ProPetro Holding Corp.: Form 10-Q for the period ended Sep 30, 2020

The financial information, discussion and analysis that follow should be read in conjunction with our consolidated financial statements and the related notes included in the Form 10-K as well as the financial and other information included therein.

Unless otherwise indicated, references in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" to the "Company," "we," "our," "us" or like terms refer to ProPetro Holding Corp. and its subsidiary.

Overview

We are a growth-oriented, Midland, Texas-based oilfield services company providing hydraulic fracturing and other complementary services to leading upstream oil and gas companies engaged in the exploration and production ("E&P") of North American unconventional oil and natural gas resources. Our operations are primarily focused in the Permian Basin, where we have cultivated long-standing customer relationships with some of the region's most active and well-capitalized E&P companies. The Permian Basin is widely regarded as one of the most prolific oil-producing area in the United States, and we believe we are one of the largest providers of hydraulic fracturing services in the region by hydraulic horsepower ("HHP").

Our total HHP as of September 30, 2020 was approximately 1,469,000 HHP which comprised of approximately 1,415,000 HHP of conventional HHP and approximately 54,000 HHP of the new DuraStim® hydraulic fracturing equipment. We expect to receive our remaining approximately 54,000 HHP of the newly built and fully paid DuraStim® equipment in 2021.

Our competitors include many large and small oilfield services companies, including RPC, Inc., Halliburton Company, Patterson-UTI Energy Inc., Nextier Oilfield Solutions Inc., Liberty Oilfield Services Inc., FTS International Inc. and a number of private companies. Although we believe price is a key factor in E&P companies' criteria in choosing a service provider, we believe that other important factors include operational efficiency, technical expertise, emissions, service and equipment quality, and health and safety standards. While we seek to price our services competitively, we believe many of our customers elect to work with us based on our deep local roots, operational expertise, the capability of our modern fleet to handle the most complex Permian Basin well completions, and commitment to safety and reliability.

Our substantial market presence in the Permian Basin positions us well to capitalize on drilling and completion activity in the region. Historically, our operational focus has been in the Permian Basin's Midland sub-basin, where our customers have primarily operated. However, as activity in the Delaware sub-basin increased, we expanded our presence in the Delaware sub-basin in response to demand from our customers. Given our dedicated relationships with a variety of Delaware sub-basin operators, we believe that we are uniquely positioned to capture large addressable growth opportunity as the basin develops. Over time, we expect the Permian Basin's Midland and Delaware sub-basins to continue to command a disproportionate share of future North American E&P spending.

Through our pressure pumping segment (which also includes our cementing operations), we primarily provide hydraulic fracturing services to E&P companies in the Permian Basin. Our hydraulic fracturing fleet has been designed to handle Permian Basin specific operating conditions and the region's increasingly high-intensity well completions, which are characterized by longer horizontal wellbores, more stages per lateral and increasing amounts of proppant per well.

In addition to our core pressure pumping segment operations, which includes our cementing operations, we also offer coiled tubing services. We believe our coiled tubing services create operational efficiencies for our customers and could allow us to capture a greater portion of their capital spending across the lifecycle of a well.

Commodity Price and Other Economic Conditions

The oil and gas industry has traditionally been volatile and is influenced by a combination of long-term, short-term and cyclical trends, including domestic and international supply and demand for oil and gas, current and expected future prices for oil and gas and the perceived stability and sustainability of those prices, and capital investments of E&P companies toward their development and production of oil and gas reserves. The oil and gas industry is also impacted by general domestic and international economic conditions, political instability in oil producing countries, government regulations (both in the United States and internationally), levels of consumer demand, adverse weather conditions, and other factors that are beyond our control.

