| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The accompanying interim unaudited condensed consolidated financial statements of Solaris Oilfield Infrastructure, Inc. (either individually or together with its subsidiaries, as the context requires, “Solaris Inc.” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). These financial statements reflect all normal recurring adjustments that are necessary for fair presentation. Operating results for the three months ended March 31, 2020 and 2019 are not necessarily indicative of the results that may be expected for the full year or for any interim period.
The unaudited interim condensed consolidated financial statements should be read in conjunction with Solaris Inc.’s Annual Report on Form 10-K for the year ended December 31, 2019.
Solaris Inc. is the managing member of Solaris Oilfield Infrastructure, LLC (“Solaris LLC”) and is responsible for all operational, management and administrative decisions relating to Solaris LLC's business. Solaris Inc. consolidates the financial results of Solaris LLC and its subsidiaries and reports non-controlling interest related to the portion of the units in Solaris LLC (the “Solaris LLC Units”) not owned by Solaris Inc., which will reduce net income attributable to the holders of Solaris Inc.’s Class A common stock
All material intercompany transactions and balances have been eliminated upon consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates used in the preparation of these condensed consolidated financial statements include, but are not limited to, collectability of accounts receivable, stock-based compensation, depreciation associated with property, plant and equipment and related impairment considerations of those assets, impairment considerations of goodwill, determination of fair value of intangible assets acquired in business combinations, income taxes, determination of the present value of lease payments and right-of-use assets, inventory valuation and certain other assets and liabilities. Actual results could differ from management’s best estimates as additional information or actual results become available in the future, and those differences could be material.
Cash and cash equivalents
For the purposes of the statements of cash flows, the Company considers all short-term, highly liquid, investments with an original maturity of three months or less to be cash equivalents. Cash is deposited in demand accounts in federally insured domestic institutions to minimize risk. Accounts of each institution are insured by Federal Deposit Insurance Corporation. Cash balances at times may exceed federally-insured limits. We have not incurred losses related to these deposits.
Accounts Receivable and Allowance for Credit Losses
Accounts receivable consists of trade receivables recorded at the invoice amount, plus accrued revenue that is not yet billed, less an estimated allowance for credit losses (if any). Accounts receivable are generally due within 60 days or less, or in accordance with terms agreed with customers. The Company considers accounts outstanding longer than the payment terms past due. The Company determines the allowance by considering a number of current conditions, past events and other factors, including the length of time trade accounts receivable are past due, previous loss history, the customer’s current ability to pay its obligation, and the condition of the general economy and the industry as a whole. Accounts receivable are written off when they are deemed uncollectible, and payments subsequently received on such receivables are credited to the allowance for credit losses. Allowance for credit losses was $1,232 and $339 as of March 31, 2020 and December 31, 2019, respectively. The related expense was included in Selling, general and administrative expense on the condensed consolidated statements of operations.
The Company accounts for credit losses in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”), Financial Instruments – Credit Losses (“ASC Topic 842”), and the Accounting Standards Update (“ASU”) No. 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) effective January 1, 2019. The Company applied ASC Topic 326 to all trade receivables existing at or commencing after January 1, 2020. The adoption of ASC Topic 326 on January 1, 2020, did not have an impact on our condensed consolidated financial statements.
Activity in the allowance for credit losses account on customer receivables for the three months ended March 31, 2020 and for the year ended December 31, 2019 is as follows:
(in thousands)
Balance, January 1, 2019
$
—
Credit losses
339
Balance, December 31, 2019
$
339
Credit losses
Balance, March 31, 2020
$
1,232
Inventories
Inventories consist of materials used in the manufacturing of the Company’s systems, which include raw materials and purchased parts and is stated at the lower of cost or net realizable value. Net realizable value is determined, giving consideration to quality, excessive levels, obsolescence and other factors. Adjustments that reduce stated amounts will be recognized as impairments in the condensed consolidated statements of operations. The Company recognized a write down of the carrying value of inventory of $2.6 million to its net realizable value during the three months ended March 31, 2020. There were no impairments recorded for the three months ended March 31, 2019.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, or fair value for assets acquired in a business combination, less accumulated depreciation and impairments. Depreciation is computed using the straight-line method over the estimated useful service lives of the assets as noted below:
Useful Life
Systems and related equipment
Up to 15 years
Machinery and equipment
3-10 years
Furniture and fixtures
5 years
Computer hardware and software
3-10 years
Vehicles
5 years
Transloading facility and equipment
15-30 years
Buildings and leasehold improvements
15 years
Systems that are in the process of being manufactured are considered property, plant and equipment. However, the systems do not depreciate until they are fully completed. Systems in process are a culmination of material, labor and overhead.
