ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. As used in this Form 10-Q, unless otherwise indicated or the context otherwise requires, all references to the “Company,” “MRC Global,” “we,” “our” or “us” refer to MRC Global Inc. and its consolidated subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
Management’s Discussion and Analysis of Financial Condition and Results of Operations (as well as other sections of this Quarterly Report on Form 10-Q) contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include those preceded by, followed by or including the words “will,” “expect,” “intended,” “anticipated,” “believe,” “project,” “forecast,” “propose,” “plan,” “estimate,” “enable” and similar expressions, including, for example, statements about our business strategy, our industry, our future profitability, growth in the industry sectors we serve, our expectations, beliefs, plans, strategies, objectives, prospects and assumptions, and estimates and projections of future activity and trends in the oil and natural gas industry. These forward-looking statements are not guarantees of future performance. These statements are based on management’s expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, most of which are difficult to predict and many of which are beyond our control, including the factors described under “Risk Factors,” that may cause our actual results and performance to be materially different from any future results or performance expressed or implied by these forward-looking statements. Such risks and uncertainties include, among other things:
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•
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decreases in oil and natural gas prices;
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•
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decreases in oil and natural gas industry expenditure levels, which may result from decreased oil and natural gas prices or other factors;
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U.S. and international general economic conditions;
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our ability to compete successfully with other companies in our industry;
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the risk that manufacturers of the products we distribute will sell a substantial amount of goods directly to end users in the industry sectors we serve;
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unexpected supply shortages;
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cost increases by our suppliers;
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our lack of long-term contracts with most of our suppliers;
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suppliers’ price reductions of products that we sell, which could cause the value of our inventory to decline;
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decreases in steel prices, which could significantly lower our profit;
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increases in steel prices, which we may be unable to pass along to our customers which could significantly lower our profit;
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our lack of long-term contracts with many of our customers and our lack of contracts with customers that require minimum purchase volumes;
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changes in our customer and product mix;
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risks related to our customers’ creditworthiness;
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the success of our acquisition strategies;
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the potential adverse effects associated with integrating acquisitions into our business and whether these acquisitions will yield their intended benefits;
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our significant indebtedness;
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the dependence on our subsidiaries for cash to meet our obligations;
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changes in our credit profile;
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a decline in demand for or adverse change in the value of certain of the products we distribute if tariffs and duties on these products are imposed or lifted;
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significant substitution of alternative fuels for oil and gas;
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environmental, health and safety laws and regulations and the interpretation or implementation thereof;
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the sufficiency of our insurance policies to cover losses, including liabilities arising from litigation;
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product liability claims against us;
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pending or future asbestos-related claims against us;
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the potential loss of key personnel;
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adverse health events, such as a pandemic;
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interruption in the proper functioning of our information systems;
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the occurrence of cybersecurity incidents;
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loss of third-party transportation providers;
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potential inability to obtain necessary capital;
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•
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risks related to adverse weather events or natural disasters;
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impairment of our goodwill or other intangible assets;
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adverse changes in political or economic conditions in the countries in which we operate;
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exposure to U.S. and international laws and regulations, including the Foreign Corrupt Practices Act and the U.K. Bribery Act and other economic sanctions programs;
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risks associated with international instability and geopolitical developments, including armed conflicts and terrorism;
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risks relating to ongoing evaluations of internal controls required by Section 404 of the Sarbanes-Oxley Act;
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our intention not to pay dividends; and
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risks related to changing laws and regulations, including trade policies and tariffs.
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Undue reliance should not be placed on our forward-looking statements. Although forward-looking statements reflect our good faith beliefs, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise, except to the extent law requires.
Overview
We are the largest distributor of pipe, valves and fittings (“PVF”) and other infrastructure products and services to the energy industry, based on sales. We provide innovative supply chain solutions and technical product expertise to customers globally through our leading position across each of our diversified end-markets including the upstream production (exploration, production and extraction of underground oil and gas), midstream pipeline (gathering and transmission of oil and gas), gas utilities and downstream and industrial (crude oil refining and petrochemical and chemical processing and general industrials) sectors. We offer over 200,000 SKUs, including an extensive array of PVF, oilfield supply, valve automation and modification, measurement, instrumentation and other general and specialty products from our global network of over 10,000 suppliers. With nearly 100 years of history, our approximate 2,850 employees serve over 13,000 customers through approximately 240 service locations including regional distribution centers, branches, corporate offices and third party pipe yards, where we often deploy pipe near customer locations. We seek to provide best-in-class service to our customers by satisfying the most complex, multi-site needs of many of the largest companies in the energy sector as their primary PVF supplier. We believe the critical role we play in our customers’ supply chain, together with our extensive product and service offerings, broad global presence, customer-linked scalable information systems and efficient distribution capabilities, serve to solidify our long-standing customer relationships and drive our growth. As a result, we have an average relationship of over 25 years with our 25 largest customers.
Key Drivers of Our Business
Our revenue is predominantly derived from the sale of PVF and other oilfield and industrial supplies to the energy sector globally. Our business is, therefore, dependent upon both the current conditions and future prospects in the energy industry and, in particular, maintenance and expansionary operating and capital expenditures by our customers in the upstream production, midstream pipeline, gas utilities and downstream and industrial sectors of the industry. Long-term growth in spending has been driven by several factors, including demand growth for petroleum and petroleum derived products, underinvestment in global energy infrastructure, growth in shale and unconventional exploration and production (“E&P”) activity, and anticipated strength in the oil, natural gas, refined products and petrochemical sectors. The outlook for future oil, natural gas, refined products and petrochemical PVF spending is influenced by numerous factors, including the following:
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Oil and Natural Gas Prices. Sales of PVF and related infrastructure products to the oil and natural gas industry constitute over 90% of our sales. As a result, we depend upon the oil and natural gas industry and its ability and willingness to make maintenance and capital expenditures to explore for, produce and process oil, natural gas and refined products. Oil and natural gas prices, both current and projected, along with the costs necessary to produce oil and gas, impact other drivers of our business, including capital spending by customers, additions to and maintenance of pipelines, refinery utilization and petrochemical processing activity.
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Economic Conditions. The demand for the products we distribute is dependent on the general economy, the energy sector and other factors. Changes in the general economy or in the energy sector (domestically or internationally) can cause demand for the products we distribute to materially change.
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Manufacturer and Distributor Inventory Levels of PVF and Related Products. Manufacturer and distributor inventory levels of PVF and related products can change significantly from period to period. Increased inventory levels by manufacturers or other distributors can cause an oversupply of PVF and related products in the industry sectors we serve and reduce the prices that we are able to charge for the products we distribute. Reduced prices, in turn, would likely reduce our profitability. Conversely, decreased manufacturer inventory levels may ultimately lead to increased demand for our products and would likely result in increased sales volumes and overall profitability.
