CHAMPIONX CORPORATION This discussion includes forward-looking statements. See "Cautionary Note Regarding Forward-Looking Statements" for certain cautionary information regarding forward-looking statements and see "Risk Factors" in Part I, Item 1A, for certain factors that could cause actual results to differ materially from those predicted in those statements. This discussion should also be read in conjunction with the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data."
EXECUTIVE OVERVIEW
ChampionX is a global leader in chemistry solutions and highly engineered equipment and technologies that help companies drill for and produce oil and gas safely and efficiently around the world.ChampionX's products provide efficient and safe operations throughout the lifecycle of a well with a focus on the production phase of wells.
On
A discussion of our consolidated results of operations and the results of operations of each of our reportable segments for the year endedDecember 31, 2020 compared to 2019 is contained herein. For discussion related to our consolidated results of operations and results of operations for each of our reportable segments for the year endedDecember 31, 2019 compared to 2018, please refer to Part II, Item 7 "Management's discussion and analysis of financial condition and results of operations" on Form 10-K for our fiscal year endedDecember 31, 2019 , filed with theSEC onMarch 2, 2020 .
Merger
OnJune 3, 2020 , the Company and Ecolab completed aReverse Morris Trust transaction in which Ecolab transferred their upstream energy business to legacyChampionX and, thereafter, distributed all of the shares of legacyChampionX common stock to certain Ecolab stockholders. Immediately following the Distribution, a wholly owned subsidiary of the Company merged with and into legacyChampionX , with legacyChampionX continuing as the surviving company in the Merger and as a wholly owned subsidiary of the Company. The Merger constitutes a business combination, with the Company (formerly known as Apergy) treated as the accounting acquirer and legacyChampionX treated as the acquired company for accounting purposes. In association with the completion of the Merger, the Company changed its name fromApergy Corporation toChampionX Corporation . See Note 3-Merger Transaction, Acquisitions, And Dispositions to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for more information. In connection with the Merger, we re-evaluated our reportable segments. As a result, we have identified two new reportable segments, Production Chemical Technologies and Reservoir Chemical Technologies, which include the results of operations of legacyChampionX . The legacy Apergy reportable segments remain unchanged. The results of operations of legacyChampionX are reflected in our accompanying consolidated financial statements from the closing date of the Merger throughDecember 31, 2020 . Results for the periods prior toJune 3, 2020 reflect the financial and operating results of legacy Apergy and do not include the financial and operating results of legacyChampionX . As such, our historical results of operations are not comparable from period to period and may not be comparable to our financial results of operations in future periods.
Business Environment
We focus on economic- and industry-specific drivers and key risk factors affecting our business segments as we formulate our strategic plans and make decisions related to allocating capital and human resources. Our business segments provide a broad range of technologies and products for the oil and gas drilling and production industry and, as a result, are substantially dependent upon activity levels in the oil and gas industry. Demand for our products, technologies and services is impacted by overall global demand for oil and gas, ongoing depletion rates of existing wells which produce oil and gas, and our customers' willingness to invest in the development and ongoing production of oil and gas resources. Our customers determine their operating and capital budgets based on current and future crude oil and natural gas prices,U.S. and worldwide rig count andU.S. well completions, among other factors. Crude oil and natural gas prices are impacted by supply and demand, which are influenced by geopolitical, macroeconomic, and local events, and have historically been subject to substantial volatility and cyclicality. Rig count, footage drilled, and exploration and production (E&P) investment by oil and gas operators have often been used as leading indicators for the level of drilling and development activity in the oil and gas sector. 27 --------------------------------------------------------------------------------
Market Conditions and Outlook
During the first half of 2020, certain unprecedented events caused a rapid decline of oil prices. Decisions by theOrganization of Petroleum Exporting Countries ("OPEC") and other oil producing nations resulted in an oversupply of crude oil. Compounding this situation, demand for oil and gas commodities declined significantly as the world was impacted by the novel coronavirus ("COVID-19") outbreak, which resulted in a sharp decline in crude oil prices. In response to the significant reduction in oil prices, customer spending associated with drilling and E&P activity deteriorated at a rapid pace due to significantly reduced capital and operating expenditures and cost cutting initiatives. Although oil prices rebounded moderately, prices remain below the average oil price during 2019. We expect market conditions to remain challenging into 2021 as we believe it will take time for global oil demand to recover from the COVID-19 pandemic.
Response to the COVID-19 Pandemic
In response to impacts of the COVID-19 pandemic, we implemented a set of immediate actions to reduce operating costs and capital spending during fiscal year 2020, which included:
•reduction in totalChampionX headcount; •temporary company-wide salary reductions, including steeper reductions for executive management and the highest reduction for our chief executive officer; and •facility rationalization and elimination of non-essential expenses. Additionally, during 2020, we significantly reduced capital expenditures within our Production & Automation Technologies and Digital Technologies segments by approximately$41 million . Within our Chemical Technologies business, we reduced capital spend during 2020 by approximately 50% against prior year levels. Should we experience further declines in oilfield service activities as a result of the ongoing COVID-19 pandemic, we will take additional restructuring actions as necessary. Ensuring the health and safety of our employees is paramount. As our businesses are classified as critical infrastructure, our manufacturing and field locations continue to operate and support the vital oil and gas infrastructure around the world. In order to protect our employees during this period, we mobilized our crisis management team and adopted a comprehensive response plan, which included: •taking precautions consistent with local, state, and national government health authority guidelines, including theCenters for Disease Control and Prevention and theWorld Health Organization ; •meetings between the crisis management team and executive management to ensure real-time understanding of developments as they occur such that our communications and responses are appropriate and timely; •equipping our employees with additional personal protective equipment; •introducing new employee screening procedures in our operations; and •enacting social distancing procedures, including staggering shifts, implementing rotating work schedules, and modifying workspaces and break areas.