Expenditures for maintenance and repairs are charged against income as incurred. Betterments that increase the value or materially extend the life of the related assets are capitalized. Upon sale or disposition of property and equipment, the cost and related accumulated depreciation and amortization are removed from the condensed consolidated financial statements and any resulting gain or loss is recognized in the condensed consolidated statements of operations.
Refer to Impairment of Long-Lived Assets, Definite-lived Intangible Assets and ROU Assets below for discussion of impairment triggers in the three months ended March 31, 2020.
Definite-lived Intangible Assets
Identified intangible assets with determinable lives consist primarily of customer relationships, a non-competition agreement and software acquired in the acquisition of Railtronix, LLC (“Railtronix”), as well as patents that were filed for our systems and other intellectual property. Amortization on these assets is calculated on the straight-line method over the estimated useful lives of the assets, which is five to fifteen years. The Company recorded amortization expense of $195 for the three months ended March 31, 2020 and 2019. Refer to Impairment of Long-Lived Assets, Definite-lived Intangible Assets and ROU Assets below for discussion of impairment triggers in the three months ended March 31, 2020.
Identified intangible assets by major classification consist of the following:
Accumulated
Net Book
Gross
Amortization
Value
As of March 31, 2020:
Customer relationships
$
4,703
$
(1,568)
$
3,135
Software acquired in the acquisition of Railtronix
346
(115)
231
Non-competition agreement
225
(105)
120
Patents and other
114
(34)
80
Total identifiable intangibles
$
5,388
$
(1,822)
$
3,566
As of December 31, 2019:
Customer relationships
$
4,703
$
(1,400)
$
3,303
Software acquired in the acquisition of Railtronix
346
(103)
243
Non-competition agreement
225
(94)
131
Patents and other
114
(30)
84
Total identifiable intangibles
$
5,388
$
(1,627)
$
3,761
Leases
The Company adopted ASC Topic 842, Leases (“ASC Topic 842”), effective January 1, 2019. As a result of the adoption of ASC Topic 842 on January 1, 2019, the Company recorded operating right-of-use (“ROU”) assets of $8,503, operating lease liabilities of $9,016 and a cumulative effect adjustment to retained earnings for operating leases of $532.
We determine if an arrangement is a lease at inception. The Company made the election to not apply the recognition requirements in ASC Topic 842 to short-term leases (i.e., leases of twelve months or less). Instead, the Company recognizes the lease payments in profit or loss on a straight-line basis over the lease term. Operating leases are included in operating lease ROU assets, current portion of operating lease liabilities, and operating lease liabilities, net of current in the Company’s condensed consolidated balance sheets. Finance leases are included in property and equipment, current portion of finance lease liabilities, and finance lease liabilities, net of current in the Company’s condensed consolidated balance sheets.
ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, we use our incremental borrowing rate in determining the present value of lease payments based on the information available at the commencement date. Our incremental borrowing rate reflects the estimated rate of interest that we would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. We use the implicit rate when readily determinable. The ROU asset also includes any lease payments made and excludes lease incentives received. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
Refer to Impairment of Long-Lived Assets, Definite-lived Intangible Assets and ROU Assets below for discussion of impairment triggers in the three months ended March 31, 2020.
Goodwill
Goodwill represents the excess of the purchase price of a business over the estimated fair value of the identifiable assets acquired and liabilities assumed. As of December 31, 2019, the Company reported $17,236 of goodwill related to the 2014 purchase of the silo manufacturing business from Loadcraft Industries Ltd. and the 2017 purchase of the assets of Railtronix. The Company evaluates goodwill for impairment annually, as of October 31, or more often as facts and circumstances warrant. Factors such as unexpected adverse economic conditions, competition and market changes may require more frequent assessments. Due to the impact of the outbreak of COVID-19 and recent oil market developments on our business, we updated our goodwill impairment assessment as of March 31, 2020.
