75.0% of Eligible Unbilled Receivables (as defined in the Credit Agreement), provided that this amount will not equal more than 35.0% of the borrowing base, plus (iii) the lesser of (A) the product of 70.0% multiplied by the value of Eligible Inventory (as defined in the Credit Agreement) at such time and (B) the product of 85.0% multiplied by the Net Recovery Percentage (as defined in the Credit Agreement) identified in the most recent Acceptable Appraisal of Inventory (as defined in the Credit Agreement), multiplied by the value of Eligible Inventory at such time, provided that this amount will not equal more than 30.0% of the borrowing base, minus (iv) the aggregate amount of Reserves (as defined in the Credit Agreement), if any, established by the Administrative Agent from time to time, including, if any, the amount of the Dilution Reserve (as defined in the Credit Agreement). The borrowing base is calculated on a monthly basis pursuant to a borrowing base certificate delivered bySelect LLC to the Administrative Agent. Borrowings under the Credit Agreement bear interest, atSelect LLC's election, at either the (a) one-, two-, three- or six-month LIBOR ("Eurocurrency Rate") or (b) the greatest of (i) the federal funds rate plus 0.5%, (ii) the one-month Eurocurrency Rate plus 1.0% and (iii) the Administrative Agent's prime rate (the "Base Rate"), in each case plus an applicable margin, and interest shall be payable monthly in arrears. The applicable margin for Eurocurrency Rate loans ranges from 1.50% to 2.00% and the applicable margin for Base Rate loans ranges from 0.50% to 1.00%, in each case, depending onSelect LLC's average excess availability under the Credit Agreement. During the continuance of a bankruptcy event of default, automatically and during the continuance of any other default, upon the Administrative 76 Table of Contents
Agent's or the required lenders' election, all outstanding amounts under the Credit Agreement will bear interest at 2.00% plus the otherwise applicable interest rate.
The obligations under the Credit Agreement are guaranteed bySES Holdings and certain subsidiaries ofSES Holdings andSelect LLC and secured by a security interest in substantially all of the personal property assets ofSES Holdings ,Select LLC and their domestic subsidiaries. The Credit Agreement contains certain customary representations and warranties, affirmative and negative covenants and events of default. If an event of default occurs and is continuing, the lenders may declare all amounts outstanding under the Credit Agreement to be immediately due and payable. In addition, the Credit Agreement restrictsSES Holdings' and Select LLC's ability to make distributions on, or redeem or repurchase, its equity interests, except for certain distributions, including distributions of cash so long as, both at the time of the distribution and after giving effect to the distribution, no default exists under the Credit Agreement and either (a) excess availability at all times during the preceding 30 consecutive days, on a pro forma basis and after giving effect to such distribution, is not less than the greater of (1) 25.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (2)$37.5 million or (b) ifSES Holdings' fixed charge coverage ratio is at least 1.0 to 1.0 on a pro forma basis, and excess availability at all times during the preceding 30 consecutive days, on a pro forma basis and after giving effect to such distribution, is not less than the greater of (1) 20.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (2)$30.0 million . Additionally, the Credit Agreement generally permitsSelect LLC to make distributions to allowSelect Inc. to make payments required under the existing Tax Receivable Agreements. The Credit Agreement also requiresSES Holdings to maintain a fixed charge coverage ratio of at least 1.0 to 1.0 at any time availability under the Credit Agreement is less than the greater of (i) 10.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (ii)$15.0 million and continuing through and including the first day after such time that availability under the Credit Agreement has equaled or exceeded the greater of (i) 10.0% of the lesser of (A) the maximum revolver amount and (B) the then-effective borrowing base and (ii)$15.0 million for 60 consecutive calendar days.