The global public health crisis associated with the COVID-19 pandemic has and is anticipated to continue to have an adverse effect on global economic activity for the immediate future and has resulted in travel limitations, business closures and the institution of quarantining and other restrictions on movement and business operations in many communities. The slowdown in global economic activity attributable to COVID-19 has resulted in a dramatic decline in the demand for energy which directly impacts our industry and the Company. In addition, global crude oil prices experienced a collapse starting in early March 2020 as a direct result of failed negotiations between OPEC and Russia. In response to the global economic slowdown, OPEC+ participants subsequently reached an agreement to cut production by up to 10 million barrels of oil per day, or BOPD, with allocations to be made among the OPEC+ participants, which began to take effect in the first half of May 2020. In addition, commodity prices remain depressed as a result of the near-term demand loss attributable to the COVID-19 health crisis and related economic slowdown.

As the breadth of the COVID-19 health crisis expanded throughout the month of March 2020 and governmental authorities implemented more restrictive measures to limit person-to-person contact, global economic activity continued to decline commensurately. The associated impact on the energy industry has been adverse and continued to be exacerbated by the unresolved conflict regarding production.

The combined effect of COVID-19 and the energy industry disruptions, which negatively impacted our operations, led to a decline in WTI crude oil prices of approximately 67 percent from the beginning of January 2020, when prices were approximately $62 per barrel, through the end of March 2020, when they were just above $20 per barrel. Overall crude oil price volatility has continued despite apparent agreement among OPEC+ regarding production cuts and as of October 31, 2020, the WTI price for a barrel of crude oil was approximately $36.

In light of the COVID-19 pandemic and the energy industry disruptions, the Permian Basin rig count decreased significantly from approximately 403 at the beginning of January 2020 to approximately 117 in mid-August 2020, according to Baker Hughes. However, the rig count slowly increased exiting August 2020 and is currently at 142 rigs at the end of October 2020. The decrease in the rig count will impact the future demand for our services. If the rig count and market conditions do not continue to improve, the Company expects a material adverse impact on the services we provide, resulting from our customers shutting down completions of wells and pressure from our customers to reduce the prices of our services. We expect the reduction in the number of wells completion activities and the pricing pressure from our customers to have a negative impact on our future revenue, results of operations and cash flows.

Although the oil and gas market is currently depressed, we still believe the Permian Basin, our primary area of operation, is the leading basin with the lowest break-even production cost in the United States. If the market rebounds, we believe there will be increased demand for pressure pumping services in the Permian Basin where we operate. If the current depressed oil prices and economic conditions remain for a longer period of time, our profitability and future cash flows will be negatively impacted, and as a result, we may be required to record additional asset impairment charges in future periods.

Our results of operations have historically reflected seasonal tendencies, typically in the fourth quarter, relating to holiday seasons, inclement winter weather and exhaustion of our customers' annual budgets. As a result, we typically experience declines in our operating results in November and December, even in a stable commodity price and operations environment. The seasonal tendencies and the current depressed oil and gas market conditions could result in a longer recovery time in the oil and gas industry thereby significantly impacting our revenue, results of operations and cash flows for a longer period of time beyond 2020.

Actions to Address the Economic Impact of COVID-19 and Decline in Commodity Prices

Since March 2020, we initiated several actions to mitigate the anticipated adverse economic conditions for the immediate future and to support our financial position, liquidity and the efficient continuity of our operations as follows:

• Growth Capital. We cancelled substantially all our planned growth capital expenditures for the remainder of 2020.
• Other Expenditures. We significantly reduced our maintenance expenditures and field level consumable costs due to our reduced activity levels. We negotiated lower pricing for our expendable items, materials used in day-to-day operations and large component replacement parts. Also, we have been internalizing certain support services that were outsourced.
• Labor Force Reductions. We reduced our workforce by over 60% between April and May 2020, due to the changing activity levels for our services. We will continue to make appropriate adjustments to our workforce to reflect outlook related to activity levels.
• Working Capital. We have negotiated more favorable payment terms with certain of our larger vendors and are continuing to increase our diligence in collecting and managing our portfolio of accounts receivables.

We will continue to evaluate and consider additional cost saving measures. We will continue to prioritize the safety and welfare of our employees and customers through these turbulent times.