Before employing detailed impairment testing methodologies, the Company may first evaluate the likelihood of impairment by considering qualitative factors relevant to the business, such as macroeconomic, industry, market or any other factors that have a significant bearing on fair value. If the Company first utilizes a qualitative approach and determines that it is more likely than not that goodwill is impaired, detailed testing methodologies are then applied. Otherwise, the Company concludes that no impairment has occurred. The Company may also choose to bypass a qualitative approach and opt instead to employ detailed testing methodologies, regardless of a possible more likely than not outcome. If the Company determines through the qualitative approach that detailed testing methodologies are required, or if the qualitative approach is bypassed, the Company compares the fair value of a reporting unit with its carrying amount. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired. If the carrying amount of a reporting unit exceeds its estimated fair value, an impairment loss is measured and recorded.
We estimated the fair value for each reporting unit using an income approach including a discounted cash flow analysis and the use of significant unobservable inputs representative of a Level 3 fair value measurement. Some of the more significant assumptions inherent in the income approach include the estimated future net annual cash flows for each reporting unit and the discount rate. The Company selected assumptions used in the discounted cash flow projections using historical data supplemented by current and anticipated market conditions and estimated growth rates. These estimates are based upon assumptions believed to be reasonable. However, given the inherent uncertainty in determining the assumptions underlying a discounted cash flow analysis, particularly in the current volatile market, actual results may differ from those used in the Company’s valuations which could result in additional impairment charges in the future. The discount rates used to value the Company’s reporting units were between 10.35% and 13.00%. As a result of the March 31, 2020 evaluation of goodwill, $4,231 of goodwill associated with the 2017 purchase of the assets of Railtronix was impaired. The goodwill associated with the Loadcraft Industries Ltd. purchase was not impaired. An impairment charge would have resulted if our estimate of fair value was approximately 40% less than the amount determined.
Impairment of Long-Lived Assets, Definite-lived Intangible Assets and ROU Assets
Long-lived assets, such as property, plant, equipment, definite-lived intangible assets and ROU Assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, such as insufficient cash flows or plans to dispose of or sell long-lived assets before the end of their previously estimated useful lives. For assets classified as held for use, we first group individual assets based on the lowest level for which identifiable cash flows are largely independent of the cash flows from other assets. We then compare estimated future undiscounted cash flows expected to result from the use and eventual disposition of the asset group to its carrying amount. If the asset group's undiscounted cash flows are less than its carrying amount, we then determine the asset group's fair value by using a discounted cash flow analysis and recognize any resulting impairment. This analysis is based on estimates such as management’s short-term and long-term forecast of operating performance, including revenue growth rates and expected profitability margins, estimates of the remaining useful life and service potential of the assets within the asset group, and a discount rate based on our weighted average cost of capital. An impairment loss is measured and recorded as the amount by which the asset group's carrying amount exceeds its fair value.
As a result of recent volatility in global oil markets driven by significant reductions in demand for oil due to COVID-19 and certain actions by oil producers globally and the expected impact on our businesses, operations and earnings, the Company concluded that such circumstances warranted an evaluation of whether indicators of impairment are present for its asset groups. Based on this evaluation, the Company performed tests for recoverability of the carrying value of these assets using forecasted undiscounted cash flows.
The Company noted that the undiscounted future cash flows of our proppant management systems and inventory management software exceeded the carrying value of their respective asset groups and were thus deemed recoverable. However, undiscounted cash flows as well as the fair value of the assets associated with our Kingfisher Facility exceeded their carrying values and the Company recognized impairment losses of $37,775, $2,845 and $410 for property, plant and equipment, ROU assets and other receivables, respectively. These impairments resulted from an accumulation of factors leading to the loss of significant customers, reduced operating activities and earnings, including impacts resulting from continued volatility in global oil markets and the COVID-19 pandemic. If these conditions persist for an extended period of time, additional impairment losses may be recognized.
Given the inherent uncertainty in determining the assumptions underlying both undiscounted and discounted cash flow analyses, particularly in the current volatile market, actual results may differ which could result in additional impairment charges. We estimated the fair value of the Kingfisher Facility using an income approach including a discounted cash flow analysis and the use of significant unobservable inputs representative of a Level 3 fair value measurement. Some of the more significant assumptions inherent in the income approach include the estimated future net annual cash flows for each reporting unit and the discount rate. The Company selected assumptions used in the discounted cash flow projections using historical data supplemented by current and anticipated market conditions and estimated growth rates. These estimates are based upon assumptions believed to be reasonable. The discount rates used to value this reporting unit were between 10.35% and 13.00%. Limited marketability for the assets group exist in the current volatile market and the analysis resulted in a full impairment of the long-lived assets of the reporting unit.