As COVID-19 vaccines become available in the jurisdictions in which we have facilities and employees, we are making information available to employees about vaccine availability and encouraging employees to get vaccinated against COVID-19 where eligible.
28
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CONSOLIDATED RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2020 AND 2019
Years Ended December 31, 2020 vs. 2019(dollars in thousands) 2020 2019 $ % Revenue$ 1,899,996 $ 1,131,251 $ 768,745 68 % Cost of goods and services 1,490,824 754,147 736,677 98 % Gross profit 409,172 377,104 32,068 9 % Selling, general and administrative expense 463,767 274,268 189,499 69 % Goodwill impairment 616,271 - 616,271 * Long-lived asset impairment 40,980 1,746 39,234 * Interest expense, net 51,731 39,301 12,430 32 % Other (income) expense, net (828) 2,603 (3,431) (132) % Income (loss) before income taxes (762,749) 59,186 (821,935) * Provision for (benefit from) income taxes (20,396) 6,226 (26,622) * Net income (loss) (742,353) 52,960 (795,313) * Net income attributable to noncontrolling interest 1,577 796 781 98 % Net income (loss) attributable to ChampionX$ (743,930) $ 52,164 $ (796,094) * Gross profit margin 21.5 % 33.3 % (1,180) bps. SG&A expense, percent of revenue 24.4 % 24.2 % 20 bps. Effective tax rate 2.7 % 10.5 % (780) bps. _______________________ * Not meaningful Outside of incremental revenues associated with the Merger, we experienced an increase in revenue inNorth America across all our business segments in the second half of 2020 as compared to the first half of 2020. This increase was driven by higher activity levels as customer spending began to recover from the compressed levels experienced during the second quarter, coupled with higher demand for our polycrystalline diamond cutters asU.S. land rig count activity began to increase later in the year. Internationally, markets were more resilient during 2020 given the longer sales cycles relative toNorth America . Revenue. Revenue for the consolidated entity increased$768.7 million , or 68%, in 2020 compared to the prior year driven by$1.2 billion of incremental revenues associated with our acquired Chemical Technologies business. The increase in revenue was offset by a decrease in Drilling Technologies revenue of$130.7 million year-over-year due to lower volumes and pricing pressure. Additionally, Production & Automation Technologies revenue decreased$268.4 million year-over-year, driven by lower volumes inNorth America and internationally, and the disposition of our pressure vessel manufacturing business in the second quarter of 2019. Gross profit. Gross profit increased$32.1 million , or 9%, year-over year, primarily due to$251.8 million generated subsequent to the Merger date by our acquired Chemical Technologies business. This was offset by lower sales volumes in our Production & Automation Technologies and Drilling Technologies segments as well as an increase in consolidated depreciation expense of$74.1 million . The increase in depreciation expense is primarily due to a change in salvage value estimate for certain of our leased assets. Selling, general and administrative expense. Selling, general and administrative expense increased$189.5 million , or 69%, year-over-year, primarily due to$168.5 million of incremental expenses associated with our acquired Chemical Technologies business as well as acquisition and integration costs of$83.6 million related to the Merger. The increase also includes$7.8 million for restructuring costs and$5.8 million for professional fees incurred related to material weakness remediation. The increase in selling, general and administrative expense was largely offset by cost savings from restructuring actions taken in the second half of 2019 to mitigate the impact of lower drilling activity levels and the second quarter of 2020 to address the energy downturn and the impact of the COVID-19 pandemic. 29 -------------------------------------------------------------------------------- Interest expense, net. Interest expense, net increased$12.4 million , or 32%, year-over-year primarily due to incremental interest expense related to the term loan assumed as part of the Merger, partially offset by repayments of approximately$125.0 million of the Company's term loan during the year. Provision for (benefit from) income taxes. The effective tax rates for 2020 and 2019 were 2.7% and 10.5% respectively. The tax benefit recognized during 2020 reflects the loss before income taxes, largely due to goodwill and intangible asset impairment charges recorded during the first quarter. The effective tax rate was primarily impacted by the tax effects of impairment of non-taxable goodwill of$560.1 million . Other items impacting the rate include the effects of valuation allowances in loss jurisdictions, foreign branch earnings, transaction costs associated with the Merger, and the impact of rates in foreign jurisdictions. SEGMENT RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2020 AND 2019
Production Chemical Technologies
Year Ended
(dollars in thousands) December 31, 2020 (1)
Revenue $ 992,805
Operating profit 94,294
Operating profit margin 9.5 %
Depreciation and amortization $ 58,328
Restructuring and other related charges 5,241
_______________________
(1) The results of operations of the Production Chemical Technologies segment are reflected in the table above from the closing date of the Merger throughDecember 31, 2020 . As such, there are no results presented for the year endedDecember 31, 2019 . Revenue. Production Chemical Technologies revenue is primarily generated from providing E&P and other customers in the oil and natural gas production and midstream markets with solutions to manage and control corrosion, oil and water separation, flow assurance, sour gas treatment and a host of water-related issues. Revenue was$992.8 million for the period. Deteriorating market conditions during 2020 have significantly impacted customer demand; however, as Production Chemical Technologies mostly supports existing production, sales are somewhat less sensitive to changes in customers' capital and operating expenditure budgets related to the exploration for and development of new oil and natural gas reserves, which are more directly affected by trends in oil and natural gas prices. Operating profit. Production Chemical Technologies generated operating profit of$94.3 million during the year endedDecember 31, 2020 , which includes depreciation and amortization expense of$58.3 million and an increase to cost of goods sold related to the step-up of inventory as part of the purchase price allocation as a result of the Merger of$13.9 million .