We were in compliance with all debt covenants as of
Off-Balance Sheet Arrangements
At
Contractual Obligations
The table below provides estimates of the timing of future payments that we are
obligated to make based on agreements in place at
Payments Due by Period More than Contractual Obligations Year 1 Years 2-3 Years 4-5 5 years Total (in thousands) Estimated interest payments$ 1,478 $ 2,710 $ - $ -$ 4,188 Operating lease obligations 24,742 29,823 21,663 44,094 120,322 Finance lease obligations 135 88
- - 223 Total$ 26,355 $ 32,621 $ 21,663 $ 44,094 $ 124,733 77 Table of Contents Tax Receivable Agreements We intend to fund any obligation under the Tax Receivable Agreements with cash from operations or borrowings under our Credit Agreement. With respect to obligations under each of our Tax Receivable Agreements (except in cases where we elect to terminate the Tax Receivable Agreements early, the Tax Receivable Agreements are terminated early due to certain mergers or other changes of control or we have available cash but fail to make payments when due), generally we may elect to defer payments due under the Tax Receivable Agreements if we do not have available cash to satisfy our payment obligations under the Tax Receivable Agreements or if our contractual obligations limit our ability to make these payments. Any such deferred payments under the Tax Receivable Agreements generally will accrue interest. OnJuly 18, 2017 , our board of directors approved amendments to each of the Tax Receivable Agreements, which amendments revised the definition of "change of control" for purposes of the Tax Receivable Agreements and acknowledged that the Rockwater Merger would not result in a change of control. We intend to account for any amounts payable under the Tax Receivable Agreements in accordance with Accounting Standards Codification ("ASC") Topic 450, Contingent Consideration. For further discussion regarding such an acceleration and its potential impact, please read "Item 1A. Risk Factors-Risks Related to Our Organizational Structure-In certain cases, payments under the Tax Receivable Agreements may be accelerated and/or significantly exceed the actual benefits, if any, we realize in respect of the tax attributes subject to the Tax Receivable Agreements." We completed an initial assessment of the amount of any liability under the Tax Receivable Agreements required under the provisions of ASC 450 in connection with preparing the Selected Consolidated Financial Statements. We determined that there was no resulting liability related to the Tax Receivable Agreements arising from the corporate reorganization and related transactions completed in connection with the Select 144A Offering as the associated deferred tax assets are fully offset by a valuation allowance. The corporate reorganization represented a reorganization of entities under common control transaction that is recorded based on the historical carrying amounts of affected assets and liabilities in accordance with ASC 805-50, Business Combinations-Related Issues. Under that guidance, any difference between consideration paid (in this case, the liability under the Tax Receivable Agreements) and the carrying amount of the assets and liabilities received is recognized within equity. The initial liability will be adjusted at each reporting date through charges or credits in the consolidated statements of operations. We concluded that accounting by analogy to the accounting treatment specified in ASC 740-20-45-11(g) for subsequent changes in a valuation allowance established against deferred tax assets that arose due to a change in tax basis in connection with a transaction with stockholders, which is recorded in the consolidated statements of operations. We believe that analogy is appropriate given the direct relationship between the amount of any estimated tax savings to be realized and the recognition and measurement of the liability under the Tax Receivable Agreements.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures about any contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our critical accounting policies are described below to provide a better understanding of how we develop our assumptions and judgments about future events and related estimations and how they can impact our financial statements. The following accounting policies involve critical accounting estimates because they are dependent on our judgment and assumptions about matters that are inherently uncertain. We base our estimates on historical experience and on various other assumptions we believe to be reasonable according to the current facts and circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions about future events and their effects are subject to uncertainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained, and as the business environment in which we operate changes. We believe the current assumptions, judgments and estimates used to determine amounts reflected in our consolidated financial statements are appropriate, however, actual results may differ under different conditions. 78
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This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report.
Goodwill and other intangible assets: The purchase price of acquired businesses is allocated to its identifiable assets and liabilities based upon estimated fair values as of the acquisition date.Goodwill and other intangible assets are initially recorded at their fair values.Goodwill represents the excess of the purchase price of acquisitions over the fair value of the net assets acquired in a business combination. Our goodwill atDecember 31, 2019 and 2018, totaled$266.9 million and$273.8 million , respectively.Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Intangible assets with finite useful lives are amortized either on a straight-line basis over the asset's estimated useful life or on a basis that reflects the pattern in which the economic benefits of the intangible assets are realized. Impairment of goodwill, long-lived assets and intangible assets: Long-lived assets, such as property and equipment and finite-lived intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Recoverability is measured by a comparison of their carrying amount to the estimated undiscounted cash flows to be generated by those assets. If the undiscounted cash flows are less than the carrying amount, we record impairment losses for the excess of their carrying value over the estimated fair value. Fair value is determined, in part, by the estimated cash flows to be generated by those assets. Our cash flow estimates are based upon, among other things, historical results adjusted to reflect our best estimate of future market rates, utilization levels, and operating performance. Development of future cash flows also requires management to make assumptions and to apply judgment, including the timing of future expected cash flows, using the appropriate discount rates and determining salvage values. The estimate of fair value represents our best estimates of these factors based on current industry trends and reference to market transactions and is subject to variability. Assets are generally grouped at the lowest level of identifiable cash flows. We operate within the oilfield service industry, and the cyclical nature of the oil and gas industry that we serve and our estimates of the period over which future cash flows will be generated, as well as the predictability of these cash flows, can have a significant impact on the estimated fair value of these assets and, in periods of prolonged down cycles, may result in impairment charges. Changes to our key assumptions related to future performance, market conditions and other economic factors could adversely affect our impairment valuation. During the year endedDecember 31, 2019 , we impaired$3.7 million of property and equipment as the carrying values were not deemed recoverable including$1.1 million of pipelines with low utilization,$1.0 million of layflat hose considered obsolete,$0.9 million related to divesting Canadian fixed assets, and$0.6 million related to an owned facility for sale. During the year endedDecember 31, 2018 , the Company reviewed certain fluid disposal machinery and equipment used in our fluid hauling and disposal services that are included in our Water Infrastructure segment. Due to the condition of the equipment, the Company determined that long-lived assets with a carrying value of$2.3 million were no longer recoverable and were written down to their estimated fair value of zero. Additionally, the Company determined that$4.4 million of Canadian fixed assets were impaired due to an expectation of a loss on asset disposals. We conduct our annual goodwill impairment tests in the fourth quarter of each year, and whenever impairment indicators arise, by examining relevant events and circumstances which could have a negative impact on our goodwill such as macroeconomic conditions, industry and market conditions, cost factors that have a negative effect on earnings and cash flows, overall financial performance, acquisitions and divestitures and other relevant entity-specific events. If a qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we would be required to perform a quantitative impairment test for goodwill comparing the reporting unit's carrying value to its fair value. The Company's reporting units are based on its organizational and reporting structure. In determining fair values for the reporting units, the Company relies primarily on the income, market and cost approaches for valuation. In the income approach, the Company discounts predicted future cash flows using a weighted-average cost of capital calculation based on publicly traded peer companies. In the market approach, valuation multiples are developed from both publicly traded peer companies as well as other company transactions. The cost approach considers replacement cost as the primary indicator of value. If the fair value of a reporting unit is less than its carrying value, impairment is calculated based on the difference between the fair value and carrying value in accordance with our early adoption of ASU 2017-04- Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). Application of the goodwill impairment test requires 79 Table of Contents judgment, including the identification of reporting units, allocation of assets (including goodwill) and liabilities to reporting units and determining the fair value. The determination of reporting unit fair value relies upon certain estimates and assumptions that are complex and are affected by numerous factors, including the general economic environment and levels of E&P activity of oil and gas companies, our financial performance and trends and our strategies and business plans, among others. Unanticipated changes, including immaterial revisions, to these assumptions, could result in a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and time frames, it is not possible to reasonably quantify the impact of changes in these assumptions. During the first quarter of 2019, we recorded$4.4 million of goodwill impairment in connection with divesting and winding down our Affirm subsidiary. During the year endedDecember 31, 2019 , the fair values of our reporting units were greater than the carrying values resulting in no additional impairment. During the year endedDecember 31, 2018 , we determined that$12.7 million of goodwill in our Oilfield Chemicals segment and$5.2 million of goodwill related to our Affirm subsidiary unit in our former Wellsite Services segment were impaired as the estimated fair values were not adequate to fully cover the associated carrying values. Although we believe the historical assumptions and estimates we have made are reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results. Revenue recognition: We use the five step process to recognize revenue which entails (i) identifying contracts with customers; (ii) identifying the performance obligations in each contract; (iii) determining the transaction price; (iv) allocating the transaction price to the performance obligations; and (v) recognizing revenue as we satisfy performance obligations. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services transferred to the customer. Revenue from our Water Services and Water Infrastructure segments is typically recognized over the course of time, whereas revenue from our Chemicals segment is typically recognized upon delivery. Revenue generated by each of our revenue streams is outlined as follows: Water Services and Water Infrastructure- We provide water-related services to customers, including the sourcing and transfer of water; the containment of fluids; measuring and monitoring of water; the filtering and treatment of fluids, well testing and handling, transportation, and recycling or disposal of fluids. Revenue from Water Services and Water Infrastructure is primarily based on a per-barrel price, day-rate pricing or other throughput metrics as specified in the contract. We recognize revenue from Water Services and Water Infrastructure when services are performed. Our agreements with our customers are often referred to as "price sheets" and sometimes provide pricing for multiple services. However, these agreements generally do not authorize the performance of specific services or provide for guaranteed throughput amounts. As customers are free to choose which services, if any, to use based on our price sheet, we price our separate services on the basis of their standalone selling prices. Customer agreements generally do not provide for performance-, cancellation-, termination-, or refund-type provisions. Services based on price sheets with customers are generally performed under separately-issued "work orders" or "field tickets" as services are requested. Of our Water Services and Water Infrastructure service lines, only sourcing and transfer of water are consistently provided as part of the same arrangement. In these instances, revenue for both sourcing and transfer are recognized concurrently when delivered. Accommodations and Rentals-We provide workforce accommodations and surface rental equipment. Accommodation services include trailer housing and mobile home units for field personnel. Equipment rentals are related to the accommodations and include generators, sewer and water tanks, and communication systems. Revenue from accommodations and equipment rental is typically recognized on a day-rate basis. Oilfield Chemical Product Sales-We develop, manufacture and market a full suite of chemicals utilized in hydraulic fracturing, stimulation, cementing and well completions, including polymers that create viscosity, crosslinkers, friction reducers, surfactants, buffers, breakers and other chemical technologies, to leading pressure pumping service companies in theU.S. We also provide production chemicals solutions, which are applied to underperforming wells in order to enhance well performance and reduce production costs through the use of production treating chemicals, corrosion and scale monitoring, chemical inventory management, well failure analysis and lab services. 80
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Oilfield Chemicals products are generally sold under sales agreements based upon purchase orders or contracts with our customers that do not include right of return provisions or other significant post-delivery obligations. Our products are produced in a standard manufacturing operation, even if produced to our customer's specifications. The prices of products are fixed and determinable and are established in price lists or customer purchases orders. We recognize revenue from product sales when title passes to the customer, the customer assumes risks and rewards of ownership, collectability is reasonably assured, and delivery occurs as directed by our customer. Self-insurance: We self-insure, through deductibles and retentions, up to certain levels for losses related to general liability, workers' compensation and employer's liability, and vehicle liability. Our exposure (i.e. the retention or deductible) per occurrence is$1.0 million for general liability,$1.0 million for workers' compensation and employer's liability, and$1.0 million for vehicle liability. We also have an excess loss policy over these coverages with a limit of$100.0 million in the aggregate. Management regularly reviews its estimates of reported and unreported claims and provide for losses through reserves. We use actuarial estimates to record our liability for future periods. If the number of claims or the costs associated with those claims was to increase significantly over our estimates, additional charges to earnings could be necessary to cover required payments. As ofDecember 31, 2019 , we estimate the range of exposure to be from$13.9 million to$15.9 million and have recorded liabilities of$13.4 million which represents management's best estimate of probable loss related to workers' compensation and employer's liability, and vehicle liability, less the portion prepaid. Additionally, we have recorded$0.5 million in general liabilities as ofDecember 31, 2019 . Equity-based compensation: We account for equity-based awards by measuring the awards at the date of grant and recognizing the grant-date fair value as an expense using either straight-line or accelerated attribution, depending on the specific terms of the award agreements over the requisite service period, which is usually equivalent to the vesting period. We expense awards with graded-vesting service conditions on a straight-line basis. Prior to our IPO, we did not have a listed price with which to calculate fair value. Therefore, prior to our IPO, we historically and consistently calculated the fair value using a market approach, taking into consideration peer group analysis of publicly traded companies. Stock options have been granted with an exercise price equal to or greater than the fair market value of its underlying equity instrument as of the date of grant. Prior to our IPO, we historically valued our equity on a quarterly basis using a market approach that included a comparison to publicly traded peer companies using earnings multiples based on their market values and a discount for lack of marketability. We utilized the Black-Scholes model to determine fair value, which incorporates assumptions to value stock-based awards. The risk-free interest rate was based on theU.S. Treasury yield curve in effect for the expected term of the option at the time of grant. As there had been no market for our equity prior to our IPO, we considered the historical volatility of publicly traded peer companies when determining the volatility factor. The expected life of the options was based on a formula considering the vesting period and term of the options awarded. During the years endedDecember 31, 2018 andDecember 31, 2017 , we granted 584,846 stock options with a grant date fair value of$5.2 million and 455,126 stock options with a grant date fair value of$3.6 million , respectively. No options were granted during the year endedDecember 31, 2019 . Restricted stock awards are based on the fair value of the award on the grant date and are recognized based on the vesting requirements that have been satisfied during the period. The grant-date fair value of our restricted stock awards is