There were no impairment indicators for the three months ended March 31, 2019.
Revenue Recognition
In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under the agreement, the following steps must be performed at contract inception: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) we satisfy each performance obligation. For contracts that contain multiple performance obligations, we allocate the transaction price to each performance obligation identified in the contract based on relative standalone prices, or estimates of such prices, and recognize the related revenue as each individual service is performed, in satisfaction of the corresponding performance obligations.
Revenues from system rental consist primarily of fixed monthly fees charged to customers for the use of our patented mobile proppant management systems that unload, store and deliver proppant and chemicals at oil and natural gas well sites, which is considered to be our performance obligation. Contracts with customers are typically on thirty- to sixty-day payment terms. Revenues are recognized over time as the performance obligations are satisfied under the terms of the customer contract. We determined that the performance obligation is satisfied over time as the customer simultaneously receives and consumes the benefits provided by the entity’s performance of services, typically as our systems are used by the customer. We measure progress using an input method based on resources consumed or expended relative to the total resources expected to be consumed or expended. We typically charge our customers for the rental of our systems on a monthly basis under agreements requiring the rental of a minimum number of systems for a period of twelve months. The Company is typically entitled to short fall payments if such minimum contractual obligations are not maintained by our customers. Minimum contractual obligations have been maintained and thus the Company has not recognized revenues related to shortfalls on such take or pay contractual obligations to date.
Revenues from system services consist primarily of the fees charged to customers for services including mobilization and transportation of our systems, field supervision and support and services coordinating proppant delivery to systems, each of which are considered to be separate performance obligations. Contracts with customers are typically on thirty- to sixty-day payment terms. When the Company provides system services including field supervision and support, we determined that the performance obligation is satisfied over time as the customer simultaneously receives and consumes the benefits provided by the entity’s performance of the services, typically based on fixed weekly or monthly contractual rates for field supervision and support and when the Company provides services coordinating proppant delivery. We measure progress using an input method based on resources consumed or expended relative to the total resources expected to be consumed or expended. When the Company provides mobilization and transportation of our systems on behalf of our customers, we determined that the performance obligation is satisfied at a point in time when the system has reached its intended destination.
Revenues from transloading services consist primarily of the fees charged to customers for transloading proppant at our transloading facility, which is considered to be our performance obligation. Transloading services operations commenced in January 2018. We provide rail-to-truck transloading and high-efficiency sand silo storage and transloading services at the facility. Contracts with customers are typically on thirty- to sixty-day payment terms. Revenues are typically recognized over time as the customer simultaneously receives and consumes the benefits provided by the entity’s performance of the transloading service based on a throughput fee per ton rate for proppant delivered to and transloaded at the facility. We measure progress based on the proppant delivered and transloaded at the facility. Under our agreements at the facility, quarterly minimum throughput volumes are required and the Company is entitled to short fall payments if such minimum quarterly contractual obligations are not maintained. These shortfalls are based on fixed minimum volumes at a fixed rate and are recognized over time as throughput volumes transloaded are below minimum throughput volumes required. The Company recorded $20 and $474 of shortfall revenue during the three months ended March 31, 2020 and 2019, respectively.
Revenues from inventory software services consist primarily of the fees charged to customers for the use of our Railtronix inventory management software, which is considered to be our performance obligation. Revenues are recognized over time as the customer simultaneously receives and consumes the benefits provided by the entity’s performance based on a throughput fee to monitor proppant that is loaded into a railcar, stored at a transload facility or loaded into a truck.
Deferred Revenue
Deferred revenue consisted of a $25,980 partial termination payment received in December 2018 in accordance with a contract modification which was accounted for prospectively and a final termination payment of $1,680 recorded as accounts receivable in November 2019 and recognized as revenue throughout the fourth quarter of 2019. The termination payments represented the distinct unsatisfied portion of a contract to provide transloading services and are considered part of the transaction price and were allocated to the remaining performance obligations under the contract, which was fully settled as of December 31, 2019. The Company recognized $3,134 of deferred revenue as Revenue from transloading services in the condensed consolidated statements of operations for the three months ended March 31, 2019. No deferred revenue was recorded or recognized as revenue during the three months ended March 31, 2020.