Production & Automation Technologies
Years Ended December 31, 2020 vs. 2019
(dollars in thousands) 2020 2019 $ %
Revenue $ 615,918 $ 884,364 $ (268,446) (30) %
Operating profit (loss) (697,937) 54,024 (751,961) *
Operating profit margin (113.3) % 6.1 % (11,940) bps
Depreciation and amortization $ 130,725 $ 110,131 20,594 19 %
Goodwill impairment 616,271 - 616,271 *
Long-lived asset impairment 40,980 1,746 39,234 *
Restructuring and other related charges 11,814 8,562 3,252 38 %
Environmental costs - 1,988 (1,988) (100) %
Acquisition transaction costs 1,173 589 584 99 %
______________________
* Not meaningful
30-------------------------------------------------------------------------------- Revenue. Production & Automation Technologies revenue decreased$268.4 million , or 30%, in 2020 compared to the prior year, driven by lower volumes inNorth America and internationally due to the impact of deteriorating market conditions during the year, and the disposition of our pressure vessel manufacturing business in the second quarter of 2019. Operating profit. Production & Automation Technologies operating profit decreased$752.0 million in 2020 primarily driven by goodwill and long-lived asset impairment charges of$616.3 million and$41.0 million , respectively, in the first quarter of 2020. Excluding impairment charges, operating profit decreased$96.5 million , primarily due to lower sales volume and an increase in depreciation and amortization expense of$20.6 million , primarily related to a change in salvage value estimate for certain of our leased assets. These costs were partially offset by cost savings from restructuring actions as well as other cost reduction efforts in response to the COVID-19 pandemic.
Drilling Technologies
Years Ended December 31, 2020 vs. 2019
(dollars in thousands) 2020 2019 $ %
Revenue $ 116,186 $ 246,887 $ (130,701) (53) %
Operating profit 2,574 73,497 (70,923) (97) %
Operating profit margin 2.2 % 29.8 % (2,760) bps
Depreciation and amortization $ 7,940 $ 9,263 $ (1,324) (14) %
Restructuring and other related charges 5,521 710 4,811 *
_______________________
* Not meaningful
Revenue. Drilling Technologies revenue decreased $130.7 million , or 53%, in 2020
compared to the prior year, primarily due to a steep decline in U.S. land-based
rig count and associated decline in customer spending on drilling activities,
which negatively impacted sales volumes of our polycrystalline diamond cutters
and diamond bearings products.
Operating profit. Drilling Technologies operating profit decreased
Reservoir Chemical Technologies
Year Ended
(dollars in thousands) December 31, 2020 (1)
Revenue $ 61,507
Operating profit (loss) (6,198)
Operating profit (loss) margin (10.1) %
Depreciation and amortization $ 5,741
Restructuring and other related charges 348
______________________
(1) The results of operations of the Reservoir Chemical Technologies segment are reflected in the table above from the closing date of the Merger throughDecember 31, 2020 . As such, there are no results presented for the year endedDecember 31, 2019 . Revenue. Reservoir Chemical Technologies revenue is primarily comprised of the sale of specialty products that support well stimulation, construction (including drilling and cementing), and remediation needs to service and equipment companies that support global E&P companies. Revenue was$61.5 million for the period. Reservoir Chemical Technologies products are sensitive to changes in its customers' capital expenditure budgets as they relate closely to the exploration and development of new oil and natural gas reserves. This exploration and development activity is affected by trends in oil and natural gas prices and its customers' corresponding levels of drilling activity, capital investment and well development. Operating profit/loss. Reservoir Chemical Technologies generated operating loss of$6.2 million for the year endedDecember 31, 2020 , which includes depreciation and amortization expense of$5.7 million and an increase in cost of goods sold related to the step-up of inventory as part of the purchase price allocation as a result of the Merger of$0.6 million . 31 --------------------------------------------------------------------------------
CAPITAL RESOURCES AND LIQUIDITY
As ofDecember 31, 2020 , approximately$88.0 million , or 44%, of our cash balances were held outside theU.S. for the primary purpose of working capital and operational support needs. All of our cash held outside theU.S. could be repatriated and could be subject to foreign withholding taxes; however, we have determined that such earnings are indefinitely reinvested. In addition, we have approximately$15.7 million in deferred tax liabilities associated with foreign withholding taxes on our foreign earnings from jurisdictions which are not asserted to be permanently reinvested.