How We Evaluate Our Operations

Our management uses Adjusted EBITDA or Adjusted EBITDA margin to evaluate and analyze the performance of our various operating segments.

Adjusted EBITDA and Adjusted EBITDA Margin

We view Adjusted EBITDA and Adjusted EBITDA margin as important indicators of performance. We define EBITDA as our earnings, before (i) interest expense, (ii) income taxes and (iii) depreciation and amortization. We define Adjusted EBITDA as EBITDA, plus (i) loss/(gain) on disposal of assets, (ii) stock-based compensation, and (iii) other unusual or nonrecurring (income)/expenses, such as impairment charges, severance, costs related to asset acquisitions and one-time professional fees. Adjusted EBITDA margin reflects our Adjusted EBITDA as a percentage of our revenues.

Adjusted EBITDA and Adjusted EBITDA margin are supplemental measures utilized by our management and other users of our financial statements such as investors, commercial banks, and research analysts, to assess our financial performance because it allows us and other users to compare our operating performance on a consistent basis across periods by removing the effects of our capital structure (such as varying levels of interest expense), asset base (such as depreciation and amortization), nonrecurring (income)/expenses and items outside the control of our management team (such as income taxes). Adjusted EBITDA and Adjusted EBITDA margin have limitations as analytical tools and should not be considered as an alternative to net income/(loss), operating income/(loss), cash flow from operating activities or any other measure of financial performance presented in accordance with GAAP.

Note Regarding Non-GAAP Financial Measures

Adjusted EBITDA and Adjusted EBITDA margin are not financial measures presented in accordance with GAAP (“non-GAAP”), except when specifically required to be disclosed by GAAP in the financial statements. We believe that the presentation of Adjusted EBITDA and Adjusted EBITDA margin provide useful information to investors in assessing our financial condition and results of operations because it allows them to compare our operating performance on a consistent basis across periods by removing the effects of our capital structure, asset base, nonrecurring expenses (income) and items outside the control of the Company. Net income (loss) is the GAAP measure most directly comparable to Adjusted EBITDA. Adjusted EBITDA and Adjusted EBITDA margin should not be considered as alternatives to the most directly comparable GAAP financial measure. Each of these non-GAAP financial measures has important limitations as analytical tools because they exclude some, but not all, items that affect the most directly comparable GAAP financial measures. You should not consider Adjusted EBITDA or Adjusted EBITDA margin in isolation or as a substitute for an analysis of our results as reported under GAAP. Because Adjusted EBITDA and Adjusted EBITDA margin may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.

Reconciliation of net income (loss) to Adjusted EBITDA ($ in thousands):

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(1) Other general and administrative expense relates to nonrecurring professional fees paid to external consultants in connection with the Company's expanded audit committee review, SEC investigation and shareholder litigation. All nonrecurring professional fees incurred after the end of June 2020 are in connection with the pending SEC investigation and shareholder litigation.

Results of Operations

We conducted our business through three operating segments: hydraulic fracturing, cementing and coiled tubing. In March 2020, the Company shut down its flowback operating segment and subsequently disposed of the assets for approximately $1.6 million. In September 2020, the Company disposed of all of its drilling rigs and ancillary assets for approximately $0.5 million and shut down its drilling operations. For reporting purposes, the hydraulic fracturing and cementing operating segments are aggregated into our one reportable segment—pressure pumping. All other operating segments and corporate administrative expenses (inclusive of our total income tax expense and interest expense) are included in the ‘‘all other’’ category. Total corporate administrative expense for the three and nine months ended September 30, 2020 was $7.0 million and $27.9 million, respectively. The corporate administrative expense for the three and nine months ended September 30, 2019 was $30.1 million and $87.3 million, respectively.

Our hydraulic fracturing operating segment revenue approximated 95.2% and 94.0% of our pressure pumping revenue during the three and nine months ended September 30, 2020, respectively. During the three and nine months ended September 30, 2019, our hydraulic fracturing operating segment revenue approximated 95.7% and 95.7% of our pressure pumping revenue, respectively.