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Steel Prices, Availability and Supply and Demand. Fluctuations in steel prices can lead to volatility in the pricing of the products we distribute, especially carbon steel line pipe products, which can influence the buying patterns of our customers. A majority of the products we distribute contain various types of steel. The worldwide supply and demand for these products, or other steel products that we do not supply, impacts the pricing and availability of our products and, ultimately, our sales and operating profitability.
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Recent Trends and Outlook
During the first six months of 2020, the average oil price of West Texas Intermediate (“WTI”) decreased to $36.58 per barrel from $57.39 per barrel in the first six months of 2019. Natural gas prices decreased to an average price of $1.80/MMBtu (Henry Hub) for the first six months of 2020 compared to $2.74/MMBtu (Henry Hub) for the first six months of 2019. North American drilling rig activity decreased 39% in the first six months of 2020 as compared to the first six months of 2019. U.S. well completions were down 36% in the first six months of 2020 compared to the same period in 2019.
The energy industry, and our business in turn, is cyclical in nature. In 2019, our customers demonstrated an increased focus on returns on invested capital, which drove a more disciplined approach to spending that continues to impact each of our business sectors. In the first half of 2020, demand for oil and natural gas declined sharply as a result of the coronavirus disease 2019 (“COVID-19”) pandemic. As various governments implemented COVID-19 isolation orders, transportation use declined, energy use declined and manufacturing declined. As a result, the need for oil consumption dropped dramatically. At the same time, the Organization of Petroleum Exporting Countries (“OPEC”) and other oil producing nations were initially unable to reach an agreement on oil production levels. This lack of agreement, between Saudi Arabia and Russia in particular, escalated concerns over the potential for oversupply of oil during a period of weakened demand thereby causing a significant, sustained decline in commodity prices. Major oil-producing nations did reduce oil production during the second quarter of 2020 to help offset the virus-related demand destruction but have recently announced their intention to start easing these cuts beginning in August 2020 due to current trends indicating a modest increase in oil demand. However, the expected level of oil demand in the near term is projected to be substantially lower than prior year levels. There remains significant uncertainty regarding the timing and extent of any recovery, including the possibility of a global recession or depression and any possible structural shift in the global economy and its demand for oil and natural gas as a result of changes in the way people work, travel and interact. As a result, spending plan estimates by sell-side research analysts indicate a decrease in oil and gas industry spending in 2020 of as much as 30% globally, including up to 50% in the U.S. upstream market. These reductions in spending directly impact both the upstream production and midstream pipeline components of our business. In addition, we have seen our customers in the downstream sector seek to defer turnarounds and routine maintenance and idle facilities in order to preserve liquidity and comply with COVID-19 related limitations on employee activities. Furthermore, approximately 80% of our business is concentrated in the U.S. market where the majority of industry spend reductions are occurring. Given these recent developments, the risk of resurgence of the COVID-19 virus and the continuing focus on capital discipline by oil and gas exploration and production operators, we experienced a sharp decline in sales during the second quarter of 2020 and expect the market to remain challenged until there is a step-change improvement related to COVID-19 concerns, improving the outlook for global oil demand.
Because of the challenging outlook for the remainder of 2020, we have taken a number of steps to further reduce our operating costs. These steps include the following:
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A voluntary early retirement program and an involuntary reduction in force to reduce headcount
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Ongoing freezes on hiring and compensation increases
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An indefinite suspension of the Company’s 401(k) matching contributions to its U.S. employees
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Reductions in annual bonus incentive targets and resulting payouts for both executive management and eligible employees
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A 30% reduction in equity grants to non-executive directors
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For eligible executives and employees, a reduction in the long-term incentive awards that the Company grants to them pursuant to the Company’s 2011 Omnibus Incentive Plan
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Management and employee furloughs
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Closure of certain branches and distribution centers where customer spending demand does not warrant continuation of those operations as we continue to adjust our distribution network as needed.
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Continued cost reductions and efficiency efforts throughout the Company
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In addition to these efforts, we are actively managing our investment in working capital to an appropriate level, which can allow us to generate cash and reduce our indebtedness.
During the second quarter of 2020, we closed 11 branches and took other actions to reduce our costs associated with leased branches. As a result of these actions, we incurred charges totaling $15 million related to impairment of right of use assets, lease abandonment and charges associated with contractual obligations under lease agreements. Through these branch closures and other reductions in force, we reduced headcount by over 300 employees during the second quarter of 2020. In connection with these reductions, we incurred severance costs of $7 million during the quarter. We continue to take actions to further reduce operating costs and have plans to close additional facilities and further reduce headcount in the third quarter. Additional severance, restructuring and closure costs may be incurred to complete these actions.
During the COVID-19 pandemic crisis, we have continued to operate our business. Our video and audio conferencing and enterprise resource planning and other operational systems have enabled our office employees to work from home, performing their job functions with minimal disruption or impact on our internal control environment. We required our employees to work from home as a result of governmental isolation orders and, in many cases, in advance of those orders for the health and safety of our employees. We have limited employee travel to local deliveries of our products. Our warehouses and regional distribution centers have remained open. Under various isolation orders by national, state, provincial and local governments, we have been exempted as an “essential” business as the products we sell are necessary for the maintenance and functioning of the energy infrastructure. We have taken measures to safeguard the health and welfare of our employees, including (among other things) social distancing measures while at work, certain screening, providing personal protection equipment such as face masks and hand sanitizer and providing “deep” cleaning services at Company facilities. Currently, of our approximate 2,850 employees, we have 27 employees with current cases of COVID-19. If we were to develop a COVID-19 hotspot at one of our facilities, we have plans to isolate those in contact with the impacted employees and to either staff the facility with employees from other facilities or supply product to customers from other facilities. We monitor guidelines of the Center for Disease Control ("CDC") and other authorities on an ongoing basis, and as various governmental isolation orders evolve, we continue to review our operational plans to continue operating our business while addressing the health and safety of our employees and those with whom our business comes into contact.
As a distribution business, we have also closely monitored the ability of our suppliers and transportation providers to continue the functioning of our supply chain, particularly in cases where there are limited alternative sources of supply. While there have been some temporary interruptions of manufacturing for some of our products, especially those who manufacture product or components in China, South Korea and Italy, many of these manufacturers have now resumed production. We have not experienced significant delays by transportation providers. Our inventory position for most products has allowed us to continue supply to most customers with little interruption. In those instances where there is interruption, we are working with our customers to discuss the impact of the COVID-19 delay. We continue to monitor the situation and have ongoing dialogue with our customers regarding the status of impacted orders.
