NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of the Business
ChampionX Corporation is a global leader in chemistry solutions and highly engineered equipment and technologies that help companies drill for and produce oil and gas safely, efficiently and sustainably around the world. Our products provide efficient and safe operations throughout the lifecycle of a well with a focus on the production phase of wells.
Unless the context requires otherwise, references in this report to “we,” “us,” “our,” “the Company,” or “ChampionX” mean ChampionX Corporation, together with our subsidiaries where the context requires.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of ChampionX have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) pertaining to interim financial information. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP have been condensed or omitted. Therefore, these financial statements should be read in conjunction with the audited consolidated financial statements, and notes thereto, which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Although these estimates are based on management’s best knowledge of current events and actions that we may undertake in the future, actual results may differ from our estimates. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments unless otherwise specified) necessary for a fair statement of our financial condition and results of operations as of and for the periods presented. Revenue, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these financial statements may not be representative of the results that may be expected for the year ending December 31, 2022.
Significant Accounting Policies
Please refer to “Note 1–Basis of Presentation and Summary of Significant Accounting Policies” to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 for the discussion of our significant accounting policies.
New Accounting Standards Issued
In September 2022, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2022-04, “Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations”, which requires that a buyer in a supplier finance program disclose information about the key terms of the program, outstanding confirmed amounts as of the end of the period, a rollforward of such amounts during each annual period, and a description of where in the financial statements outstanding amounts are presented. The ASU does not affect the recognition, measurement or financial statement presentation of obligations covered by supplier finance programs. The guidance is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023, with early adoption permitted. We are currently assessing the impact that this ASU will have on our disclosures and will adopt the amendments in this update upon the effective dates.
NOTE 2—SEGMENT INFORMATION
Our reporting segments are:
•Production Chemical Technologies—provides 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.
•Production & Automation Technologies—designs, manufactures, markets and services a full range of artificial lift equipment, end-to-end digital automation solutions, as well as other production equipment and asset monitoring technologies. Production & Automation Technologies’ products are sold under a collection of brands including Harbison-Fischer, Norris, Alberta Oil Tool, Oil Lift Technology, PCS Ferguson, Pro-Rod, Upco, Unbridled ESP, Scientific Aviation, Norriseal-Wellmark, Quartzdyne, Spirit, Theta, Timberline, Windrock, and Leak Surveys (“LSI”).
•Drilling Technologies—designs, manufactures and markets polycrystalline diamond cutters and bearings primarily for use in oil and gas drill bits under the US Synthetic brand.
•Reservoir Chemical Technologies—manufactures specialty products that support well stimulation, construction (including drilling and cementing) and well intervention in the oil and natural gas industry.
We refer to our Production Chemical Technologies segment and our Reservoir Chemical Technologies segment collectively as our Chemical Technologies business. Business activities that do not meet the criteria of an operating segment have been combined into Corporate and other. Corporate and other includes (i) corporate and overhead expenses, and (ii) revenue and costs for activities that are not operating segments.
Segment revenue and segment operating profit
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Segment revenue: | | | | | | | |
Production Chemical Technologies | $ | 643,604 | | | $ | 487,670 | | | $ | 1,710,987 | | | $ | 1,347,090 | |
Production & Automation Technologies | 247,717 | | | 204,473 | | | 710,465 | | | 559,491 | |
Drilling Technologies | 60,965 | | | 49,415 | | | 175,682 | | | 121,998 | |
Reservoir Chemical Technologies | 35,485 | | | 38,192 | | | 119,499 | | | 101,305 | |
Corporate and other (1) | 33,790 | | | 39,035 | | | 103,460 | | | 122,961 | |
Total revenue | $ | 1,021,561 | | | $ | 818,785 | | | $ | 2,820,093 | | | $ | 2,252,845 | |
| | | | | | | |
Segment operating profit (loss): | | | | | | | |
Production Chemical Technologies | $ | 86,649 | | | $ | 45,696 | | | $ | 143,518 | | | $ | 109,924 | |
Production & Automation Technologies | 22,485 | | | 14,407 | | | 70,845 | | | 32,061 | |
Drilling Technologies | 14,856 | | | 11,146 | | | 45,119 | | | 21,400 | |
Reservoir Chemical Technologies | (61,711) | | | 37,800 | | | (73,327) | | | 31,979 | |
Total segment operating profit | 62,279 | | | 109,049 | | | 186,155 | | | 195,364 | |
Corporate and other (1) | 13,354 | | | 11,639 | | | 43,044 | | | 51,751 | |
Interest expense, net | 11,454 | | | 12,849 | | | 33,582 | | | 40,884 | |
Income before income taxes | $ | 37,471 | | | $ | 84,561 | | | $ | 109,529 | | | $ | 102,729 | |
_______________________
(1) Corporate and other includes costs not directly attributable or allocated to our reporting segments such as corporate executive management and other administrative functions, and the results attributable to our noncontrolling interest. Additionally, the sales and expenses related to the Cross Supply and Product Transfer Agreement with Ecolab Inc. (“Ecolab”) are included within Corporate and other.
NOTE 3—REVENUE
Our revenue is generated primarily from product sales. Service revenue is generated from providing services to our customers. These services include installation, repair and maintenance, laboratory and logistics services, chemical management services, troubleshooting, reporting, water treatment services, technical advisory assistance, emissions detection and monitoring, and other field services. Lease revenue is derived from rental income of leased production equipment. As our costs are shared across the various revenue categories, cost of goods sold is not tracked separately and is not discretely identifiable.
In certain geographical areas, the Company utilizes joint ventures and independent third-party distributors and sales agents to sell and market products and services. Amounts payable to independent third-party distributors and sales agents may fluctuate based on sales and timing of distributor fee payments. For services rendered by such independent third-party distributors and sales agents, the Company records the consideration received on a net basis within product revenue in our condensed consolidated statements of income. Additionally, amounts owed to distributors and sales agents are reported within accrued distributor fees within our condensed consolidated balance sheets.
