6
See notes to consolidated financial statements.
SPECTRUM TRACER SERVICES, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
Note 1 – Organization, Business and Summary of Significant Accounting Policies
Organization and business
Spectrum Tracer Services, LLC, (the Company) an Oklahoma limited liability company (LLC), is in the business of producing radioactive, chemical and oil soluble tracers and providing tracing services used by oil and gas operators to determine hydraulic fracture efficiencies and reservoir diagnostics. As an LLC, members are not personally liable for any debts, liabilities or obligations of the Company beyond their equity in the Company. The Company will continue in existence until it is liquidated or dissolved in accordance with the Operating Agreement and the State of Oklahoma Limited Liability Company Act. Spectrum Tracer Services, LLC operates in Oklahoma, Texas, West Virginia, Montana and Canada.
On August 30, 2017, the Company entered into an agreement with NCS Multistage Holdings, Inc. (NCS), a publicly traded company, whereby NCS acquired 100% of the equity interests in the Company in exchange for $83 million, which was comprised of (i) $76 million in cash and (ii) 0.4 million shares of common stock of NCS, which shares were issued to certain unitholders of the Company who elected to receive a portion of the consideration payable to them in equity. The cash consideration is subject to certain adjustments, including an earn-out that would permit up to an additional $12.5 million in consideration if certain financial performance measures related to the Company’s operations are achieved, working capital adjustments and reimbursement by NCS for specified capital expenditures. This transaction closed on August 31, 2017.
Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, STS Logistics and Analytics, LLC, STS Holdings, Inc. and STS Tracer Services, Ltd., a Canadian subsidiary. All material intercompany transactions have been eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Accounts receivable
Accounts receivable are recorded at the invoiced amount and do not bear interest. Accounts receivable are uncollateralized customer obligations due under normal trade terms, requiring payment within 30 days from the invoice date. The carrying amount of accounts receivable is reduced, if needed, by a valuation allowance that reflects management's best estimate of the amounts that may not be collected. Management individually reviews all balances which exceed 90 days from invoice date and based on an assessment of current creditworthiness, estimates the portion, if any, of the balance that will not be collected. Management provides for probable uncollectible amounts through a charge to earnings and a credit to the valuation
allowance based on its assessment of the current status of the individual accounts. Balances which are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance. At December 31, 2016, the allowance for doubtful accounts was $11,102.
Inventories
Inventories are stated at the lower of cost (determined using the average cost of inventory) or market (net realizable value).
Revenue recognition
Revenue, net of discounts, is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable and collection is reasonably assured. Revenue recognized is net of discounts of $45,051,451 at December 31, 2016.
Properties and equipment
Depreciation of properties and equipment, which includes amortization of assets under capital leases, is provided for financial reporting purposes using the straight-line method over the following estimated useful lives:
| |
Description | Useful Lives |
| |
Trucks and other vehicles (A) | 5 years |
Furniture and fixtures | 7 years |
Tools, machinery and equipment | 7 years |
Computers and software | 3 - 5 years |
| (A) | | Including assets under capital leases |
Foreign currency translation
STS Tracer Services, Ltd., a foreign subsidiary, uses Spectrum Tracer Services, LLC’s local currency, the U.S. Dollar, as its reporting currency. Transactions denominated in currencies other than the functional currency are recorded based on exchange rates at the time such transactions arise. Subsequent changes in exchange rates result in transaction gains and losses which are reflected as other comprehensive income within Members' equity.
Unit-based compensation
The Company recognizes compensation expense on a straight-line basis for unit appreciation rights awarded with time-based service conditions (see Note 6). The Company measures its liability awards based on the award's intrinsic value remeasured at each reporting date until date of settlement.
Income taxes
As a limited liability company, the Company's U.S. federal taxable income or loss is allocated to its members in accordance with their respective percentage ownership. Therefore, no provision or liability for U.S. federal income taxes has been included in the accompanying consolidated balance sheets. The Company is subject to income taxes in certain states which do not recognize LLCs as disregarded entities. Foreign income tax expense relates to the Company's operations in Canada.
Subsequent events
Management has evaluated subsequent events through November 13, 2017, the date the consolidated financial statements were available to be issued.