In recent years, the United States imposed tariffs on imports of some products that we distribute. Although these actions generally cause the price we pay for products to increase, we are generally able to leverage long-standing relationships with our suppliers and the volume of our purchases to receive market competitive pricing. In addition, our contracts with customers generally allow us to react quickly to price increases through mechanisms that enable us to pass those increases along to customers as they occur. Of course, the price increases that tariffs and quotas engender may be offset by the pricing impacts of lower demand that the COVID-19 pandemic has caused. These issues are dynamic and continue to evolve. To the extent our products are further impacted by higher prices caused by tariffs and quotas, the ultimate impact on our revenue and cost of sales, which is determined using the last-in, first-out (“LIFO”) inventory costing methodology, remains subject to uncertainty and volatility.
Effective January 31, 2020, the United Kingdom formally exited the European Union (“EU”). Following the exit, there is a transition period until December 31, 2020. During the transition period, the U.K.'s trading relationship with the EU will remain the same while the two sides negotiate a free trade deal. At the same time, many other aspects of the U.K.'s future relationship with the EU - including law enforcement, data sharing and security - will also be negotiated. If a trade agreement is timely completed, the U.K.'s new trading relationship with the EU can begin immediately after the transition. If not, there would be no trade agreement, which could negatively impact our business, including any commodity pricing, transfer pricing and other cross border issues. However, we have a physical presence in both the U.K. and EU member states that would allow us to continue to operate and to serve our customers as needed. In 2019, 2.4% of our revenue was derived from our U.K. business.
We determine backlog by the amount of unshipped customer orders, either specific or general in nature, which the customer may revise or cancel in certain instances. The table below details our backlog by segment (in millions):
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June 30,
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December 31,
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June 30,
|
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2020
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2019
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|
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2019
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U.S.
|
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$
|
220
|
|
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$
|
301
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|
|
$
|
351
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|
Canada
|
|
|
22
|
|
|
|
34
|
|
|
|
39
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|
International
|
|
|
150
|
|
|
|
174
|
|
|
|
188
|
|
|
|
$
|
392
|
|
|
$
|
509
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|
|
$
|
578
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|
Approximately 3% of our June 30, 2019 ending backlog was associated with two customers in our U.S. segment. In addition, approximately 2% of our ending backlog for June 30, 2019 was associated with one customer in our International segment. In each case, these were related to significant customer projects that were substantially completed before the end of 2019. Excluding these projects, our backlog as of June 30, 2020 had decreased 23% and 28% from December 31, 2019 and June 30, 2019, respectively. There can be no assurance that the backlog amounts will ultimately be realized as revenue or that we will earn a profit on the backlog of orders, but we expect that substantially all of the sales in our backlog will be realized in the next twelve months.
The following table shows key industry indicators for the three and six months ended June 30, 2020 and 2019:
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Three Months Ended
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Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Average Rig Count (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
392
|
|
|
|
989
|
|
|
|
588
|
|
|
|
1,016
|
|
Canada
|
|
|
25
|
|
|
|
82
|
|
|
|
110
|
|
|
|
132
|
|
Total North America
|
|
|
417
|
|
|
|
1,071
|
|
|
|
698
|
|
|
|
1,148
|
|
International
|
|
|
834
|
|
|
|
1,109
|
|
|
|
954
|
|
|
|
1,069
|
|
Total
|
|
|
1,251
|
|
|
|
2,180
|
|
|
|
1,652
|
|
|
|
2,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Average Commodity Prices (2):
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|
|
|
|
|
|
|
|
|
|
|
|
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|
WTI crude oil (per barrel)
|
|
$
|
27.96
|
|
|
$
|
59.88
|
|
|
$
|
36.58
|
|
|
$
|
57.39
|
|
Brent crude oil (per barrel)
|
|
$
|
29.70
|
|
|
$
|
69.04
|
|
|
$
|
40.23
|
|
|
$
|
66.07
|
|
Natural gas ($/MMBtu)
|
|
$
|
1.70
|
|
|
$
|
2.57
|
|
|
$
|
1.80
|
|
|
$
|
2.74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Monthly U.S. Well Permits (3)
|
|
|
1,441
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|
|
|
4,887
|
|
|
|
1,844
|
|
|
|
5,363
|
|
U.S. Wells Completed (2)
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|
|
1,475
|
|
|
|
3,904
|
|
|
|
4,764
|
|
|
|
7,397
|
|
3:2:1 Crack Spread (4)
|
|
$
|
12.11
|
|
|
$
|
21.73
|
|
|
$
|
12.91
|
|
|
$
|
19.39
|
|
_______________________
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(1) Source-Baker Hughes (www.bhge.com) (Total rig count includes oil, natural gas and other rigs.)
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(2) Source-Department of Energy, EIA (www.eia.gov) (As revised)
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(3) Source-Evercore ISI Research
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(4) Source-Bloomberg
|
Results of Operations
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
The breakdown of our sales by sector for the three months ended June 30, 2020 and 2019 was as follows (in millions):
|
|
Three Months Ended
|
|
|
|
June 30, 2020
|
|
|
June 30, 2019
|
|
Upstream production
|
|
$
|
134
|
|
|
|
22
|
%
|
|
$
|
284
|
|
|
|
29
|
%
|
Midstream pipeline
|
|
|
87
|
|
|
|
15
|
%
|
|
|
174
|
|
|
|
18
|
%
|
Gas utilities
|
|
|
205
|
|
|
|
34
|
%
|
|
|
247
|
|
|
|
25
|
%
|
Downstream & industrial
|
|
|
176
|
|
|
|
29
|
%
|
|
|
279
|
|
|
|
28
|
%
|
|
|
$
|
602
|
|
|
|
100
|
%
|
|
$
|
984
|
|
|
|
100
|
%
|
For the three months ended June 30, 2020 and 2019, the following table summarizes our results of operations (in millions):
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
474
|
|
|
$
|
806
|
|
|
$
|
(332
|
)
|
|
|
(41
|
)%
|
Canada
|
|
|
28
|
|
|
|
58
|
|
|
|
(30
|
)
|
|
|
(52
|
)%
|
International
|
|
|
100
|
|
|
|
120
|
|
|
|
(20
|
)
|
|
|
(17
|
)%
|
Consolidated
|
|
$
|
602
|
|
|
$
|
984
|
|
|
$
|
(382
|
)
|
|
|
(39
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
(226
|
)
|
|
$
|
39
|
|
|
$
|
(265
|
)
|
|
N/M
|
|
Canada
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(2
|
)
|
|
N/M
|
|
International
|
|
|
(61
|
)
|
|
|
2
|
|
|
|
(63
|
)
|
|
N/M
|
|
Consolidated
|
|
|
(289
|
)
|
|
|
41
|
|
|
|
(330
|
)
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(7
|
)
|
|
|
(10
|
)
|
|
|
3
|
|
|
|
(30
|
)%
|
Other, net
|
|
|
(2
|
)
|
|
|
1
|
|
|
|
(3
|
)
|
|
N/M
|
|
Income tax benefit (expense)
|
|
|
17
|
|
|
|
(8
|
)
|
|
|
25
|
|
|
N/M
|
|
Net (loss) income
|
|
|
(281
|
)
|
|
|
24
|
|
|
|
(305
|
)
|
|
N/M
|
|
Series A preferred stock dividends
|
|
|
6
|
|
|
|
6
|
|
|
|
-
|
|
|
|
0
|
%
|
Net (loss) income attributable to common stockholders
|
|
$
|
(287
|
)
|
|
$
|
18
|
|
|
$
|
(305
|
)
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
79
|
|
|
$
|
174
|
|
|
$
|
(95
|
)
|
|
|
(55
|
)%
|
Adjusted Gross Profit (1)
|
|
$
|
118
|
|
|
$
|
190
|
|
|
$
|
(72
|
)
|
|
|
(38
|
)%
|
Adjusted EBITDA (1)
|
|
$
|
17
|
|
|
$
|
60
|
|
|
$
|
(43
|
)
|
|
|
(72
|
)%
|
(1) Adjusted Gross Profit and Adjusted EBITDA are non-GAAP financial measures. For a reconciliation of these measures to an equivalent GAAP measure, see pages 22-24 herein.