Revenue disaggregated by geography was as follows:
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| Three Months Ended September 30, 2022 |
(in thousands) | Production Chemical Technologies | | Production & Automation Technologies | | Drilling Technologies | | Reservoir Chemical Technologies | | Corporate and other (1) | | Total |
United States | $ | 228,007 | | | $ | 192,914 | | | $ | 47,645 | | | $ | 19,756 | | | $ | 19,651 | | | $ | 507,973 | |
Latin America | 184,964 | | | 4,963 | | | 7 | | | 3,283 | | | 758 | | | 193,975 | |
Middle East & Africa | 77,162 | | | 15,567 | | | 1,562 | | | 8,314 | | | 1,358 | | | 103,963 | |
Canada | 75,334 | | | 18,922 | | | 4,614 | | | 334 | | | 49 | | | 99,253 | |
Europe | 50,206 | | | 2,776 | | | 5,774 | | | 1,102 | | | 3,584 | | | 63,442 | |
Asia-Pacific | 8,851 | | | 1,528 | | | 1,363 | | | 767 | | | 8,390 | | | 20,899 | |
Australia | 5,518 | | | 10,803 | | | — | | | 30 | | | — | | | 16,351 | |
Other | 13,562 | | | 244 | | | — | | | 1,899 | | | — | | | 15,705 | |
Total revenue | $ | 643,604 | | | $ | 247,717 | | | $ | 60,965 | | | $ | 35,485 | | | $ | 33,790 | | | $ | 1,021,561 | |
| | | | | | | | | | | |
| Three Months Ended September 30, 2021 |
(in thousands) | Production Chemical Technologies | | Production & Automation Technologies | | Drilling Technologies | | Reservoir Chemical Technologies | | Corporate and other (1) | | Total |
United States | $ | 163,184 | | | $ | 158,534 | | | $ | 37,716 | | | $ | 26,332 | | | $ | 26,890 | | | $ | 412,656 | |
Latin America | 110,592 | | | 4,752 | | | — | | | 3,410 | | | 1,048 | | | 119,802 | |
Middle East & Africa | 66,584 | | | 14,243 | | | 1,582 | | | 4,958 | | | 1,467 | | | 88,834 | |
Canada | 68,907 | | | 14,922 | | | 3,697 | | | 662 | | | 43 | | | 88,231 | |
Europe | 47,891 | | | 731 | | | 4,459 | | | 930 | | | 3,529 | | | 57,540 | |
Asia-Pacific | 11,703 | | | 1,853 | | | 1,945 | | | 1,113 | | | 6,058 | | | 22,672 | |
Australia | 8,693 | | | 9,393 | | | — | | | 28 | | | — | | | 18,114 | |
Other | 10,116 | | | 45 | | | 16 | | | 759 | | | — | | | 10,936 | |
Total revenue | $ | 487,670 | | | $ | 204,473 | | | $ | 49,415 | | | $ | 38,192 | | | $ | 39,035 | | | $ | 818,785 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, 2022 |
(in thousands) | Production Chemical Technologies | | Production & Automation Technologies | | Drilling Technologies | | Reservoir Chemical Technologies | | Corporate and other (1) | | Total |
United States | $ | 624,370 | | | $ | 548,698 | | | $ | 140,312 | | | $ | 76,015 | | | $ | 61,544 | | | $ | 1,450,939 | |
Latin America | 409,109 | | | 16,324 | | | 7 | | | 10,094 | | | 2,388 | | | 437,922 | |
Middle East & Africa | 227,234 | | | 51,340 | | | 4,471 | | | 21,596 | | | 1,959 | | | 306,600 | |
Canada | 223,714 | | | 55,858 | | | 11,032 | | | 1,445 | | | 112 | | | 292,161 | |
Europe | 145,116 | | | 8,505 | | | 14,640 | | | 2,973 | | | 10,352 | | | 181,586 | |
Asia-Pacific | 26,852 | | | 3,983 | | | 5,180 | | | 2,721 | | | 27,105 | | | 65,841 | |
Australia | 16,321 | | | 25,386 | | | 15 | | | 229 | | | — | | | 41,951 | |
Other | 38,271 | | | 371 | | | 25 | | | 4,426 | | | — | | | 43,093 | |
Total revenue | $ | 1,710,987 | | | $ | 710,465 | | | $ | 175,682 | | | $ | 119,499 | | | $ | 103,460 | | | $ | 2,820,093 | |
| | | | | | | | | | | |
| Nine Months Ended September 30, 2021 |
(in thousands) | Production Chemical Technologies | | Production & Automation Technologies | | Drilling Technologies | | Reservoir Chemical Technologies | | Corporate and other (1) | | Total |
United States | $ | 469,900 | | | $ | 426,246 | | | $ | 93,515 | | | $ | 61,530 | | | $ | 83,132 | | | $ | 1,134,323 | |
Latin America | 275,597 | | | 13,924 | | | — | | | 10,016 | | | 3,740 | | | 303,277 | |
Middle East & Africa | 191,167 | | | 38,346 | | | 3,744 | | | 17,554 | | | 8,534 | | | 259,345 | |
Canada | 193,838 | | | 42,204 | | | 9,510 | | | 1,768 | | | 325 | | | 247,645 | |
Europe | 131,545 | | | 4,504 | | | 9,236 | | | 3,420 | | | 9,476 | | | 158,181 | |
Asia-Pacific | 32,757 | | | 6,059 | | | 4,351 | | | 3,626 | | | 17,754 | | | 64,547 | |
Australia | 21,082 | | | 28,151 | | | 130 | | | 112 | | | — | | | 49,475 | |
Other | 31,204 | | | 57 | | | 1,512 | | | 3,279 | | | — | | | 36,052 | |
Total revenue | $ | 1,347,090 | | | $ | 559,491 | | | $ | 121,998 | | | $ | 101,305 | | | $ | 122,961 | | | $ | 2,252,845 | |
______________________
(1) Revenues associated with sales under the Cross Supply and Product Transfer Agreement with Ecolab are included within Corporate and other.
Revenue is attributed to regions based on the location of our direct customer, which in some instances is an intermediary and not necessarily the end user.