Cash Flows
Years Ended December 31,
(in thousands) 2020 2019
Cash provided by operating activities $ 310,040 $ 155,899
Cash provided by (used for) investing activities 22,130 (49,876)
Cash used for financing activities (175,366) (112,403)
Effect of exchange rate changes on cash and cash equivalents 9,327 (162)
Net increase (decrease) in cash and cash equivalents $ 166,131 $ (6,542)
Operating Cash Flows
Cash provided by operating activities in 2020 increased $154.1 million compared
to 2019. The increase in cash provided by operating activities was primarily
driven by increases from changes in our operating assets and liabilities in 2020
as compared to 2019, largely due to collection of trade receivables and a
reduction in our cash outflows for inventory procurement and cash outflows on
leased assets due to strict adherence to cost and capital discipline.
Expenditures for assets that are placed into our leased asset program expected
to be recovered through sale are reported in leased assets in the operating
section of our consolidated statements of cash flows. All other capitalizable
expenditures for assets that are placed into our leased asset program are
classified as capital expenditures in the investing section of our consolidated
statements of cash flows.
Investing Cash Flows
Cash provided by investing activities was $22.1 million in 2020 and was
primarily comprised of cash acquired in the Merger of $57.6 million and $9.7
million of cash proceeds on sale of fixed assets, partially offset by capital
expenditures of $45.2 million . See Note 3-Merger Transaction, Acquisitions, And
Dispositions in Part II, Item 8.-Financial Statements and Supplementary Data of
this Annual Report on Form 10-K for additional information on the Merger.
Cash used for investing activities was $49.9 million in 2019 and was primarily
comprised of capital expenditures of $39.8 million , a $12.5 million payment to
acquire a provider of digital technology strategic to our artificial lift
product offering and a $2.2 million payment to dispose of our pressure vessel
manufacturing business. These cash outflows were partially offset by $4.6
million of cash proceeds on sale of fixed assets, primarily due to the sale of
two of our properties during 2019. See Note 3-Merger Transaction, Acquisitions,
And Dispositions in Part II, Item 8.-Financial Statements and Supplementary Data
of this Annual Report on Form 10-K for additional information related to these
acquisitions and dispositions.
Capital expenditures in the investing cash flows section of our consolidated
statement of cash flows include expenditures for long-term equipment expected to
be placed into our leased asset program. During the years ended December 31,
2020 and 2019, capital expenditures consisted mostly of infrastructure related
capital spending and investment in assets for our leased asset program of $20.9
million and $16.0 million , respectively.
Financing Cash Flows
Cash used for financing activities of$175.4 million in 2020 was primarily the result of repayments totaling$161.5 million on our long-term debt,$4.4 million in debt issuance costs related to the amendment of the credit agreement in contemplation of the Merger,$5.1 million of payments of finance lease obligations, and a distribution of$2.2 million to non-controlling interest. Net borrowings under our revolving credit facility totaled zero in 2020 as we borrowed and fully repaid the borrowing within the same period. See Note 8-Debt included in Part II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on Form 10-K. 32 -------------------------------------------------------------------------------- Cash used for financing activities of$112.4 million in 2019 was primarily the result of$105.0 million of debt repayment on the principal balance of our term loan and payments totaling$5.6 million for finance lease obligations. Net borrowings under our revolving credit facility totaled zero in 2019.
Debt and Liquidity
Total borrowings were comprised of the following:
December 31,
(in thousands) 2020 2019
2018 Credit Facility $ - $ -
2018 Term Loan Facility 140,000 265,000
2020 Term Loan Facility 523,575 -
6.375% Senior Notes due 2026 277,041 300,000
Total borrowings $ 940,616 $ 565,000 2018 Credit Facility
OnMay 9, 2018 , we entered into a credit agreement ("credit agreement") governing the terms of our senior secured credit facilities, consisting of (i) a 7-year senior secured term loan B facility ("term loan facility") and (ii) a 5-year senior secured revolving credit facility ("revolving credit facility," and together with the term loan facility, the "senior secured credit facilities"), withJPMorgan Chase Bank, N.A . as administrative agent. The net proceeds of the senior secured credit facilities were used (i) to pay fees and expenses in connection with the Separation from Dover, (ii) partially fund the cash payment to Dover and (iii) provide for working capital and other general corporate purposes. The senior secured credit facilities are jointly and severally guaranteed byChampionX and certain ofChampionX's wholly ownedU.S. subsidiaries, including, upon the consummation of the Merger, certain legacyChampionX wholly ownedU.S. subsidiaries, ("guarantors"), on a senior secured basis, and are secured by substantially all tangible and intangible assets ofChampionX and the guarantors, except for certain excluded assets. At our election, outstanding borrowings under the senior secured credit facilities will accrue interest at a per annum rate of (i) LIBOR plus a margin or (ii) a base rate plus a margin. Interest on borrowings in which interest is accrued at a base rate plus an applicable margin is payable on the last business day of each quarter. The senior secured credit facilities contain a number of customary covenants that, among other things, limit or restrict the ability ofChampionX and the restricted subsidiaries to, subject to certain qualifications and exceptions, perform certain activities which include, but are not limited to (i) incur additional indebtedness, (ii) make acquisitions and (iii) pay dividends or other payments in respect of our capital stock. Additionally,ChampionX is required to maintain (a) a minimum interest coverage ratio, as defined in the credit agreement, of 2.50 to 1.00 and (b) a maximum total leverage ratio, as defined in the credit agreement, of 4.00 to 1.00 through the fiscal