Sales. Our sales were $602 million for the three months ended June 30, 2020 as compared to $984 million for the three months ended June 30, 2019, a decrease of $382 million, or 39%. The weakening of foreign currencies in areas where we operate relative to the U.S. dollar unfavorably impacted sales by $7 million, or 1%.
U.S. Segment—Our U.S. sales decreased to $474 million for the three months ended June 30, 2020 from $806 million for the three months ended June 30, 2019. This $332 million, or 41%, decrease reflected a $122 million decrease in the upstream production sector, a $79 million decrease in the midstream pipeline sector, a $44 million decrease in the gas utilities sector and an $87 million decrease in the downstream and industrial sector. The decline in the upstream production sector is a result of reduced customer spending and resulting lower activity levels, including a 62% corresponding reduction in well completions. The decline in the midstream pipeline sector is attributable to reduced customer spending as well as the timing of project activity. The decline in gas utilities was primarily due to pandemic restrictions as customers paused spending. All sectors were negatively impacted by the economic slowdown resulting from the COVID-19 pandemic in the second quarter of 2020.
Canada Segment—Our Canada sales decreased to $28 million for the three months ended June 30, 2020 from $58 million for the three months ended June 30, 2019, a decrease of $30 million, or 52%. The decline reflected a $23 million decrease in the upstream production sector which was adversely affected by the COVID-19 pandemic and associated reduced demand. In addition, the midstream pipeline sector declined $6 million as a result of non-recurring project work. The weakening of the Canadian dollar relative to the U.S. dollar unfavorably impacted sales by $1 million, or 2%.
International Segment—Our International sales decreased to $100 million for the three months ended June 30, 2020 from $120 million for the same period in 2019. The $20 million, or 17%, decrease is, in part, attributable to the 2019 completion of a multi-year project in Kazakhstan. In addition, the weakening of foreign currencies in areas where we operate relative to the U.S. dollar which unfavorably impacted sales by $6 million, or 5%.
Gross Profit. Our gross profit was $79 million (13.1% of sales) for the three months ended June 30, 2020 as compared to $174 million (17.7% of sales) for the three months ended June 30, 2019. As compared to average cost, our LIFO inventory costing methodology reduced cost of sales by $6 million for the second quarter of 2020 compared to $1 million in the second quarter of 2019. In addition, gross profit for the three months ended June 30, 2020 was negatively impacted by $34 million of inventory-related charges.
Adjusted Gross Profit. Adjusted Gross Profit decreased to $118 million (19.6% of sales) for the three months ended June 30, 2020 from $190 million (19.3% of sales) for the three months ended June 30, 2019, a decrease of $72 million. Adjusted Gross Profit is a non-GAAP financial measure. We define Adjusted Gross Profit as sales, less cost of sales, plus depreciation and amortization, plus amortization of intangibles, plus inventory-related charges and plus or minus the impact of our LIFO inventory costing methodology. We present Adjusted Gross Profit because we believe it is a useful indicator of our operating performance without regard to items, such as amortization of intangibles, that can vary substantially from company to company depending upon the nature and extent of acquisitions. Similarly, the impact of the LIFO inventory costing method can cause results to vary substantially from company to company depending upon whether they elect to utilize LIFO and depending upon which method they may elect. We use Adjusted Gross Profit as a key performance indicator in managing our business. We believe that gross profit is the financial measure calculated and presented in accordance with U.S. generally accepted accounting principles that is most directly comparable to Adjusted Gross Profit.
The following table reconciles Adjusted Gross Profit, a non-GAAP financial measure, with gross profit, as derived from our financial statements (in millions):
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
Percentage
|
|
|
June 30,
|
|
|
Percentage
|
|
|
|
2020
|
|
|
of Revenue*
|
|
|
2019
|
|
|
of Revenue
|
|
Gross profit, as reported
|
|
$
|
79
|
|
|
|
13.1
|
%
|
|
$
|
174
|
|
|
|
17.7
|
%
|
Depreciation and amortization
|
|
|
5
|
|
|
|
0.8
|
%
|
|
|
6
|
|
|
|
0.6
|
%
|
Amortization of intangibles
|
|
|
6
|
|
|
|
1.0
|
%
|
|
|
11
|
|
|
|
1.1
|
%
|
Decrease in LIFO reserve
|
|
|
(6
|
)
|
|
|
(1.0
|
)%
|
|
|
(1
|
)
|
|
|
(0.1
|
)%
|
Inventory-related charges
|
|
|
34
|
|
|
|
5.6
|
%
|
|
|
-
|
|
|
|
0.0
|
%
|
Adjusted Gross Profit
|
|
$
|
118
|
|
|
|
19.6
|
%
|
|
$
|
190
|
|
|
|
19.3
|
%
|
* Does not foot due to rounding.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, General and Administrative (“SG&A”) Expenses. Our SG&A expenses were $126 million for the three months ended June 30, 2020 as compared to $133 million for the three months ended June 30, 2019. The $7 million decrease in SG&A was driven by lower employee-related costs, including incentives and benefits, resulting from the decline in business activity. These lower personnel costs were partially offset by $15 million of expenses associated with facilities closures in the three months ended June 30, 2020, and $7 million of severance and restructuring charges. Excluding these charges, SG&A would have been $104 million. The weakening of foreign currencies in areas where we operate outside of the U.S. dollar favorably impacted SG&A by $2 million.