Contract Balances
The beginning and ending contract asset and contract liability balances from contracts with customers were as follows: | | | | | | | | | | | |
(in thousands) | September 30, 2022 | | December 31, 2021 |
Contract assets | $ | — | | | $ | — | |
Contract liabilities - current | $ | 13,660 | | | $ | 15,246 | |
NOTE 4—INTANGIBLE ASSETS AND GOODWILL
Intangible Assets
The components of our definite- and indefinite-lived intangible assets were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
(in thousands) | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Definite-lived intangible assets: | | | | | | | | | | | |
Customer relationships | $ | 581,504 | | | $ | 395,810 | | | $ | 185,694 | | | $ | 593,242 | | | $ | 365,773 | | | $ | 227,469 | |
Unpatented technologies | 142,845 | | | 51,624 | | | 91,221 | | | 142,540 | | | 37,264 | | | 105,276 | |
Favorable supply agreements | 57,000 | | | 44,290 | | | 12,710 | | | 59,000 | | | 30,546 | | | 28,454 | |
Trademarks | 59,852 | | | 35,095 | | | 24,757 | | | 59,873 | | | 32,270 | | | 27,603 | |
Patents | 38,025 | | | 31,100 | | | 6,925 | | | 38,735 | | | 31,080 | | | 7,655 | |
Other | 5,242 | | | 5,193 | | | 49 | | | 5,390 | | | 5,177 | | | 213 | |
| 884,468 | | | 563,112 | | | 321,356 | | | 898,780 | | | 502,110 | | | 396,670 | |
Indefinite-lived intangible assets: | | | | | | | | | | | |
Trademarks | 3,600 | | | — | | | 3,600 | | | 3,600 | | | — | | | 3,600 | |
In-process research and development | 1,200 | | | — | | | 1,200 | | | 1,200 | | | — | | | 1,200 | |
| 4,800 | | | — | | | 4,800 | | | 4,800 | | | — | | | 4,800 | |
Total | $ | 889,268 | | | $ | 563,112 | | | $ | 326,156 | | | $ | 903,580 | | | $ | 502,110 | | | $ | 401,470 | |
Goodwill
The carrying amount of goodwill, including changes therein, by reportable segment is below:
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(in thousands) | Production Chemical Technologies | | Production & Automation Technologies | | Drilling Technologies | | Reservoir Chemical Technologies | | Total |
December 31, 2021 | $ | 356,638 | | | $ | 205,467 | | | $ | 101,136 | | | $ | 39,626 | | | $ | 702,867 | |
Acquisition (1) | — | | | 6,345 | | | — | | | — | | | 6,345 | |
Allocated to disposal group (2) | (3,271) | | | — | | | — | | | — | | | (3,271) | |
| | | | | | | | | |
Foreign currency translation | 3,192 | | | (665) | | | — | | | (8) | | | 2,519 | |
September 30, 2022 | $ | 356,559 | | | $ | 211,147 | | | $ | 101,136 | | | $ | 39,618 | | | $ | 708,460 | |
_______________________
(1) See Note 11—Acquisitions and Divestitures for additional information related to the acquisition of LSI completed during the first quarter of 2022.
(2) See Note 11—Acquisitions and Divestitures for additional information on the reclassification of assets and liabilities held for sale as part of the planned divestiture of our operations in Russia.
Goodwill is not subject to amortization but is tested for impairment on an annual basis or more frequently if impairment indicators arise.
NOTE 5—DEBT
Long-term debt consisted of the following:
| | | | | | | | | | | |
(in thousands) | September 30, 2022 | | December 31, 2021 |
2022 Revolving Credit Facility | $ | 45,000 | | | $ | — | |
2018 Term Loan Facility | — | | | 140,000 | |
2020 Term Loan Facility | — | | | 496,725 | |
2022 Term Loan Facility | 625,000 | | | — | |
6.375% Senior Notes due 2026 | — | | | 92,041 | |
Total | 670,000 | | | 728,766 | |
Net unamortized discounts and issuance costs | (21,283) | | | (4,259) | |
Total long-term debt | 648,717 | | | 724,507 | |
Current portion of long-term debt (1) | (4,688) | | | (26,850) | |
Long-term debt, less current portion | $ | 644,029 | | | $ | 697,657 | |
_______________________
(1) Represents the mandatory amortization payments due within twelve months related to the 2022 Term Loan Facility as of September 30, 2022 and 2020 Term Loan Facility as of December 31, 2021.
On May 9, 2018, we entered into a credit agreement (“Credit Agreement”) governing the terms of, among other things, a 7-year senior secured term loan B facility that had an initial commitment of $415 million (the “2018 Term Loan Facility”), and on June 3, 2020, ChampionX Holding Inc. entered into a term loan facility for $537.0 million (the “2020 Term Loan Facility”).
On June 7, 2022, we entered into a restated credit agreement (the “Restated Credit Agreement”), which amends and restates the Credit Agreement. The Restated Credit Agreement provides for (i) a $625 million 7-year senior secured term loan B facility (the “2022 Term Loan Facility”) and (ii) a five-year senior secured revolving credit facility in an aggregate principal amount of $700 million, of which $100 million is available for the issuance of letters of credit (the “2022 Revolving Credit Facility,” together with the 2022 Term Loan Facility, the “Senior Secured Credit Facility”). The full amount of the 2022 Term Loan Facility was funded, and $135 million of the 2022 Revolving Credit Facility was drawn, on June 7, 2022, with the aggregate proceeds used to repay outstanding amounts under our Credit Agreement, repay and terminate our 2020 Term Loan Facility, and to redeem all outstanding 6.375% Senior Notes due 2026 (the “Notes”). Proceeds from future borrowings under the 2022 Revolving Credit Facility are expected to be used for working capital and general corporate purposes. The initial amount drawn on the 2022 Revolving Credit Facility has been repaid. As of September 30, 2022, we had $45.0 million outstanding on the 2022 Revolving Credit Facility.
The 2022 Term Loan Facility matures June 7, 2029 and the 2022 Revolving Credit Facility matures June 7, 2027. The 2022 Term Loan Facility is subject to mandatory amortization payments of 1% per annum of the initial commitment paid quarterly, which begins on December 30, 2022. The Senior Secured Credit Facility contains customary representations and warranties, covenants, and events of default for loan facilities of this type. We were in compliance with all covenants as of September 30, 2022.
At the Company’s election, outstanding borrowings under the Senior Secured Credit Facility will accrue interest at a per annum rate of (i) an adjusted SOFR rate plus the applicable spread or (ii) a base rate plus the applicable spread. On June 29, 2022, the Company executed a five-year amortizing floating-to-fixed interest rate swap to hedge our exposure to increases in variable interest rates on the 2022 Term Loan Facility. This interest rate swap agreement is based on a $300 million notional amount for the first three years, reducing to $150 million for years four and five. See Note 13—Derivatives and Hedging Transactions for additional information on interest rate swaps.