quarter endingMarch 31, 2021 , then 3.75 to 1.00 thereafter. OnFebruary 14, 2020 , the Company entered into an amendment to the credit agreement (as amended, the "2018 Credit Facility"), which (i) provided for the incurrence of an additional$150.0 million of revolving commitments under the 2018 Credit Facility, upon consummation of the Merger with legacyChampionX , (ii) permitted the consummation of the Merger and the incurrence of a senior secured term loan facility ("2020 Term Loan Facility") in an aggregate amount up to$537.0 million by legacyChampionX , and (iii) continued to provide that all obligations under the 2018 Credit Facility are guaranteed by the guarantors. The weighted average interest rate on borrowings during the period was 4.00%. The revolving credit facility consists of a 5-year senior secured facility with aggregate commitments in an amount equal to$400.0 million , of which up to$100.0 million is available for the issuance of letters of credit. Amounts repaid under the revolving credit facility may be re-borrowed. The revolving credit facility matures inMay 2023 . 33 -------------------------------------------------------------------------------- A summary of our revolving credit facility as ofDecember 31, 2020 was as follows: Letters Debt of (in millions) Amount Outstanding Credit Unused Capacity Maturity
Five-year revolving credit facility$ 400.0 $ -$ 50.4 $ 349.6 May 2023
As of
2018 Term Loan Facility
The term loan facility had an initial commitment of$415.0 million . The full amount of the term loan facility was funded onMay 9, 2018 . Amounts borrowed under the term loan facility that are repaid or prepaid may not be re-borrowed. The term loan facility matures inMay 2025 . Net proceeds of$408.7 million from the term loan facility were utilized to partially fund the cash payment to Dover at the Separation and to pay fees and expenses incurred in connection with the Separation. The term loan is subject to mandatory amortization payments of 1% per annum of the initial commitment of$415.0 million paid quarterly. Additionally, subject to certain exceptions, the term loan facility is subject to mandatory prepayments, including the amount equal to: 100% of the net cash proceeds of all non-ordinary course asset sales subject to (i) reinvestment periods and (ii) step-downs to 75% and 50% based on certain leverage targets; and 50% of excess cash flow, as defined in the credit agreement, with step-downs to 25% and 0% based on certain leverage targets.ChampionX may voluntarily prepay amounts outstanding under the term loan facility in whole or in part at any time without premium or penalty, as defined in the credit agreement. The weighted average interest rate on borrowings during the period was 3.18%.
2020 Term Loan Facility
OnJune 3, 2020 , legacyChampionX entered into a term loan facility for$537.0 million ("2020 Term Loan Facility"). Proceeds from the 2020 Term Loan Facility were utilized to fund a cash payment of$527.4 million from legacyChampionX to Ecolab upon the completion of the Merger. We assumed the 2020 Term Loan Facility upon completion of the Merger, which is fully and unconditionally guaranteed by the Company and the guarantors, which also guarantee the obligations under the 2018 Credit Facility. The 2020 Term Loan Facility matures at the earlier of (i)June 3, 2027 or (ii)January 30, 2026 in the event the Company's senior unsecured notes dueMay 1, 2026 remain outstanding. Amounts outstanding under the 2020 Term Loan Facility bear interest, at the option of the Company, at a rate equal to (a) LIBOR plus 5.0% for eurocurrency rate loans (to the extent LIBOR is less than 1%, the LIBOR rate will be deemed to be 1%) or (b) the highest of (i) the Federal Funds Rate plus 1/2 of 1%, (ii) the "prime rate" quoted byBank of America, N.A ., (iii) LIBOR plus 1.00% and (iv) 1.00%, plus 4.0%. The 2020 Term Loan Facility contains customary representations and warranties, covenants, and events of default for loan facilities of this type. The weighted average interest rate on borrowings during the period was 6.02%. The term loan is subject to mandatory amortization payments of$6.7 million paid quarterly, which began onSeptember 30, 2020 . Any voluntary prepayment of the 2020 Term Loan Facility which occurs prior toJune 3, 2022 , is subject to a make-whole prepayment premium on the aggregate prepaid principal amount of the 2020 Term Loan Facility. Senior Notes OnMay 3, 2018 , and in connection with the Separation, we completed the offering of$300.0 million in aggregate principal amount of 6.375% senior notes dueMay 2026 ("Senior Notes"). Interest on the Senior Notes is payable semi-annually in arrears onMay 1 andNovember 1 of each year and commenced onNovember 1, 2018 . Net proceeds of$293.8 million from the offering were utilized to partially fund the$700.0 million cash payment to Dover at the Separation and to pay fees and expenses incurred in connection with the Separation. Payment obligations of the Senior Notes are fully and unconditionally guaranteed by the guarantors on a joint and several basis. OnJune 18, 2020 , the wholly owned subsidiaries of legacyChampionX that guarantee the 2018 Credit Facility and the 2020 Term Loan Facility, delivered a Supplemental Indenture to join as guarantors of the Senior Notes. 34 -------------------------------------------------------------------------------- The terms of the Senior Notes are governed by the indenture dated as ofMay 3, 2018 , between the Company andWells Fargo Bank, N.A. , as trustee, and are guaranteed, on a senior unsecured basis, by the guarantors. At any time prior toMay 1, 2021 , we may redeem all or part of the Senior Notes at a redemption price equal to 100% of the principal amount of the Senior Notes redeemed plus a premium, as defined in the indenture, plus accrued and unpaid interest. Beginning on or afterMay 1, 2021 , we may redeem the Senior Notes, in whole or in part, at certain tiered redemption prices as defined in the indenture, plus accrued and unpaid interest. The Senior Notes are our senior unsecured obligations. The Senior Notes rank equally in right of payment with our future and existing senior debt but are effectively subordinated to our future and existing debt to the extent of the assets securing such senior debt. The Senior Notes rank senior in right of payment to all of our future subordinated debt.