Goodwill and Intangible Asset Impairment. In the first half of 2020, demand for oil and natural gas declined sharply as a result of the COVID-19 pandemic. This disruption in demand and the resulting decline in the price of oil has had a dramatic negative impact on our business. We experienced a significant reduction in sales beginning in April 2020 which continued throughout the second quarter. At this time, there remains ongoing uncertainty around the timing and extent of any recovery. We have taken a more pessimistic long-term outlook due to the significant reduction in the demand for oil, the implications of that demand destruction on the price of oil for an extended period of time and actions our customers have taken to curtail costs and reduce spending. As a result of these developments, we concluded that it was more likely than not the fair values of our U.S. and International reporting units were lower than their carrying values. Accordingly, we completed an interim goodwill impairment test as of April 30, 2020. This test resulted in a $217 million goodwill impairment charge comprised of $177 million in our U.S. reporting unit and $40 million in our International reporting unit.
As a result of the same factors that necessitated an interim impairment test for goodwill, we completed an interim impairment test for our U.S. indefinite-lived tradename asset. This test resulted in an impairment charge of $25 million. The remaining balance of the indefinite-lived tradename was $107 million as of June 30, 2020. The U.S. tradename is our only indefinite-lived intangible asset.
Operating(Loss) Income. Operating loss was $289 million for the three months ended June 30, 2020 as compared to operating income of $41 million for the three months ended June 30, 2019, a decline of $330 million.
U.S. Segment—Operating loss for our U.S. segment was $226 million for the three months ended June 30, 2020 compared to operating income of $39 million for the three months ended June 30, 2019, a $265 million decline. Operating loss for the second quarter of 2020 was impacted by $202 million of goodwill and intangible asset impairments, $19 million of inventory-related charges, $6 million of severance costs, and $2 million of costs associated with facility closures. Excluding these charges, operating income would have been $3 million, a decline of $36 million, which was driven by lower sales offset by a reduction in SG&A.
Canada Segment—Operating loss for our Canada segment was $2 million for the three months ended June 30, 2020 and 2019 as compared to $0 million for the three months ended June 30, 2019. The $2 million decline included $1 million of costs associated with facility closures.
International Segment—Operating loss for our international segment was $61 million for the three months ended June 30, 2020 as compared to operating income of $2 million for the three months ended June 30, 2019. The $63 million decline included $40 million of goodwill impairment charges, $14 million of inventory-related charges, $1 million of severance costs and $12 million of costs associated with facility closures. Excluding these charges, operating income would have been $6 million for the three months ended June 30, 2020.
Interest Expense. Our interest expense was $7 million and $10 million for the three months ended June 30, 2020 and 2019, respectively. The decrease in interest expense was attributable to lower average debt levels and interest rates during the second quarter of 2020 as compared to the second quarter of 2019.
Other, net. Our other expense was $2 million for the three months ended June 30, 2020 as compared to other income of $1 million for the three months ended June 30, 2019. Other expense in the second quarter of 2020 included $3 million of asset write-downs related to facility closures.
Income Tax (Benefit) Expense. Our income tax benefit was $17 million for the three months ended June 30, 2020 as compared to $8 million of expense for the three months ended June 30, 2019. We typically record income tax expense for interim periods based on estimated annual effective tax rates. However, due to the uncertainty in our industry and the effects of COVID-19, the income tax benefit for the three months ended June 30, 2020 was computed based on a year-to-date effective tax rate. We will return to utilizing an estimated annual effective tax rate when appropriate. Our effective tax rates were 6% and 25% for the three months ended June 30, 2020 and 2019, respectively. Our rates generally differ from the U.S. federal statutory rate of 21% as a result of state income taxes and differing foreign income tax rates. The effective tax rate for three months ended June 30, 2020 was lower primarily due to a non-tax deductible goodwill impairment charge during the quarter.
In response to COVID-19, President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) on March 27, 2020. The CARES Act provides numerous tax provisions and other stimulus measures that do not materially impact the Company’s deferred tax liability and its year-to-date effective tax rate. Given the uncertain outlook, we will continue to evaluate any future tax impacts resulting from the CARES Act.
Net (Loss) Income. Our net loss was $281 million for the three months ended June 30, 2020 as compared to net income of $24 million for the three months ended June 30, 2019, respectively.
Adjusted EBITDA. Adjusted EBITDA, a non-GAAP financial measure, was $17 million (2.8% of sales) for the three months ended June 30, 2020 as compared to $60 million (6.1% of sales) for the three months ended June 30, 2019.
We define Adjusted EBITDA as net income plus interest, income taxes, depreciation and amortization, amortization of intangibles and certain other expenses, including non-cash expenses (such as equity-based compensation, severance and restructuring, changes in the fair value of derivative instruments and asset impairments, including intangible assets and inventory) and plus or minus the impact of our LIFO inventory costing methodology.
We believe Adjusted EBITDA provides investors a helpful measure for comparing our operating performance with the performance of other companies that may have different financing and capital structures or tax rates. We believe it is a useful indicator of our operating performance without regard to items, such as amortization of intangibles, which can vary substantially from company to company depending upon the nature and extent of acquisitions. Similarly, the impact of the LIFO inventory costing method can cause results to vary substantially from company to company depending upon whether they elect to utilize LIFO and depending upon which method they may elect. We use Adjusted EBITDA as a key performance indicator in managing our business. We believe that net income is the financial measure calculated and presented in accordance with U.S. generally accepted accounting principles that is most directly comparable to Adjusted EBITDA.