In connection with the Restated Credit Agreement, as noted above, we completed the redemption of all of the remaining Notes at 103.188% of the principal amount thereof. We redeemed $92.0 million in aggregate principal amount of the Notes for $95.6 million in cash, including $0.6 million in accrued interest. In connection with these redemptions, we recognized a net loss of approximately $3.9 million for the nine months ended September 30, 2022, inclusive of the write off of the remaining unamortized debt financing costs related to the Notes, which is included in other expense, net in our condensed consolidated statements of income (loss).
NOTE 6—COMMITMENTS AND CONTINGENCIES
Guarantees and Indemnifications
We have provided indemnities in connection with sales of certain businesses and assets, including indemnities for environmental health and safety, tax, and employment matters. We do not have any material liabilities recorded for these indemnifications and are not aware of any claims or other information that would give rise to material payments under such indemnities.
In connection with the Company’s separation from Dover Corporation (“Dover”) in 2018, we entered into agreements with Dover that govern the treatment between Dover and us for certain indemnification matters and litigation responsibility. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and to place financial responsibility for the obligations and liabilities of Dover’s business with Dover. The separation and distribution agreement also establishes procedures for handling claims subject to indemnification and related matters.
In connection with the acquisition of the Chemical Technologies business from Ecolab in 2020 (the “Merger”), we entered into agreements with Ecolab that govern the treatment between Ecolab and us for certain indemnification matters and litigation responsibility. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and to place financial responsibility for the obligations and liabilities of Ecolab’s business with Ecolab. The separation and distribution agreement also establishes procedures for handling claims subject to indemnification and related matters. In addition, pursuant to the tax matters agreement relating to the Merger (the “Tax Matters Agreement”), we have agreed to indemnify Ecolab and its affiliates for (i) all taxes for which ChampionX is responsible as defined within the Tax Matters Agreement, (ii) all taxes resulting from a breach by ChampionX of any of its representations (but only to the extent relating to a breach occurring after the consummation of the Merger) or any of its covenants under the Tax Matters Agreement, (iii) all taxes resulting from an acquisition after the Merger of any of the stock or assets of ChampionX, other than as a result of the Merger or a repayment of the 2018 Credit Facility (as defined in “Note 8–Debt” to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2021), 2018 Term Loan Facility or 2020 Term Loan Facility and (iv) reasonable costs and expenses (including reasonable attorneys’ fees and expenses) related to the foregoing.
As of September 30, 2022 and December 31, 2021, we had $73.0 million and $80.2 million, respectively, of outstanding letters of credit, surety bonds and guarantees, which expire at various dates through 2039. 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, surety bonds, and guarantees in the event of default in the performance of our obligations, the probability of which we believe is remote.
Litigation and Environmental Matters
The Company is party to various proceedings and claims incidental to its business, including matters arising under provisions relating to the protection of the environment. We review the probable outcome of such proceedings, the costs and expenses reasonably expected to be incurred and accrued to date, and the availability and extent of insurance coverage. We accrue a liability for legal matters that are probable and can be reasonably estimated. If the reasonable estimate of a probable loss is a range, the Company records the most probable estimate of the loss or the minimum amount when no amount within the range is a better estimate than any other amount. While many of these matters involve inherent uncertainty, we believe that the amount of the liability, if any, ultimately incurred with respect to these proceedings and claims will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Environmental Matters
The Company is currently participating in environmental assessments and remediation at approximately 11 locations, the majority of which are in the United States (“U.S.”), and environmental liabilities have been accrued reflecting our best estimate of future costs. Potential insurance reimbursements are not anticipated in the Company’s accruals for environmental liabilities. As of September 30, 2022 and December 31, 2021, environmental liability accruals related to these locations were $6.1 million and $6.8 million, respectively.
Prior to the separation from Dover in 2018, groundwater contamination was discovered at the Norris Sucker Rods plant site located in Tulsa, Oklahoma (“Norris”). Initial remedial efforts were undertaken at the time of discovery of the contamination and Norris has since coordinated monitoring and remediation with the Oklahoma Department of Environmental Quality (“ODEQ”). As part of the ongoing long-term remediation process, Norris contracted an engineering and consulting firm to
develop a range of possible additional remedial alternatives in order to accelerate the remediation process and associated cost estimates for the work. In October 2019, we received the firm’s preliminary remedial alternatives for consideration. We have submitted our long-term remediation plan and it was approved by ODEQ. We are now in discussion with ODEQ to finalize a consent order. Because we have not yet finalized the consent order for further remediation at the site and discussions with ODEQ remain ongoing, we cannot fully anticipate the timing, outcome or possible impact of such further remedial activities, financial or otherwise. As a result of the recommendations in the report, we accrued liabilities for these remediation efforts of approximately $2.0 million as of December 31, 2019. Liabilities could increase in the future at such time as we ultimately reach agreement with ODEQ on our remediation plan and such liabilities become probable and can be reasonably estimated; however, there have been no changes to our estimated liability as of September 30, 2022.
Matters Related to Deepwater Horizon Incident Response
On April 22, 2010, the deepwater drilling platform, the Deepwater Horizon, operated by a subsidiary of BP plc, sank in the Gulf of Mexico after an explosion and fire, resulting in a massive oil spill. Certain entities that are now subsidiaries of ChampionX as a result of the Merger (collectively the “COREXIT Defendants”) supplied COREXIT™ 9500, an oil dispersant product listed on the U.S. EPA National Contingency Plan Product Schedule, which was used in the response to the spill. In connection with the provision of COREXIT™ 9500, the COREXIT Defendants were named in several lawsuits. Cases arising out of the Deepwater Horizon accident were administratively transferred and consolidated for pre-trial purposes under In Re: Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mexico, on April 20, 2010, Case No. 10-md-02179 in the United States District Court in the Eastern District of Louisiana (E.D. La.) (“MDL 2179”). Claims related to the response to the oil spill were consolidated in a master complaint captioned the “B3 Master Complaint.” In 2011, Transocean Deepwater Drilling, Inc. and its affiliates (the “Transocean Entities”) named the COREXIT Defendants and other unaffiliated companies as first party defendants (In re the Complaint and Petition of Triton Asset Leasing GmbH, et al, MDL No. 2179, Civil Action 10-2771). In April and May 2011, the Transocean Entities, Cameron International Corporation, Halliburton Energy Services, Inc., M-I L.L.C., Weatherford U.S., L.P. and Weatherford International, Inc. (collectively, the “Cross Claimants”) filed cross claims in MDL 2179 against the COREXIT Defendants and other unaffiliated cross defendants. In April and June 2011, in support of its defense of the claims against it, the COREXIT Defendants filed counterclaims against the Cross Claimants. On May 18, 2012, the COREXIT Defendants filed a motion for summary judgment as to the claims in the B3 Master Complaint. On November 28, 2012, the Court granted the COREXIT Defendants’ motion and dismissed with prejudice the claims in the B3 Master Complaint asserted against the COREXIT Defendants. There currently remain two “B3” cases that had asserted claims against the COREXIT Defendants and that remain pending against other defendants. Because the Court’s decision was not a “final judgment” for purposes of appeal with respect to those claims, under Federal Rule of Appellate Procedure 4(a), plaintiffs will have 30 days after entry of final judgment in each case to appeal the Court’s summary judgment decision.