Tender Offer
During the fourth quarter of 2020, the Company initiated a tender offer to purchase certain of the Senior Notes (the "Tender Offer"). Approximately$23.0 million in aggregate principal amount of the Senior Notes was repurchased for$23.4 million in cash, including principal, and$0.2 million in accrued interest. In connection with these repurchases, we recognized a net loss of approximately$0.9 million for the year endedDecember 31, 2020 and is included in other expense, net in our consolidated statement of income (loss).
See Note 8-Debt included in Part II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Outlook
Our primary source of cash is from operating activities. We have historically generated, and expect to continue to generate, positive cash flow from operations. Cash generated from operations is generally allocated to working capital requirements, investments in facilities and systems, acquisitions that create value with bolt-on capabilities that broaden our existing business offerings and overall growth strategy, and debt repayments. We expect to generate our liquidity and capital resources through operations and, when needed, through our revolving credit facility. The volatility in credit, equity and commodity markets resulting from current market conditions can create uncertainty for our businesses. However, the Company believes, based on our current financial condition and current expectations of future market conditions, that we will meet our short- and long-term needs with a combination of cash on hand, cash generated from operations, our use of our revolving credit facility and access to capital markets. Over the next year, we expect to fund our capital expenditures and reduce outstanding debt through earnings and working capital improvements. In 2021, we project capital spending to be approximately three percent of revenue for infrastructure related capital expenditures, inclusive of capital investments directed at expanding our portfolio of electric submersible pump leased assets. Additionally, we have other purchase obligations as well as operating and finance leases for real estate, vehicles and equipment that include future minimum payments with initial terms of one year or more. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. See Note 9-Commitments And Contingencies and Note 10-Leases included in Part II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on Form 10-K. We continue to evaluate acquisitions that meet our strategic priorities, expand our technology and product portfolio, improve our cost position or productivity, or broaden our geographic reach. As ofDecember 31, 2020 , we had approximately$88.8 million in outstanding letters of credit, surety bonds, and guarantees which expire at various dates through 2026. These financial instruments are primarily maintained as security for insurance, warranty, and other performance obligations. Generally, we would only be liable for the amount of these letters of credit and surety bonds in the event of default in the performance of our obligations, the probability of which we believe is remote. 35 --------------------------------------------------------------------------------
CONDENSED CONSOLIDATING FINANCIAL INFORMATION
Senior Notes
See Note 8-Debt, included in Part II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on Form 10-K, for information related to our Senior Notes, which are fully and unconditionally guaranteed by certain wholly owned subsidiaries (the "Guarantors") ofChampionX on a joint and several basis. OnJune 18, 2020 , the wholly owned subsidiaries of legacyChampionX that guarantee the 2018 Credit Facility and the 2020 Term Loan Facility, delivered a Supplemental Indenture to join as guarantors of the Senior Notes. The Senior Notes indenture restricts the ability of the Guarantors to pay dividends or other distributions, make loans or advances, or sell, lease or otherwise transfer property and other assets to certain restricted subsidiaries or the Company. As part of the Senior Notes indenture, a guarantee of the Senior Notes byChampionX or a Guarantor is subject to release in the following circumstances: •the sale, exchange or transfer (by merger or otherwise) of (i) the capital stock of the Guarantor after which the Guarantor is no longer a restricted subsidiary or (ii) all or substantially all of the assets of such Guarantor made in a manner not in violation of the indenture; •the release or discharge of the guarantee by, or direction obligation of, such Guarantor with respect to the senior secured credit facilities or capital markets debt securities that resulted in the creation of such guarantee, except a discharge by or as a result of payment under such guarantee; •the designation of the subsidiary as an unrestricted subsidiary under the indenture; •the legal defeasance or covenant defeasance of the Senior Notes in accordance with the terms of the indenture; •the merger or consolidation of any Guarantor with and into the Company or another Guarantor that is the surviving person in such merger or consolidation, or upon the liquidation of such Guarantor following the transfer of all its assets to the Company or another Guarantor; or •an amendment of the Senior Note indenture agreement.
The obligations of each Guarantor under its note guarantee are limited as necessary to prevent such note guarantee from constituting a fraudulent conveyance under applicable law.
The following summarized financial information presents the Company and
Guarantors (collectively and together with the Parent, the "
Condensed Combined Statement of Loss of the
Year Ended
(dollars in thousands) December 31, 2020
Total Revenue $ 1,791,463
Cost of goods and services 1,399,575
Selling, general and administrative expense 447,127
Goodwill impairment 396,017
Long-lived asset impairment 40,980
Loss before income taxes (541,394)
Net loss $ (502,990)
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Condensed Combined Balance Sheets of the
December 31,
(dollars in thousands) 2020 2019
Current assets:
Current assets $ 1,195,251 $ 419,692
Noncurrent assets:
Goodwill 631,184 639,280
Advances due from affiliates 16,558 18,534
Other non-current assets 1,473,605 430,553
Total assets $ 3,316,598 $ 1,508,059
Current liabilities:
Current liabilities $ 591,625 $ 173,372
Noncurrent liabilities:
Advances due to affiliates 91,495 87,682
Other non-current liabilities 1,210,016 664,581
Total Liabilities $ 1,893,136 $ 925,635
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make certain estimates,
judgments and assumptions about future events that affect the reported amounts
of assets and liabilities at the date of the financial statements, the reported
amounts of revenue and expenses during the periods presented and the related
disclosures in the accompanying notes to the consolidated financial statements.