The following table reconciles Adjusted EBITDA, a non-GAAP financial measure, with net income, as derived from our financial statements (in millions):
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Net (loss) income
|
|
$
|
(281
|
)
|
|
$
|
24
|
|
Income tax (benefit) expense
|
|
|
(17
|
)
|
|
|
8
|
|
Interest expense
|
|
|
7
|
|
|
|
10
|
|
Depreciation and amortization
|
|
|
5
|
|
|
|
6
|
|
Amortization of intangibles
|
|
|
6
|
|
|
|
11
|
|
Goodwill and intangible asset impairment
|
|
|
242
|
|
|
|
-
|
|
Inventory-related charges
|
|
|
34
|
|
|
|
-
|
|
Facility closures
|
|
|
18
|
|
|
|
-
|
|
Severance and restructuring
|
|
|
7
|
|
|
|
-
|
|
Decrease in LIFO reserve
|
|
|
(6
|
)
|
|
|
(1
|
)
|
Equity-based compensation expense
|
|
|
3
|
|
|
|
3
|
|
Foreign currency gains
|
|
|
(1
|
)
|
|
|
(1
|
)
|
Adjusted EBITDA
|
|
$
|
17
|
|
|
$
|
60
|
|
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
The breakdown of our sales by sector for the six months ended June 30, 2020 and 2019 was as follows (in millions):
|
|
Six Months Ended
|
|
|
|
June 30, 2020
|
|
|
June 30, 2019
|
|
Upstream production
|
|
$
|
356
|
|
|
|
25
|
%
|
|
$
|
596
|
|
|
|
31
|
%
|
Midstream pipeline
|
|
|
206
|
|
|
|
15
|
%
|
|
|
321
|
|
|
|
16
|
%
|
Gas utilities
|
|
|
407
|
|
|
|
29
|
%
|
|
|
461
|
|
|
|
24
|
%
|
Downstream & industrial
|
|
|
427
|
|
|
|
31
|
%
|
|
|
576
|
|
|
|
29
|
%
|
|
|
$
|
1,396
|
|
|
|
100
|
%
|
|
$
|
1,954
|
|
|
|
100
|
%
|
For the six months ended June 30, 2020 and 2019, the following table summarizes our results of operations (in millions):
|
|
Six Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
1,112
|
|
|
$
|
1,585
|
|
|
$
|
(473
|
)
|
|
|
(30
|
)%
|
Canada
|
|
|
78
|
|
|
|
126
|
|
|
|
(48
|
)
|
|
|
(38
|
)%
|
International
|
|
|
206
|
|
|
|
243
|
|
|
|
(37
|
)
|
|
|
(15
|
)%
|
Consolidated
|
|
$
|
1,396
|
|
|
$
|
1,954
|
|
|
$
|
(558
|
)
|
|
|
(29
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
|
|
$
|
(208
|
)
|
|
$
|
71
|
|
|
$
|
(279
|
)
|
|
N/M
|
|
Canada
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(2
|
)
|
|
N/M
|
|
International
|
|
|
(57
|
)
|
|
|
5
|
|
|
|
(62
|
)
|
|
N/M
|
|
Consolidated
|
|
|
(267
|
)
|
|
|
76
|
|
|
|
(343
|
)
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(15
|
)
|
|
|
(21
|
)
|
|
|
6
|
|
|
|
(29
|
)%
|
Other, net
|
|
|
(2
|
)
|
|
|
1
|
|
|
|
(3
|
)
|
|
N/M
|
|
Income tax benefit (expense)
|
|
|
12
|
|
|
|
(14
|
)
|
|
|
26
|
|
|
N/M
|
|
Net (loss) income
|
|
|
(272
|
)
|
|
|
42
|
|
|
|
(314
|
)
|
|
N/M
|
|
Series A preferred stock dividends
|
|
|
12
|
|
|
|
12
|
|
|
|
-
|
|
|
|
0
|
%
|
Net (loss) income attributable to common stockholders
|
|
$
|
(284
|
)
|
|
$
|
30
|
|
|
$
|
(314
|
)
|
|
N/M
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
227
|
|
|
$
|
348
|
|
|
$
|
(121
|
)
|
|
|
(35
|
)%
|
Adjusted Gross Profit (1)
|
|
$
|
275
|
|
|
$
|
380
|
|
|
$
|
(105
|
)
|
|
|
(28
|
)%
|
Adjusted EBITDA (1)
|
|
$
|
51
|
|
|
$
|
116
|
|
|
$
|
(65
|
)
|
|
|
(56
|
)%
|
(1) Adjusted Gross Profit and Adjusted EBITDA are non-GAAP financial measures. For a reconciliation of these measures to an equivalent GAAP measure, see pages 26-28 herein.
Sales. Our sales were $1,396 million for the six months ended June 30, 2020 as compared to $1,954 million for the six months ended June 30, 2019, a decrease of $558 million, or 29%. The weakening of foreign currencies in areas where we operate relative to the U.S. dollar unfavorably impacted sales by $13 million, or 1%.
U.S. Segment—Our U.S. sales decreased to $1,112 million for the six months ended June 30, 2020 from $1,585 million for the six months ended June 30, 2019. This $473 million, or 30%, decrease reflected a $189 million decrease in the upstream production sector, a $102 million decrease in the midstream pipeline sector, a $49 million decrease in the gas utilities sector and a $133 million decrease in the downstream and industrial sector. The decline in the upstream production sector is a result of reduced customer spending and resulting lower activity levels, including a 36% corresponding reduction in well completions. The decline in the midstream pipeline sector is attributable to reduced customer spending, as well as the timing of project activity. The decline in gas utilities was primarily due to pandemic restrictions as customers paused spending. All sectors were negatively impacted by the economic slowdown resulting from the COVID-19 pandemic which started in March 2020.
Canada Segment—Our Canada sales decreased to $78 million for the six months ended June 30, 2020 from $126 million for the six months ended June 30, 2019, a decrease of $48 million, or 38%. The decline reflected a $32 million decrease in the upstream production sector, which was adversely impacted by the COVID-19 pandemic and associated reduced demand. In addition, the midstream pipeline sector declined $8 million as a result of non-recurring project work.
International Segment—Our International sales decreased to $206 million for the six months ended June 30, 2020 from $243 million for the same period in 2019. The $37 million, or 15%, decrease is, in part, attributable to the 2019 completion of a multi-year project in Kazakhstan. In addition, the weakening of foreign currencies in areas where we operate relative to the U.S. dollar which unfavorably impacted sales by $12 million, or 5%.
Gross Profit. Our gross profit was $227 million (16.3% of sales) for the six months ended June 30, 2020 as compared to $348 million (17.8% of sales) for the six months ended June 30, 2019. As compared to average cost, our LIFO inventory costing methodology reduced cost of sales by $9 million for the first six months of 2020 compared to $1 million in the first six months of 2019. In addition, gross profit for the six months ended June 30, 2020 included $34 million of inventory-related charges.
Adjusted Gross Profit. Adjusted Gross Profit decreased to $275 million (19.7% of sales) for the six months ended June 30, 2020 from $380 million (19.4% of sales) for the six months ended June 30, 2019, a decrease of $105 million. Adjusted Gross Profit is a non-GAAP financial measure. We define Adjusted Gross Profit as sales, less cost of sales, plus depreciation and amortization, plus amortization of intangibles, plus inventory-related charges and plus or minus the impact of our LIFO inventory costing methodology. We present Adjusted Gross Profit because we believe it is a useful indicator of our operating performance without regard to items, such as amortization of intangibles, that can vary substantially from company to company depending upon the nature and extent of acquisitions. Similarly, the impact of the LIFO inventory costing method can cause results to vary substantially from company to company depending upon whether they elect to utilize LIFO and depending upon which method they may elect. We use Adjusted Gross Profit as a key performance indicator in managing our business. We believe that gross profit is the financial measure calculated and presented in accordance with U.S. generally accepted accounting principles that is most directly comparable to Adjusted Gross Profit.