The Company believes the claims asserted against the COREXIT Defendants are without merit and intends to defend these lawsuits vigorously. The Company also believes that it has rights to contribution and/or indemnification (including legal expenses) from third parties. However, we cannot predict the outcome of these lawsuits, the involvement it might have in these matters in the future, or the potential for future litigation.
NOTE 7—RESTRUCTURING AND OTHER RELATED CHARGES
We approved various restructuring plans related to the consolidation of product lines and associated facility closures and workforce reductions during the current and prior periods. During the second quarter of 2022, the restructuring plans included the exit of one of our product lines within the Reservoir Chemical Technologies segment. The exit of this product line was completed during the third quarter of 2022 and as such, we recognized additional restructuring charges primarily related to certain contract termination costs as well as the exit of facilities. Liabilities for these contract termination costs are recognized and measured at fair value in the period in which we cease using the rights conveyed by the existing contracts. The liability will be paid out over the remaining term of the contracts, ranging from approximately 1 – 8 years.
We recognized charges of $69.8 million and $84.9 million during the three and nine months ended September 30, 2022, respectively, consisting primarily of contract termination costs, employee severance and related benefits, disposals of equipment and warehouse closures, partially offset by gains realized on the sale of facilities. During the three and nine months ended September 30, 2021, we recorded restructuring and other charges of $2.1 million and $10.1 million, respectively.
The following table presents the restructuring and other related charges by segment as classified in our condensed consolidated statements of income.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Segment restructuring charges (income): | | | | | | | |
Production Chemical Technologies | $ | (335) | | | $ | 1,031 | | | $ | 11,637 | | | $ | 4,822 | |
Production & Automation Technologies | 4,282 | | | 947 | | | 260 | | | 4,903 | |
Drilling Technologies | — | | | — | | | — | | | — | |
Reservoir Chemical Technologies | 63,458 | | | 65 | | | 69,559 | | | 307 | |
Corporate and other | 2,350 | | | 44 | | | 3,403 | | | 86 | |
Total | $ | 69,755 | | | $ | 2,087 | | | $ | 84,859 | | | $ | 10,118 | |
| | | | | | | |
Statements of Income classification: | | | | | | | |
Cost of goods and services | $ | 66,488 | | | $ | 802 | | | $ | 67,496 | | | $ | 4,708 | |
Selling, general and administrative expense | 3,267 | | | 1,285 | | | 17,363 | | | 5,410 | |
Total | $ | 69,755 | | | $ | 2,087 | | | $ | 84,859 | | | $ | 10,118 | |
Our liability balance for restructuring and other related charges at September 30, 2022 reflects contract termination costs, employee severance and related benefits initiated during the period. Additional programs may be initiated during the remainder of 2022 with related restructuring charges.
The following table details our restructuring accrual activities during the nine months ended September 30, 2022:
| | | | | |
(in thousands) | Restructuring Accrual Balance |
December 31, 2021 | $ | 3,743 | |
Restructuring charges | 84,859 | |
Asset sales | (13,235) | |
Payments | (13,771) | |
Other, including foreign currency translation | (66) | |
September 30, 2022 | $ | 61,530 | |
NOTE 8—EQUITY AND CASH INCENTIVE PROGRAMS
Stock-based compensation expense is reported within selling, general and administrative expense in the condensed consolidated statements of income. Stock-based compensation expense relating to all stock-based incentive plans was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Stock-based compensation expense | $ | 5,009 | | | $ | 5,557 | | | $ | 14,808 | | | $ | 17,913 | |
Tax benefit | (1,052) | | | (1,167) | | | (3,110) | | | (3,762) | |
Stock-based compensation expense, net of tax | $ | 3,957 | | | $ | 4,390 | | | $ | 11,698 | | | $ | 14,151 | |
A summary of activity relating to our share-based awards for the nine months ended September 30, 2022 was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in shares) | Stock-Settled Appreciation Rights | | Performance Share Awards | | Restricted Stock Units | | Non-Qualified Stock Options |
Outstanding at January 1, 2022 | 393,523 | | | 505,509 | | | 2,342,107 | | | 5,488,653 | |
Granted | — | | | 347,920 | | | 945,616 | | | — | |
Forfeited / expired | (1,758) | | | (6,022) | | | (226,671) | | | (2,859) | |
Exercised / vested | — | | | (72,410) | | | (466,898) | | | (586,064) | |
| | | | | | | |
Outstanding at September 30, 2022 | 391,765 | | | 774,997 | | | 2,594,154 | | | 4,899,730 | |
NOTE 9—STOCKHOLDERS' EQUITY
Dividends
On February 4, 2022, our Board of Directors (“Board”) approved a plan to initiate a regular quarterly cash dividend of $0.075 per share of the Company’s common stock. Our third quarter cash dividend of $0.075 per share was declared on August 11, 2022, and is payable on October 28, 2022 to stockholders of record on October 7, 2022. As a result, we recorded a dividend payable of $15.8 million on our condensed consolidated balance sheet as of September 30, 2022. Subsequent dividend declarations, if any, including the amounts and timing of future dividends, are subject to approval by the Board and will depend on future business conditions, financial conditions, results of operations and other factors.
Repurchases
On March 7, 2022, the Company announced that our Board authorized the Company to repurchase up to $250 million of its common stock. On October 24, 2022, our Board increased the authorization under this program to $750 million. This program has no time limit and does not obligate the Company to acquire any particular amount of shares of its common stock. During the three months ended September 30, 2022, we repurchased and cancelled 3,698,106 shares of common stock at a volume-weighted average price of $21.63 per share for a total of $80.1 million, including commissions. During the nine months ended September 30, 2022, we repurchased and cancelled 4,487,622 shares of common stock at a volume-weighted average price of $22.28 per share for a total of $100.1 million, including commissions.