Management reviewed these critical accounting estimates with the Audit Committee
of the Board of Directors. We believe the following critical accounting
estimates used in preparing our consolidated financial statements address all
important areas where the nature of the estimates or assumptions is material due
to the levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change. See Note
1-Basis Of Presentation And Summary Of Significant Accounting Policies in Part
II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on
Form 10-K for a description of our significant accounting policies.
Determination of Fair Value in Business Combinations
Accounting for the acquisition of a business requires allocation of the purchase price to the various assets acquired and liabilities assumed at their respective fair values. The determination of fair value requires the use of significant estimates and assumptions, and in making these determinations management uses all available information. If necessary, we have up to one year after the acquisition closing date to finalize these fair value determinations. For tangible and identifiable intangible assets acquired in a business combination, the determination of fair value utilizes several valuation methodologies including discounted cash flows which has assumptions with respect to the timing and amount of future revenue and expenses associated with an asset. The assumptions made in performing these valuations include, but are not limited to, discount rate, future revenues and operating costs, projections of capital costs, royalty rate, and other assumptions believed to be consistent with those used by principal market participants. Due to the specialized nature of these calculations, we engage third-party specialists to assist management in evaluating our assumptions as well as appropriately measuring the fair value of assets acquired and liabilities assumed.
Inventory Valuation
Inventory is recorded at the lower of cost or net realizable value. We evaluate
the components of inventory on a regular basis for excess and obsolescence. We
record the decline in the carrying value of estimated excess or obsolete
inventory as a reduction of inventory and as an expense included in cost of
goods and services in the period in which it is identified. Our estimate of
excess and obsolete inventory is susceptible to change from period to period and
requires management to make judgments about the future demand of inventory.
Factors that could materially impact our estimate include changes in crude oil
prices and its effect on the oil and gas industry, which would impact the demand
for our products and services, as well as
37
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changes in the pattern of demand for the products that we offer. We believe our
inventory valuation reserve is adequate to properly value potential excess and
obsolete inventory as of December 31, 2020 . However, any significant changes to
the factors mentioned above could lead our estimate to change. See Note 1-Basis
Of Presentation And Summary Of Significant Accounting Policies in Part II, Item
8.-Financial Statements and Supplementary Data of this Annual Report on Form
10-K for additional information related to inventory.
Long-Lived and Intangible Assets Valuation
Long-lived assets to be held and used, including property, plant and equipment, identifiable intangible assets being amortized and capitalized software costs are reviewed for impairment whenever events or circumstances indicate the carrying amount of the long-lived asset may not be recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If it is determined that an impairment loss occurred, the loss is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value. The determination of future cash flows as well as the estimated fair value of long-lived assets involves significant estimates on the part of management. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined based on the present values of expected future cash flows using discount rates believed to be consistent with those used by principal market participants, or based on a multiple of operating cash flow validated with historical market transactions of similar assets, where possible. The expected future cash flows used for impairment reviews and related fair value calculations are based on judgmental assessments of future productivity of the asset, operating costs and capital decisions and all available information at the date of review. If future market conditions deteriorate from our current expectations or assumptions, impairment of long-lived assets may be identified if we conclude that the carrying amounts are no longer recoverable. Long-lived assets classified as held for sale are reported at the disposal group's fair value, less cost to sell, beginning in the period in which the held-for-sale criteria have been met. An impairment loss is recognized in the amount in which the carrying amount of the disposal group exceeds its fair value. The fair value of a disposal group is measured based on market information when available, such as negotiated selling price. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired held for sale assets is typically determined based on the present values of expected future cash flows using discount rates believed to be consistent with those used by principal market participants. In the first quarter of 2020, we determined that certain events as discussed below in Valuation ofGoodwill constituted a triggering event which caused us to review all asset groups within our Artificial Lift and Automation reporting units. As a result of this analysis, we recorded a long-lived asset impairment charge of$41.0 million , related to definite-lived intangible assets during 2020. During 2019 and 2018, we recognized impairment charges of$1.7 million and$1.0 million , respectively, related to tangible long-lived assets.