Note 2 – Inventories
Inventories consist of the following at December 31:
| | |
| 2016 |
| | |
Raw materials | $ | 1,816,737 |
Finished goods | | 1,188,979 |
| | |
Inventories | $ | 3,005,716 |
Note 3 – Properties and Equipment
Properties and equipment, including assets under capital leases, consist of the following at December 31:
| | |
| 2016 |
| | |
Trucks and other vehicles | $ | 1,601,671 |
Tools, machinery and equipment | | 3,960,348 |
Leasehold improvements | | 36,482 |
Furniture and fixtures | | 21,780 |
| | |
| | 5,620,281 |
Less accumulated depreciation | | 2,614,040 |
| | |
Properties and equipment, net | $ | 3,006,241 |
Note 4 – Revolving Line of Credit and Notes Payable
In April 2016, the Company entered into a nonrevolving line of credit and term loan agreement with a bank for up to $4,000,000, due April 2020. The Company received an advance of $2,000,000 under this agreement during 2016. The note requires monthly payments of $45,836 at a fixed interest rate of 4.75%. The note is collateralized by substantially all the assets of the Company as well as personal guarantees of certain members. The balance as of December 31, 2016 is $1,691,242.
The Company has a $1,000,000 revolving line of credit with a bank, which matures in May 2017. Borrowings bear interest at a variable interest rate, are collateralized by the Company's accounts receivable, and are guaranteed by the subsidiaries of Spectrum Tracer Services, LLC and the majority owners of the Company. The line of credit agreement contains various affirmative and negative covenants, which, among other things, requires the Company maintain a minimum tangible net worth and limits the incurrence of debt. The Company did not have any borrowings during 2016.
The Company financed the purchase of annual insurance policies totaling $243,243 at a fixed rate of 4.55% during the year ended December 31, 2016. Principal and interest are payable in three quarterly installments in the amount of $56,560 beginning in August 2016. The balance as of December 31, 2016 is $55,494.
In 2016, the Company adopted Accounting Standards Update (ASU) 2015-03, Interest – Imputation of Interest. ASU 2015-03 is intended to simplify the presentation of debt issuance costs. Debt issuance costs related to a recognized debt liability are presented on the balance sheet as a direct deduction from the debt liability to be amortized over the term of the associated loan. The Company had approximately $10,000 in debt issuance costs related to its term loan in 2016.
Long-term notes payable maturities are as follows:
| | | |
Year | | Amount |
| | | |
2017 | | $ | 534,592 |
2018 | | | 502,688 |
2019 | | | 527,438 |
2020 | | | 182,018 |
| | | |
| | | 1,746,736 |
Less unamortized debt issuance costs | | | 8,598 |
| | | |
| | $ | 1,738,138 |
Note 5 – Members' Equity
The Company has a total of 2,583.33 units outstanding to its members at December 31, 2016, and each Member receives units in proportion to the cash and estimated fair value of property or services contributed.
Contributions
In accordance with the Operating Agreement, additional cash contributions can be required at the discretion of the Manager. With the exception of certain members who contributed property or loan guarantees, members would be required to contribute an amount equal to their pro rata share of units they own applied to the amount of the capital call.
Allocations and distributions
Allocations of operating profits to the members are determined on the basis of whether the allocation occurs during one of the following phases: Before Payout, After Payout or Earn-out.
Cash available for distributions is determined by a majority vote of the Board of Directors and distributed to the members on the basis of whether such distribution occurs Before Payout, After Payout or during Earn-out.
The Company distributed $1,524,846 to its members in 2016.
Note 6 – Unit Appreciation Rights Plan
The Company has established a Unit Appreciation Rights Plan (the Plan). Under the Plan, Unit Appreciation Rights (Rights) may be granted by the Board of Directors to key employees. Each Right entitles a participant to the excess of fair value of one Company membership unit (Unit) on the exercise date over the fair value of the Unit on the grant date. The determination of fair value is made at the sole discretion of the Board of Directors.
Rights may be exercised upon the sale of all or substantially all of the assets or Units of the Company (Triggering Event). Participants vest in one-third of the Rights after five years of employment; one-third after ten years of employment; and one-third after 15 years of employment. Rights vest immediately upon the occurrence of a Triggering Event during the participant's employment. Due to the nature of rights-based transactions, the Rights are accounted for as liability awards and unit appreciation for each Right awarded are charged to expense over the vesting period.