Accumulated other comprehensive loss
Accumulated other comprehensive loss—Accumulated other comprehensive loss consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | Foreign Currency Translation | | Defined Pension and Other Post-Retirement Benefits | | Cash Flow Hedges | | Accumulated Other Comprehensive Loss |
December 31, 2021 | $ | (19,430) | | | $ | (3,476) | | | $ | 1,281 | | | $ | (21,625) | |
Other comprehensive loss before reclassifications, net of tax | (1,565) | | | — | | | (1,299) | | | (2,864) | |
Reclassification adjustment for net losses included in net income, net of tax | — | | | 69 | | | — | | | 69 | |
Other comprehensive loss, net of tax | (1,565) | | | 69 | | | (1,299) | | | (2,795) | |
March 31, 2022 | $ | (20,995) | | | $ | (3,407) | | | $ | (18) | | | $ | (24,420) | |
Other comprehensive income before reclassifications, net of tax | 21,169 | | | — | | | (3,403) | | | 17,766 | |
Reclassification adjustment for net losses included in net income, net of tax | — | | | 70 | | | — | | | 70 | |
Other comprehensive income, net of tax | 21,169 | | | 70 | | | (3,403) | | | 17,836 | |
June 30, 2022 | $ | 174 | | | $ | (3,337) | | | $ | (3,421) | | | $ | (6,584) | |
Other comprehensive income before reclassifications, net of tax | $ | (47,067) | | | $ | — | | | $ | 16,310 | | | $ | (30,757) | |
Reclassification adjustment for net losses included in net income, net of tax | $ | — | | | $ | 68 | | | $ | — | | | $ | 68 | |
Other comprehensive income, net of tax | (47,067) | | | 68 | | | 16,310 | | | (30,689) | |
September 30, 2022 | $ | (46,893) | | | $ | (3,269) | | | $ | 12,889 | | | $ | (37,273) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | Foreign Currency Translation | | Defined Pension and Other Post-Retirement Benefits | | Cash Flow Hedges | | Accumulated Other Comprehensive Loss |
December 31, 2020 | $ | (14,965) | | | $ | (13,470) | | | $ | (2,320) | | | $ | (30,755) | |
Other comprehensive income before reclassifications, net of tax | 3,213 | | | — | | | 413 | | | 3,626 | |
Reclassification adjustment for net losses included in net income, net of tax | — | | | 167 | | | — | | | 167 | |
Other comprehensive income, net of tax | 3,213 | | | 167 | | | 413 | | | 3,793 | |
March 31, 2021 | $ | (11,752) | | | $ | (13,303) | | | $ | (1,907) | | | $ | (26,962) | |
Other comprehensive income (loss) before reclassifications, net of tax | 8,332 | | | — | | | (277) | | | 8,055 | |
Reclassification adjustment for net losses included in net income, net of tax | — | | | 6,373 | | | — | | | 6,373 | |
Other comprehensive income (loss), net of tax | 8,332 | | | 6,373 | | | (277) | | | 14,428 | |
June 30, 2021 | $ | (3,420) | | | $ | (6,930) | | | $ | (2,184) | | | $ | (12,534) | |
Other comprehensive income (loss) before reclassifications, net of tax | (11,737) | | | — | | | 3,218 | | | (8,519) | |
Reclassification adjustment for net losses included in net income, net of tax | — | | | 46 | | | — | | | 46 | |
Other comprehensive income (loss), net of tax | (11,737) | | | 46 | | | 3,218 | | | (8,473) | |
September 30, 2021 | $ | (15,157) | | | $ | (6,884) | | | $ | 1,034 | | | $ | (21,007) | |
Reclassifications from accumulated other comprehensive loss—Reclassification adjustments from accumulated other comprehensive loss to net income (loss) related to defined pension and other post-retirement benefits consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, | | Affected line items on the condensed consolidated statements of income (loss) |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 | |
Pensions and other post-retirement benefits: | | | | | | | | | |
Amortization of actuarial loss and other | $ | 68 | | | $ | 46 | | | $ | 207 | | | $ | 6,586 | | | Other expense (income), net |
| | | | | | | | | |
Total before tax | 68 | | | 46 | | | 207 | | | 6,586 | | | Income before income taxes |
Tax benefit | — | | | — | | | — | | | — | | | Provision for income taxes |
Net of tax | $ | 68 | | | $ | 46 | | | $ | 207 | | | $ | 6,586 | | | Net income |
NOTE 10—EARNINGS PER SHARE
A reconciliation of the number of shares used for the basic and diluted earnings per share calculation was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands, except per share data) | 2022 | | 2021 | | 2022 | | 2021 |
Net income attributable to ChampionX | $ | 23,068 | | | $ | 56,828 | | | $ | 87,112 | | | $ | 69,850 | |
| | | | | | | |
Weighted-average number of shares outstanding | 201,421 | | | 201,852 | | | 202,600 | | | 201,329 | |
Dilutive effect of stock-based compensation | 5,101 | | | 6,693 | | | 5,555 | | | 6,844 | |
Total shares and dilutive securities | 206,522 | | | 208,545 | | | 208,155 | | | 208,173 | |
| | | | | | | |
Earnings per share attributable to ChampionX: | | | | | | | |
Basic | $ | 0.11 | | | $ | 0.28 | | | $ | 0.43 | | | $ | 0.35 | |
Diluted | $ | 0.11 | | | $ | 0.27 | | | $ | 0.42 | | | $ | 0.34 | |
For all periods presented, the computation of diluted earnings per share excludes awards with an anti-dilutive impact. For the three and nine months ended September 30, 2022, the diluted shares include the dilutive impact of equity awards except for approximately 0.4 million and 0.4 million shares, respectively, that were excluded because their inclusion would be anti-dilutive. For the three and nine months ended September 30, 2021, the diluted shares include the dilutive impact of equity awards except for approximately 0.5 million and 0.6 million shares, respectively, that were excluded because their inclusion would be anti-dilutive.