The following table reconciles Adjusted Gross Profit, a non-GAAP financial measure, with gross profit, as derived from our financial statements (in millions):
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
Percentage
|
|
|
June 30,
|
|
|
Percentage
|
|
|
|
2020
|
|
|
of Revenue
|
|
|
2019
|
|
|
of Revenue
|
|
Gross profit, as reported
|
|
$
|
227
|
|
|
|
16.3
|
%
|
|
$
|
348
|
|
|
|
17.8
|
%
|
Depreciation and amortization
|
|
|
10
|
|
|
|
0.7
|
%
|
|
|
11
|
|
|
|
0.6
|
%
|
Amortization of intangibles
|
|
|
13
|
|
|
|
0.9
|
%
|
|
|
22
|
|
|
|
1.1
|
%
|
Decrease in LIFO reserve
|
|
|
(9
|
)
|
|
|
(0.6
|
)%
|
|
|
(1
|
)
|
|
|
(0.1
|
)%
|
Inventory-related charges
|
|
|
34
|
|
|
|
2.4
|
%
|
|
|
-
|
|
|
|
0.0
|
%
|
Adjusted Gross Profit
|
|
$
|
275
|
|
|
|
19.7
|
%
|
|
$
|
380
|
|
|
|
19.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, General and Administrative (“SG&A”) Expenses. Our SG&A expenses were $252 million for the six months ended June 30, 2020 as compared to $272 million for the six months ended June 30, 2019. The $20 million decrease in SG&A was driven by lower employee-related costs, including incentives and benefits, resulting from the decline in business activity. These lower personnel costs were partially offset by $15 million of expenses associated with facilities closures, and $7 million of severance and restructuring charges in the six months ended June 30, 2020. The weakening of foreign currencies in areas where we operate outside of the U.S. dollar favorably impacted SG&A by $3 million.
Goodwill and Intangible Asset Impairment. In the first half of 2020, demand for oil and natural gas declined sharply as a result of the COVID-19 pandemic. This disruption in demand and the resulting decline in the price of oil has had a dramatic negative impact on our business. We experienced a significant reduction in sales beginning in April 2020 which continued throughout the second quarter. At this time, there remains ongoing uncertainty around the timing and extent of any recovery. We have taken a more pessimistic long-term outlook due to the significant reduction in the demand for oil, the implications of that demand destruction on the price of oil for an extended period of time and actions our customers have taken to curtail costs and reduce spending. As a result of these developments, we concluded that it was more likely than not the fair values of our U.S. and International reporting units were lower than their carrying values. Accordingly, we completed an interim goodwill impairment test as of April 30, 2020. This test resulted in a $217 million goodwill impairment charge comprised of $177 million in our U.S. reporting unit and $40 million in our International reporting unit.
As a result of the same factors that necessitated an interim impairment test for goodwill, we completed an interim impairment test for our U.S. indefinite-lived tradename asset. This test resulted in an impairment charge of $25 million. The remaining balance of the indefinite-lived tradename was $107 million as of June 30, 2020. The U.S. tradename is our only indefinite-lived intangible asset.
Operating (Loss) Income
. Operating loss was
$267 million for the
six months ended June 30, 2020 as compared to operating income of
$76 million for the
six months ended June 30, 2019, a decline of
$343 million.
U.S. Segment—Operating loss for our U.S. segment was $208 million for the six months ended June 30, 2020 compared to operating income of $71 million for the six months ended June 30, 2019. The $279 million decline in the first half of 2020 was impacted by $202 million of goodwill and intangible asset impairments, $19 million of inventory-related charges, $6 million of severance costs, and $2 million of costs associated with facility closures. Excluding these charges, operating income would have been $21 million, a decline of $50 million, which was driven by lower sales offset by a reduction in SG&A.
Canada Segment—Operating loss for our Canada segment was $2 million for the six months ended June 30, 2020 compared to operating income of $0 million for the six months ended June 30, 2019. The $2 million decline included $1 million of costs associated with facility closures.
International Segment—Operating loss for our international segment was $57 million for the six months ended June 30, 2020 as compared to operating income of $5 million for the six months ended June 30, 2019. The $62 million decline included $40 million of goodwill impairment charges, $14 million of inventory-related charges, $1 million of severance and $12 million of cost associated with facility closures. Excluding these charges, operating income would have been $10 million which was primarily attributable to cost reductions that occurred in the fourth quarter of 2019.
Interest Expense. Our interest expense was $15 million and $21 million for the six months ended June 30, 2020 and 2019, respectively. The decrease in interest expense was attributable to lower average debt levels and interest rates during the first six months of 2020 as compared to the first six months of 2019.
Other, net. Our other expense was $2 million for the six months ended June 30, 2020 and other income of $1 million for the six months ended June 30, 2019. Other expense in the first six months of 2020 included $3 million of asset write-downs related to facility closures.
Income Tax (Benefit) Expense. Our income tax benefit was $12 million for the six months ended June 30, 2020 as compared to $14 million expense for the six months ended June 30, 2019. We typically record income tax expense for interim periods based on estimated annual effective tax rates. However, due to the uncertainty in our industry and the effects of COVID-19, the income tax expense for the six months ended June 30, 2020 was computed based on a year-to-date effective tax rate. We will return to utilizing an estimated annual effective tax rate when appropriate. Our effective tax rates were 4% and 25% for the six months ended June 30, 2020 and 2019, respectively. Our rates generally differ from the U.S. federal statutory rate of 21% as a result of state income taxes and differing foreign income tax rates. The effective tax rate for the six months ended June 30, 2020 was lower primarily due to a non-tax deductible goodwill impairment charge during the quarter.
The CARES Act provides numerous tax provisions and other stimulus measures that do not materially impact the Company’s deferred tax liability and its year-to-date effective tax rate. Given the uncertain outlook, we will continue to evaluate any future tax impacts resulting from the CARES Act.
Net (Loss) Income. We had a net loss of $272 million and net income of $42 million for the six months ended June 30, 2020 and 2019, respectively.
Adjusted EBITDA. Adjusted EBITDA, a non-GAAP financial measure, was $51 million (3.7% of sales) for the six months ended June 30, 2020 as compared to $116 million (5.9% of sales) for the six months ended June 30, 2019.
We define Adjusted EBITDA as net income plus interest, income taxes, depreciation and amortization, amortization of intangibles and certain other expenses, including non-cash expenses (such as equity-based compensation, severance and restructuring, changes in the fair value of derivative instruments and asset impairments, including intangible assets and inventory) and plus or minus the impact of our LIFO inventory costing methodology.
We believe Adjusted EBITDA provides investors a helpful measure for comparing our operating performance with the performance of other companies that may have different financing and capital structures or tax rates. We believe it is a useful indicator of our operating performance without regard to items, such as amortization of intangibles, which can vary substantially from company to company depending upon the nature and extent of acquisitions. Similarly, the impact of the LIFO inventory costing method can cause results to vary substantially from company to company depending upon whether they elect to utilize LIFO and depending upon which method they may elect. We use Adjusted EBITDA as a key performance indicator in managing our business. We believe that net income is the financial measure calculated and presented in accordance with U.S. generally accepted accounting principles that is most directly comparable to Adjusted EBITDA.