determined using our stock price on the grant date. During the years endedDecember 31, 2019 ,December 31, 2018 andDecember 31, 2017 , we granted 1,417,458 restricted stock awards with a weighted-average grant date fair value of$8.80 per share, 438,182 restricted stock awards with a weighted-average grant date fair value of$19.52 per share and 41,117 restricted stock awards with a weighted-average grant date fair value of$19.91 per share, respectively. During 2019 and 2018, we approved grants of performance share units ("PSUs") subject to both performance-based and service-based vesting provisions. Compensation expense related to the PSUs is determined by multiplying the number of shares of Class A Common Stock underlying such awards that, based on the Company's estimate, are probable to vest, by the measurement-date (i.e., the last day of each reporting period date) fair value and recognized using the accelerated attribution method. As ofDecember 31, 2019 andDecember 31, 2018 , we had 1,014,990 PSUs valued at$9.28 per share and 255,364 PSUs valued at
$6.32 per share, respectively. 81 Table of Contents During 2018, we approved grants of stock-settled incentive awards to certain key employees that are subject to both market-based and service-based vesting provisions. Compensation expense associated with the stock-settled incentive awards is recognized ratably over the corresponding requisite service period. The fair value of the stock-settled incentive awards was determined using aMonte Carlo option pricing model, similar to the Black-Scholes-Merton model, and adjusted for the specific characteristics of the awards. The estimated fair value being recognized as stock compensation over the vesting period is$1.1 million . During 2017, our phantom awards were cash-settled awards that were contingent upon meeting certain equity returns and a liquidation event. As a result of the cash-settlement feature of these awards, we considered these awards to be liability awards, which were measured at fair value at each reporting date and the pro rata vested portion of the award was recognized as a liability to the extent that the performance condition was deemed probable. Prior toMay 5, 2017 , we settled our outstanding phantom unit awards for an aggregate amount equal to$7.8 million as a result of the completion of our IPO, which constituted a liquidity event with respect to such phantom unit awards. Based on the fair market value of a share of our Class A common stock on the date of our IPO of$14.00 , the cash payment with respect to each phantom unit was approximately$5.53 before employer taxes. Under the Merger Agreement, all outstanding Rockwater equity-based awards were replaced by us and converted into our equivalent replacement awards. The portion of the replacement award that is attributable to pre-combination service by the employee is included in the measure of consideration transferred to acquire Rockwater. The remaining fair value of the replacement awards will be recognized as equity-based compensation expense over the remaining vesting period. Total equity-based compensation expense recognized related to Rockwater's equity-based awards that were replaced by us and converted into our equivalent equity-based awards during the year endedDecember 31, 2017 was$5.2 million . 82 Table of Contents
Recent Accounting Pronouncements
Recent accounting pronouncements: InFebruary 2016 , theFinancial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2016-02, Leases, which modifies the lease recognition requirements and requires entities to recognize the assets and liabilities arising from leases on the balance sheet and to disclose key qualitative and quantitative information about the entity's leasing arrangements. Based on the original guidance in ASU 2016-02, lessees and lessors would have been required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, including a number of optional practical expedients. InJuly 2018 , the FASB issued ASU No. 2018-11, Leases (ASC 842): Targeted Improvements, which provides entities with an option to apply the guidance prospectively, instead of retrospectively, and allows for other classification provisions. ASU 2016-02 is effective for annual reporting periods beginning afterDecember 15, 2018 , including interim periods within those fiscal years, with early adoption permitted. The Company adopted ASU 2016-02 in the first quarter of 2019. The Company elected to recognize its lease assets and liabilities on a prospective basis, beginning onJanuary 1, 2019 , using the modified retrospective transition method. Additionally, the Company elected practical expedients to (i) exclude right-of-use assets and lease liabilities for short-term leases, (ii) elected to treat lease and non-lease components as a single lease component, (iii) grandfathered its current accounting for land easements that commenced beforeJanuary 1, 2019 , and (iv) used the package of practical expedients to retain prior lease classification, prior treatment of initial direct costs and prior determination of whether a contract constituted a lease. See Note 5-Leases for additional information. InJune 2016 , the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which amends GAAP by introducing a new impairment model for financial instruments that is based on expected credit losses rather than incurred credit losses. The new impairment model applies to most financial assets, including trade accounts receivable. The amendments are effective for interim and annual reporting periods beginning afterDecember 15, 2019 , although it may be adopted one year earlier, and requires a modified retrospective transition approach. After reviewing the new standard and reexamining current and prior year bad debt expense from trade receivables, as well as updating future expectations, the adoption of the new standard is not expected to have a material impact to the Company's financial statements. InDecember 2019 , the FASB issued ASU 2019-12, Income Taxes (Topic 740), which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2020 . Early adoption of the amendments is permitted, including adoption in any interim period for which financial statements have not yet been issued. Depending on the amendment, adoption may be applied on the retrospective, modified retrospective or prospective basis. The Company is currently reviewing the provisions of this new pronouncement.
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