NOTE 11—ACQUISITIONS AND DIVESTITURES
Acquisitions
On February 23, 2022, we acquired LSI, a leader in optical gas imaging technology that provides aerial and ground-based emissions leak detection to the oil and gas industry. LSI has been included in our Production & Automation Technologies segment. Under the terms of the agreement, we paid an initial amount of $3.2 million, net of cash acquired, with an additional $0.5 million payable on the first anniversary of the closing date. We may also be required to make future payments of up to an additional $2.5 million, contingent on the future performance of the business. As part of our purchase price allocation, we recorded goodwill of $6.3 million. The pro forma effect of this acquisition on revenue and net income has been determined to be immaterial to our financial statements.
Divestitures
Given the continued economic pressure and sanctions imposed by the United States, European Union, and United Kingdom, we initiated a plan to dispose of our operations in Russia (the “CT Russia Business”), which is included in our Production Chemical Technologies segment. As a result, the CT Russia Business met the criteria to be classified as held for sale as of June 30, 2022, which required us to present the related assets and liabilities as separate line items in our condensed consolidated balance sheet. We recorded an initial charge of $22.9 million during the second quarter of 2022, in order to properly reflect the carrying value of the disposal group at the lower of its carrying value or fair value less any costs to sell.
We assess the fair value of a long-lived asset or disposal group (less any costs to sell) each reporting period that it remains classified as held for sale and report any subsequent changes as an adjustment to the carrying value of the asset or disposal group, as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. During the three months ended September 30, 2022, we recognized a gain of $6.4 million to adjust the carrying value of the disposal group. Upon the ultimate disposition, we will recognize the cumulative translation adjustment balance associated with the CT Russia Business in our condensed consolidated statement of income as part of the gain or loss on the sale.
The following table presents information related to the major classes of assets and liabilities of the CT Russia Business that were held for sale in our condensed consolidated balance sheet:
| | | | | |
(in thousands) | |
Receivables | $ | 8,330 | |
Inventory | 6,638 | |
Prepaid expenses and other current assets | 3,078 | |
Property, plant, and equipment | 4,721 | |
Goodwill | 3,271 | |
Intangible assets | 6,927 | |
Operating lease right-of-use assets | 2,001 | |
Loss on disposal group | (16,515) | |
Total assets held for sale | $ | 18,451 | |
Accounts payable | $ | 2,168 | |
Other current liabilities | 3,933 | |
Other noncurrent liabilities | 3,257 | |
Total liabilities held for sale | $ | 9,358 | |
NOTE 12—FAIR VALUE MEASUREMENTS
Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. A hierarchy has been established for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the most observable inputs be used when available. The hierarchy is broken down into three levels:
Level 1- Inputs are quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities.
Level 2- Inputs include observable inputs other than quoted prices in active markets.
Level 3- Inputs are unobservable inputs for which there is little or no market data available.
The carrying amount and the estimated fair value for assets and liabilities measured on a recurring basis are as follows:
| | | | | | | | | | | | | | | | | |
| | | Carrying Amount |
(in thousands) | Measurement Level | | September 30, 2022 | | December 31, 2021 |
Assets | | | | | |
Foreign currency forward contracts | Level 2 | | $ | 17,074 | | | $ | 4,081 | |
Interest rate swaps | Level 2 | | 8,885 | | | — | |
Total | | | $ | 25,959 | | | $ | 4,081 | |
| | | | | |
Liabilities | | | | | |
Foreign currency forward contracts | Level 2 | | $ | 11,989 | | | $ | 3,773 | |
Interest rate swaps | Level 2 | | 133 | | | — | |
Total | | | $ | 12,122 | | | $ | 3,773 | |
For purposes of fair value disclosure above, derivative values are presented gross. See Note 13—Derivatives and Hedging Transactions for further discussion of gross versus net presentation of the Company’s derivatives.
The carrying amounts of cash and cash equivalents, trade receivables, accounts payable, as well as amounts included in other current assets and other current liabilities that meet the definition of financial instruments, approximate fair value due to their short-term nature.
The carrying amount and the estimated fair value of long-term debt, including current maturities, held by the Company were:
| | | | | | | | | | | | | | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
(in thousands) | Carrying Amount | | Fair Value | | Carrying Amount | | Fair Value |
2022 Revolving Credit Facility | $ | 45,000 | | | $ | 45,000 | | | $ | — | | | $ | — | |
2018 Term Loan Facility | $ | — | | | $ | — | | | $ | 140,000 | | | $ | 138,950 | |
2020 Term Loan Facility | $ | — | | | $ | — | | | $ | 496,725 | | | $ | 502,313 | |
2022 Term Loan Facility | $ | 625,000 | | | $ | 609,375 | | | $ | — | | | $ | — | |
6.375% Senior Notes due 2026 | $ | — | | | $ | — | | | $ | 92,041 | | | $ | 95,805 | |
The fair value of the Notes is based on Level 1 quoted market prices. The fair value of our term loan facilities are based on Level 2 quoted market prices for the same or similar debt instruments. The fair value of our revolving line of credit approximates carrying value due to the variable interest rates charged on the borrowings, which reprice frequently (Level 2).
NOTE 13—DERIVATIVES AND HEDGING TRANSACTIONS
The Company uses foreign currency forward contracts to manage risks associated with foreign currency exchange rates. The Company also utilizes floating-to-fixed interest rate swap agreements as cash flow hedges on certain debt, to mitigate interest rate risk. The Company does not hold derivative financial instruments of a speculative nature or for trading purposes. Derivative contracts are recorded as assets and liabilities on the balance sheet at fair value. We evaluated the interest rate swap hedge effectiveness and determined it to be perfectly effective. We evaluate foreign currency forward contracts hedge effectiveness at contract inception and thereafter on a quarterly basis. If a derivative is no longer expected to be effective, hedge accounting is discontinued. Changes in fair value are recognized immediately in earnings unless the derivative qualifies and is designated as a hedge. Changes in fair value attributable to changes in spot exchange rates for derivative contracts that have been designated as cash flow hedges are recognized in accumulated other comprehensive income (loss) (“AOCI”) and reclassified into earnings in the same period the hedged transaction affects earnings and are presented in the same income statement line as the earnings effect of the hedged item. The Company accounts for the interest rate swap agreements as a cash flow hedge, thus the effective portion of gains and losses resulting from changes in fair value are recognized in AOCI and are amortized to interest expense over the term of the respective debt. Cash flows from derivatives are classified in the statement of cash flows in the same category as the cash flows from the items subject to designated hedge or undesignated (economic) hedge relationships.