In February 2013, the Board of Directors granted Rights as follows:
| (a) | | Rights for 55.355 units at such time as the Company attains After Payout; |
| (b) | | Rights for 34.06825 units at such time as the Company attains Earn-out Phase I; |
| (c) | | Rights for 39.74325 units at such time as the Company attains Earn-out Phase II. |
The fair value of a Unit was determined by the Board of Directors to be $5,000 on the grant date. The Company was in the Earn-out Phase II at December 31, 2015. The accumulated intrinsic value of the Rights expensed at December 31, 2016, is reflected as deferred compensation of $644,940.
In March 2014, the Company granted 129.16 Rights to an employee. The Rights were awarded ratably over a 12-month period beginning April 30, 2014. The fair value of a Unit was determined by the Board of Directors to be $13,548 on the grant date. The accumulated intrinsic value of the Rights expensed at December 31, 2016, is reflected as deferred compensation of $139,213.
As of December 31, 2016, there was $4,496,579 of unrecognized compensation expense related to the Plan. The sale of the Company on August 30, 2017 (See Note 1) was a Triggering Event resulting in immediate vesting of all outstanding Rights and recognition of the remaining compensation expense subsequent to period end.
Note 7 – Leasing Arrangements
The Company leases office space, as well as certain vehicles and equipment. Many of these leases include renewal options.
Future minimum lease payments under operating leases at December 31 are as follows:
| | | |
Year | | Amount |
| | | |
2017 | | $ | 770,695 |
2018 | | | 614,488 |
2019 | | | 357,233 |
2020 | | | 266,033 |
2021 | | | 107,308 |
| | | |
| | $ | 2,115,757 |
The Company leases certain vehicles under capital leases with various expiration dates from April 2017 to November 2018. Monthly payments are due in amounts ranging from $1,027 to $1,320, including interest at rates ranging from 6.25% to 6.95%. At December 31, 2016, assets under capital leases amounted to $1,093,919, net of accumulated depreciation of $418,443.
The following is a schedule of future minimum lease payments under capital leases together with the present value of the net minimum lease payments at December 31, 2016:
| | | |
Year | | Amount |
| | | |
2017 | | $ | 222,611 |
2018 | | | 69,802 |
| | | |
Total minimum lease payments | | | 292,413 |
Less interest | | | 16,187 |
| | | |
Present value of minimum lease payments | | $ | 276,226 |
Note 8 – Legal Matters
The Company and certain members of the Company were defendants in a lawsuit filed by a member's former employer alleging misappropriation of trade secrets for the alleged theft of customer lists and certain software related to fracking services. The legal proceedings concluded in April 2016. The final judgment against the Company of $915,000 was accrued at December 31, 2015, and paid during the year ended December 31, 2016.
During 2015, the Company entered into a confidential settlement agreement relating to alleged violations of the Fair Labor Standards Act for $875,000. This amount was accrued at December 31, 2015 and paid during the year ended December 31, 2016.
Note 9 – Concentration of Risk
The Company conducts business primarily with customers who rely on the oil and natural gas exploration and production industry and could therefore be materially affected by economic fluctuations in the supply, demand and price of oil and natural gas.
The Company maintains cash balances that typically exceed Federal Deposit Insurance Corporation limits.
Note 10 – Contingencies
The Company voluntarily disclosed to the Environmental Protection Agency (EPA) that it was not in compliance with the Toxic Substances Control Act. The EPA is currently conducting an examination and the potential exists for fines. The amount of the fines cannot be reasonably estimated yet; however, the Company does not believe it will be material. The examination was concluded in the first half of 2017.
Note 11 – Restatement
The consolidated balance sheet as of December 31, 2016, and consolidated statements of income and comprehensive income, changes in members' equity and cash flows were restated to record the cost of inventory held at district site locations.
As of December 31, 2016, inventories, total current assets, total assets, members' equity and total liabilities and members' equity increased by $923,509 from amounts previously reported. For the year ended December 31, 2016, cost of revenues and total costs and expenses decreased by $41,160, while, income from operations, income before taxes and net income increased by $41,160 from amounts previously reported.
For the year ended December 31, 2015, net income increased by $370,375 from amounts previously reported.