Stock-based Compensation
We follow the fair value recognition provisions in accordance with GAAP. Under the fair value recognition provisions, stock-based compensation cost is measured at the grant date based on the fair value of the award and is amortized to compensation expense on a straight-line basis over the awards’ vesting period, which is generally the requisite service period. For options to purchase Class A common stock, we have historically and consistently calculated fair value using the Black-Scholes option-pricing model. This valuation approach involves significant judgments and estimates, including estimates regarding our future operations, price variation and the appropriate risk-free rate of return. Our estimates of these variables are made for the purpose of using the valuation model to determine an expense for each reporting period and are not subsequently adjusted. We recognize expense related to the estimated vesting of our performance share units granted.
Research and Development
The Company expenses research and development costs as incurred, which is included in Selling, general and administrative expenses in the condensed consolidated statements of operations. No research and development costs were incurred for the three months ended March 31, 2020 and 2019.
Financial Instruments
The carrying value of the Company’s financial instruments, consisting of cash, accounts receivable, notes receivable, accounts payable and insurance premium financing, approximates their fair value due to the short maturity of such instruments. Financial instruments also consist of a revolving credit facility and term loans, for which fair value approximates carrying value as the debt bears interest at a variable rate which is reflective of current rates otherwise available to the Company. As of March 31, 2020, we had no borrowings under the 2019 Credit Agreement (as defined below) outstanding. Unless otherwise noted, it is management’s opinion that the Company is not exposed to significant interest, currency or credit risks arising from these financial instruments other than allowance for credit losses described in Accounts Receivable and Allowance for Credit Losses.
Fair Value Measurements
The Company’s financial assets and liabilities, as well as other recurring and nonrecurring fair value measurements such as goodwill impairment, long lived assets impairment and purchase accounting, are to be measured using inputs from the three levels of the fair value hierarchy, of which the first two are considered observable and the last unobservable, which are as follows:
·
Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date;
·
Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active or other inputs corroborated by observable market data for substantially the full term of the assets or liabilities; and
·
Level 3—Unobservable inputs that reflect the Company’s assumptions that market participants would use in pricing assets or liabilities based on the best information available, including nonfinancial asset measurements for assessing the impairment of goodwill and long-lived assets.
Income Taxes
Solaris Inc. is a corporation and, as a result, is subject to United States federal, state and local income taxes. For the three months ended March 31, 2020 and 2019, we recognized a combined United States federal and state benefit and expense for income taxes of $6,078 and $4,181, respectively.
Solaris LLC is treated as a partnership for United States federal income tax purposes and therefore does not pay United States federal income tax on its taxable income. Instead, the Solaris LLC unitholders, including Solaris Inc., are liable for United States federal income tax on their respective shares of Solaris LLC’s taxable income reported on the unitholders’ United States federal income tax returns. Solaris LLC is liable for income taxes in those states not recognizing its status as a partnership for United States federal income tax purposes.
Our revenues are derived through transactions in several states, which may be subject to state and local taxes. Accordingly, we have recorded a liability for state and local taxes that management believes is adequate for activities as of March 31, 2020 and December 31, 2019.
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events included in the condensed consolidated financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the book value and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period in which the enactment date occurs.
We recognize deferred tax assets to the extent we believe these assets are more-likely-than-not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent results of operations.
We record uncertain tax positions on the basis of a two-step process in which (1) we determine whether it is more-likely-than-not the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions meeting the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority.
Interest and penalties related to income taxes are included in the benefit (provision) for income taxes in our condensed consolidated statement of operations. We have not incurred any significant interest or penalties related to income taxes in any of the periods presented.
See Note 9. “Income Taxes” for additional information regarding income taxes.
Payable Related to the Tax Receivable Agreement
In connection with Solaris Inc.’s initial public offering (the “IPO” or the “Offering”), Solaris Inc. entered into a Tax Receivable Agreement (the “Tax Receivable Agreement”) with the members of Solaris LLC immediately prior to the IPO (each such person and any permitted transferee, a “TRA Holder,” and together, the “TRA Holders”) on May 17, 2017. This agreement generally provides for the payment by Solaris Inc. to each TRA Holder of 85% of the net cash savings, if any, in United States federal, state and local income tax and franchise tax that Solaris Inc. actually realizes (computed using simplifying assumptions to address the impact of state and local taxes) or is deemed to realize in certain circumstances in periods after the IPO as a result of (i) certain increases in tax basis that occur as a result of Solaris Inc.’s acquisition (or deemed acquisition for United States federal income tax purposes) of all or a portion of such TRA Holder’s Solaris LLC Units in connection with the IPO or pursuant to the exercise of the Redemption Right or the Call Right ( |