The Company is exposed to credit risk in the event of nonperformance of counterparties for foreign currency forward exchange contracts and interest rate swaps. We monitor our exposure to credit risk by using major global banks and financial institutions as counterparties and monitoring their financial condition and credit profile. The Company does not anticipate nonperformance
by any of these counterparties, and therefore, recording a valuation allowance against the Company’s derivative balance is not considered necessary.
Derivative Positions Summary
Certain of the Company’s derivative transactions are subject to master netting arrangements that allow the Company to settle with the same counterparties. These arrangements generally do not call for collateral and as of the applicable dates presented in the following table, no cash collateral had been received or pledged related to the underlying derivatives. We have elected to present our derivative balances on a gross basis on the condensed consolidated balance sheet.
The following table summarizes the gross fair value of the Company’s outstanding derivatives and the lines in which they are presented on the condensed consolidated balance sheet.
| | | | | | | | | | | | | | | | | | | | | | | |
| Derivative Assets | | Derivative Liabilities |
(in thousands) | September 30, 2022 | | December 31, 2021 | | September 30, 2022 | | December 31, 2021 |
Prepaid expenses and other current assets | $ | 20,027 | | | $ | 4,081 | | | $ | — | | | $ | — | |
Other non-current assets | 5,932 | | | — | | | — | | | — | |
Accrued expenses and other current liabilities | — | | | — | | | 12,122 | | | 3,773 | |
Other long-term liabilities | — | | | — | | | — | | | — | |
| $ | 25,959 | | | $ | 4,081 | | | $ | 12,122 | | | $ | 3,773 | |
The following table summarizes the notional values of the Company’s outstanding derivatives:
| | | | | | | | | | | |
(in thousands) | September 30, 2022 | | December 31, 2021 |
Notional value of foreign currency forward contracts and interest rate swaps | $ | 953,246 | | | $ | 704,190 | |
Cash Flow Hedges
The Company utilizes foreign currency forward contracts to hedge the effect of foreign currency exchange rate fluctuations on forecasted foreign currency transactions, primarily related to inventory purchases. These forward contracts are designated as cash flow hedges. The changes in fair value of these contracts attributable to changes in spot exchange rates are recorded in AOCI until the hedged items affect earnings, at which time the gain or loss is reclassified into the same line item in the condensed consolidated statements of income (loss) as the underlying exposure being hedged. The forward points are marked-to-market monthly and recognized in the same line item in the condensed consolidated statements of income (loss) as the underlying exposure being hedged.
Under interest rate swaps, we agree with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. Any unrealized gain or loss at the time of settlement will be reclassified to interest expense, where we record the interest expense on the associated debt.
Derivatives Not Designated as Hedging Instruments
The Company also uses foreign currency forward contracts to offset its exposure to the change in value of certain foreign currency denominated assets and liabilities, primarily receivables and payables, which are remeasured at the end of each period. Although the contracts are effective economic hedges, they are not designated as accounting hedges. Therefore, changes in the value of these derivatives are recognized immediately in earnings, thereby offsetting the current earnings effect of the related foreign currency denominated assets and liabilities.
Effect of Derivative Instruments on Income
The loss of all derivative instruments recognized is summarized below:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Loss (gain) reclassified from AOCI to income on cash flow hedges: | | | | | | | |
Cost of goods and services | $ | (837) | | | $ | 1,447 | | | $ | (884) | | | $ | 3,219 | |
Interest expense | 585 | | | — | | | 585 | | | — | |
Loss on derivatives not designated as hedging instruments: | | | | | | | |
Other (income) expense, net | 1,167 | | | 955 | | | 6,578 | | | 2,417 | |
Total loss of derivative instruments | $ | 915 | | | $ | 2,402 | | | $ | 6,279 | | | $ | 5,636 | |
NOTE 14—INVENTORIES
Inventories consisted of the following:
| | | | | | | | | | | |
(in thousands) | September 30, 2022 | | December 31, 2021 |
Raw materials | $ | 148,119 | | | $ | 186,516 | |
Work in progress | 20,363 | | | 13,615 | |
Finished goods | 523,042 | | | 421,702 | |
| 691,524 | | | 621,833 | |
Inventory reserve | (26,927) | | | (24,646) | |
LIFO adjustments (1) | (93,777) | | | (54,277) | |
Inventories, net | $ | 570,820 | | | $ | 542,910 | |
_______________________(1) Represents the amount by which the current cost of LIFO inventories exceeded their carrying value.
NOTE 15—ACCOUNTS RECEIVABLE FACILITY
On June 28, 2022, we entered into an uncommitted accounts receivable purchase agreement (the “Accounts Receivable Facility”) with JPMorgan Chase Bank, N.A. as the purchaser. Transfers under the Accounts Receivable Facility are accounted for as sales of receivables, resulting in the receivables being derecognized from our consolidated balance sheet. The purchaser assumes the credit risk at the time of sale and has the right at any time to assign or transfer (including as a participation interest) any of its rights under the purchased receivables to another bank or financial institution.
The amount available for sale under the Accounts Receivable Facility fluctuates over time based on the total amount of eligible receivables generated during the normal course of business. A maximum of $160.0 million in receivables may be sold and remain unpaid under the Accounts Receivable Facility at any time.
Accounts receivable sold were $101.2 million for the three and nine months ended September 30, 2022. The accounts receivable sold that remained outstanding as of September 30, 2022 was $60.0 million. During these periods, cash receipts from the purchaser at the time of the sale were classified as operating activities in our condensed consolidated statement of cash flows. The difference between the carrying amount of the accounts receivable sold and the sum of the cash received is recorded as a loss on sale of receivables in other income (expense), net in our condensed consolidated statements of income. The loss on sale of accounts receivable was $0.7 million for the three and nine months ended September 30, 2022.
NOTE 16—CASH FLOW INFORMATION
Leased Asset Program
Our electrical submersible pumping (“ESP”) leased asset program is reported in our Production & Automation Technologies segment. At the time of purchase, assets are recorded to inventory and are transferred to property, plant, and equipment when a customer contracts for an asset under our leased asset program. During the nine months ended September 30, 2022 and September 30, 2021, we transferred $32.1 million and $33.9 million, respectively, of inventory into property, plant, and equipment as a result of assets entering our leased asset program.
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 condensed 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 condensed consolidated statements of cash flows.