The following table reconciles Adjusted EBITDA, a non-GAAP financial measure, with net income, as derived from our financial statements (in millions):
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Net (loss) income
|
|
$
|
(272
|
)
|
|
$
|
42
|
|
Income tax (benefit) expense
|
|
|
(12
|
)
|
|
|
14
|
|
Interest expense
|
|
|
15
|
|
|
|
21
|
|
Depreciation and amortization
|
|
|
10
|
|
|
|
11
|
|
Amortization of intangibles
|
|
|
13
|
|
|
|
22
|
|
Goodwill and intangible asset impairment
|
|
|
242
|
|
|
|
-
|
|
Inventory-related charges
|
|
|
34
|
|
|
|
-
|
|
Facility closures
|
|
|
18
|
|
|
|
-
|
|
Severance and restructuring
|
|
|
7
|
|
|
|
-
|
|
Decrease in LIFO reserve
|
|
|
(9
|
)
|
|
|
(1
|
)
|
Equity-based compensation expense
|
|
|
5
|
|
|
|
7
|
|
Gain on early extinguishment of debt
|
|
|
(1
|
)
|
|
|
-
|
|
Foreign currency losses
|
|
|
1
|
|
|
|
-
|
|
Adjusted EBITDA
|
|
$
|
51
|
|
|
$
|
116
|
|
Liquidity and Capital Resources
Our primary credit facilities consist of a Term Loan maturing in September 2024 with an original principal amount of $400 million and an $800 million Global ABL Facility. As of June 30, 2020, the outstanding balance on our Term Loan, net of original issue discount and issuance costs, was $385 million. On an annual basis, we are required to repay an amount equal to 50% of excess cash flow, as defined in the Term Loan agreement, reducing to 25% if the Company’s senior secured leverage ratio is no more than 2.75 to 1.00. No payment of excess cash flow is required if the Company’s senior secured leverage ratio is less than or equal to 2.50 to 1.00. For the current year, as a result of declining profitability and the generation of positive cash flow from working capital contraction, we will likely be required to make a repayment by April 2021 pursuant to this provision. Any such payment would be sourced from cash on hand and availability on our Global ABL Facility. As such, the payment would reduce overall liquidity.
The Global ABL Facility matures in September 2022 and provides $675 million in revolver commitments in the United States, $65 million in Canada, $18 million in Norway, $15 million in Australia, $13 million in the Netherlands, $7 million in the United Kingdom and $7 million in Belgium. The Global ABL Facility contains an accordion feature that allows us to increase the principal amount of the facility by up to $200 million, subject to securing additional lender commitments. Availability is dependent on a borrowing base comprised of a percentage of eligible accounts receivable and inventory which is subject to redetermination from time to time. As of June 30, 2020, we had $89 million of borrowings outstanding and $411 million of Excess Availability, as defined under our Global ABL Facility. Including cash on hand of $19 million, total liquidity was $430 million.
Our primary sources of liquidity consist of cash generated from our operating activities, existing cash balances and borrowings under our Global ABL Facility. Our ability to generate sufficient cash flows from our operating activities will continue to be primarily dependent on our sales of products and services to our customers at margins sufficient to cover our fixed and variable expenses. As of June 30, 2020 and December 31, 2019, we had cash of $19 million and $32 million, respectively, substantially all of which was maintained in the accounts of our various foreign subsidiaries and, if transferred among countries or repatriated to the U.S., may be subject to additional tax liabilities, which would be recognized in our financial statements in the period during which the transfer decision was made.
Our credit ratings are below “investment grade” and, as such, could impact both our ability to raise new funds as well as the interest rates on our future borrowings. In the second quarter of 2020, Moody’s Investor Services and S&P Global Ratings downgraded our credit ratings, from B1 to B2 and B to B-, respectively, largely due to softening demand for our products due to the COVID-19 pandemic and the reduction in our customer’s spending outlook from unusually low oil and gas prices. Our existing obligations restrict our ability to incur additional debt. We were in compliance with the covenants contained in our various credit facilities as of and during the three months ended June 30, 2020 and, based on our current forecasts, we expect to remain in compliance. Our credit facilities contain provisions that address the potential need to transition away from LIBOR if LIBOR is discontinued or replaced.
We believe our sources of liquidity will be sufficient to satisfy the anticipated cash requirements associated with our existing operations for the foreseeable future. However, our future cash requirements could be higher than we currently expect as a result of various factors. Additionally, our ability to generate sufficient cash from our operating activities depends on our future performance, which is subject to general economic, political, financial, competitive and other factors beyond our control. We may, from time to time, seek to raise additional debt or equity financing or re-price or refinance existing debt in the public or private markets, based on market conditions. Any such capital markets activities would be subject to market conditions, reaching final agreement with lenders or investors, and other factors, and there can be no assurance that we would successfully consummate any such transactions.
Cash Flows
The following table sets forth our cash flows for the periods indicated below (in millions):
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Net cash provided by (used in) :
|
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
84
|
|
|
$
|
8
|
|
Investing activities
|
|
|
(5
|
)
|
|
|
(4
|
)
|
Financing activities
|
|
|
(90
|
)
|
|
|
(13
|
)
|
Net decrease in cash and cash equivalents
|
|
$
|
(11
|
)
|
|
$
|
(9
|
)
|
Operating Activities
Net cash provided by operating activities was $84 million during the six months ended June 30, 2020 compared to $8 million during the six months ended June 30, 2019. The change in operating cash flows was primarily the result of lower working capital requirements due to declining sales in the first six months of 2020 as compared to the first six months of 2019. A reduction in working capital provided cash of $48 million in the first six months of 2020 compared to $75 million used to grow working capital in the first six months of 2019. In particular, accounts receivable provided $69 million of cash in the first six months of 2020 compared to utilizing $47 million in the first six months of 2019. In addition, inventory provided $41 million of cash in the first six months of 2020 as compared to $0 million in the same period of 2019. The accounts receivable and inventory increase in cash were offset by $51 million of cash utilized by a decrease in accounts payable in the first six months of 2020 as compared to $2 million cash provided in the first three months of 2019.
Investing Activities
Net cash used in investing activities was primarily comprised of capital expenditures totaling $5 million and $6 million for the six months ended June 30, 2020 and 2019, respectively.
Financing Activities
Net cash used in financing activities was $90 million for the six months ended June 30, 2020 compared to $13 million for the six months ended June 30, 2019. In the first six months of 2020, we had net payments under revolving credit facilities of $71 million as compared to net borrowing of $56 million in the first six months of 2019. We used $50 million in the first six months of 2019 to fund purchases of our common stock. We used $12 million to pay dividends on preferred stock for the six months ended June 30, 2020 and 2019. In addition, we repurchased and retired $3 million of our outstanding Term Loan in March 2020.
Critical Accounting Policies
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expense in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in our results of operations for the period in which the actual amounts become known.
Accounting policies are considered critical when they require management to make assumptions about matters that are highly uncertain at the time the estimates are made and when there are different estimates that management reasonably could have made, which would have a material impact on the presentation of our financial condition, changes in our financial condition or results of operations. For a description of our critical accounting policies, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.