Valuation of
Goodwill is not subject to amortization but is tested for impairment on an annual basis, or more frequently if impairment indicators arise.Goodwill is tested at the reporting unit level, which is at or one level below our operating segments. We have establishedOctober 1 as the date of our annual test for impairment of goodwill for the legacy Apergy reporting units which consist of (i) Artificial Lift, (ii) Automation, and (iii) Drilling Technologies. Artificial Lift and Automation are reported in our Production & Automation Technologies reportable segment, and Drilling Technologies in our Drilling Technologies reportable segment. As a result of the Merger, we added two reporting units (i) Production Chemical Technologies and (ii) Reservoir Chemical Technologies for which the goodwill annual testing date isMay 31 . Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. The goodwill impairment test involves comparing management's estimate of fair value of a reporting unit with its carrying value, including goodwill. If the fair value of the reporting unit is less than the carrying value, then goodwill is impaired to the extent of the difference; however, the impairment may not exceed the balance of goodwill assigned to that reporting unit. Fair value of reporting units is determined using a combination of two valuation methods: an income approach and a market approach, with each method given equal weight in determining the fair value assigned to each reporting unit. Absent an indication of fair value from a potential buyer or similar specific transaction, we believe the use of these two methods provides a reasonable estimate of a reporting unit's fair value. The income approach is based on forecasted future debt-free cash flows that are discounted to present value using factors that consider timing and risk of future cash flows. We believe this approach is appropriate because it provides a fair value estimate based upon the reporting unit's expected long-term operating cash flow performance. Discounted cash flow projections are based on financial forecasts developed from operating plans and economic outlooks, growth rates, estimates of future expected changes in operating margins, terminal value growth rates, future capital expenditures and changes in working capital 38 -------------------------------------------------------------------------------- requirements. Estimates of discounted cash flows may differ from actual cash flows due to, among other things, changes in economic conditions which are inherently uncertain, unpredictable, and do not reflect unanticipated events and circumstances that may occur, changes to business models, regulatory or political environment changes, changes in customer demand, changes in our weighted average cost of capital ("WACC"), or changes in operating performance. The discount rate applied to the estimated future cash flows is one of the most significant assumptions utilized under the income approach. We determine the appropriate discount rate for each reporting unit based on the WACC for each individual reporting unit. The WACC takes into account both the pre-tax cost of debt and cost of equity, as well as, company-specific risks associated with each reporting unit. The market approach estimates fair value by first determining earnings before interest, taxes, depreciation and amortization ("EBITDA") multiples for comparable publicly traded companies with similar characteristics of the reporting unit. The EBITDA multiples for comparable companies are based upon current enterprise value. The enterprise value is based upon current market capitalization and includes a control premium. We believe this approach is appropriate as it provides a fair value estimate using multiples from entities with operations and economic characteristics comparable to its reporting unit; however, past performance may not be indicative of future performance, especially in our current market environment. Certain of the inherent estimates and assumptions used in determining fair value of the reporting units are outside of the control of management. While the Company believes it has made reasonable estimates and assumptions to calculate the fair values of the reporting units, actual results may differ from those used in the Company's valuations and could result in impairment charges. The Company will continue to monitor its reporting units for any triggering events or other signs of impairment. The Company may be required to perform interim impairment tests based on changes in the economic environment, further sustained deterioration of the Company's market capitalization, and other factors in the future. During the first quarter of 2020, we performed an interim quantitative analysis as certain events, such as the COVID-19 pandemic and the unprecedented decline in oil prices, impacted our future revenues and cash flows and were deemed to be a triggering event. In performing the quantitative assessment, we estimated the fair value of each of our reporting units using a combination of the income and market approaches, which determined that the fair values were less than the respective carrying values for our Artificial Lift and Automation reporting units. Significant assumptions used in ourMarch 31, 2020 goodwill impairment review included: (i) WACC ranging from 14.5% to 16.5%; (ii) annual revenue growth rates generally ranging from (56%) to 42% in the short term and 3% to 25% in the long term; (iii) operating margins ranging from (11%) to 25% in the short term associated with market declines, but sustained or slightly increased gross margins long term; (iv) terminal values for each reporting unit using a long-term growth rate of 3%; and (v) peer group EBITDA multiples. As a result, we recorded a goodwill impairment charge totaling$616.3 million , which consisted of a$539.2 million charge in Artificial Lift and a$77.1 million charge in Automation. As part of our annual goodwill impairment analysis, onOctober 1 , we performed a qualitative goodwill impairment analysis for each of our legacy Apergy reporting units. We concluded that goodwill related to those reporting units was not impaired and further quantitative testing was not required. In addition, there were no negative conditions, or triggering events, that occurred subsequent to our annual goodwill impairment analysis requiring us to perform additional impairment reviews.
Accounting for Income Taxes
Our income tax expense, and deferred tax asset and liability balances reflect management's best assessment of estimated future taxes to be paid. We are subject to income taxes inthe United States and certain foreign jurisdictions. Significant judgments and estimates are required in determining our consolidated income tax expense. In determining our current income tax provision, we assess temporary differences resulting from differing treatments of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on our consolidated balance sheets. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. When we maintain deferred tax assets, we must assess the likelihood that these assets will be recovered through adjustments to future taxable income. To the extent we believe recovery is not likely, we establish a valuation allowance to reduce the asset to a value we believe will be recoverable based on our expectation of future taxable income. We believe the accounting estimate related to the valuation allowance is a critical accounting estimate because it is susceptible to change from period to period, requires management to make assumptions about our future income over the lives of the deferred tax assets, and because the impact of increasing or decreasing the valuation allowance is potentially material to our results of operations. The calculation of our income tax expense involves dealing with uncertainties in the application of complex tax laws and regulations in numerous jurisdictions in which we operate. We recognize tax benefits related to uncertain tax positions when, in our judgment, it is more likely than not that such positions will be sustained on examination, including resolutions of any related appeals or litigation, based on the technical merits. We adjust our liabilities for uncertain tax positions when our judgment changes as a result of new information previously unavailable. We routinely monitor the potential impact of these 39 -------------------------------------------------------------------------------- situations. The total amount of unrecognized tax benefits atDecember 31, 2020 was$0.9 million . The total balance of unrecognized tax benefit would impact the Company's future effective income tax rate if recognized.
Recently Issued Accounting Standards
See Note 2-New Accounting Standards in Part II, Item 8.-Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
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