The following table sets forth the results of operations for the periods presented:

(in thousands, except for percentages)

(1) Exclusive of depreciation and amortization.

(2) Inclusive of stock-based compensation.

(3) For definitions of the non-GAAP financial measures of Adjusted EBITDA and Adjusted EBITDA margin and reconciliation of Adjusted EBITDA to our most directly comparable financial measures calculated in accordance with GAAP, please read "How We Evaluate Our Operations". Included in our Adjusted EBITDA is idle fees of $6.9 million and $0.5 million for the three months ended September 30, 2020 and 2019, respectively.

(4) The non-GAAP financial measure of Adjusted EBITDA margin for the pressure pumping segment is calculated by taking Adjusted EBITDA for the pressure pumping segment as a percentage of our revenue for the pressure pumping segment.

Three Months Ended September 30, 2020 Compared to the Three Months Ended September 30, 2019

Revenues. Revenues decreased 75.3%, or $408.1 million, to $133.7 million during the three months ended September 30, 2020, as compared to $541.8 million during the three months ended September 30, 2019. Our pressure pumping segment revenues decreased 75.2%, or $397.5 million, for the three months ended September 30, 2020, as compared to the three months ended September 30, 2019. The decreases were primarily attributable to the significant decrease in demand for pressure pumping services, as well as pricing discounts we provided to our customers following the depressed oil prices and slowdown in economic activity resulting from the COVID-19 pandemic. The decrease in demand for our pressure pumping services resulted in a significant decrease in our average effectively utilized fleet count to approximately 8.5 active fleets during the three months ended September 30, 2020 from approximately 25.1 active fleets for the three months ended September 30, 2019. Included in our revenue for the three months ended September 30, 2020 and 2019 was revenue generated from idle fees charged to our customer of approximately $6.9 million and $0.5 million, respectively.

Revenues from services other than pressure pumping decreased 81.6%, or $10.6 million, to $2.4 million for the three months ended September 30, 2020, as compared to $13.0 million for the three months ended September 30, 2019. The decrease in revenue from services other than pressure pumping was primarily attributable to the significant reduction in utilization experienced by our coiled tubing operations, which was driven by lower E&P completions activity following the depressed oil prices and impact of the COVID-19 pandemic.

Cost of Services. Cost of services decreased 74.9%, or $297.3 million, to $99.6 million for the three months ended September 30, 2020, as compared to $396.9 million during the three months ended September 30, 2019. Cost of services in our pressure pumping segment decreased $287.7 million for the three months ended September 30, 2020, as compared to the three months ended September 30, 2019. These decreases were primarily attributable to the significantly lower activity levels following the depressed oil prices and economic slowdown caused by the COVID-19 pandemic that negatively impacted E&P completions activity. As a percentage of pressure pumping segment revenues (including idle fees), pressure pumping cost of services was 74.1% for the three months ended September 30, 2020, as compared to 72.8% for the three months ended September 30, 2019. The increase in our cost of services percentage was primarily attributable to pricing pressure on our services resulting in customer discounts, partially offset by the idle fees revenue. Excluding idle fees revenue of $6.9 million and $0.5 million recorded during the three months ended September 30, 2020 and 2019, respectively, our pressure pumping cost of services as a percentage of pressure pumping revenues for the three months ended September 30, 2020 and 2019, was approximately 78.3% and 72.9%, respectively.

General and Administrative Expenses. General and administrative expenses decreased 20.8%, or $5.7 million, to $21.8 million for the three months ended September 30, 2020, as compared to $27.6 million for the three months ended September 30, 2019. The net decrease was primarily attributable to a decrease in (i) nonrecurring advisory and professional fees of $6.5 million, (ii) retention bonus and severance expense of $3.1 million and (iii) $0.5 million in other remaining general and administrative expenses, partially offset by a net increases of $2.0 million in stock compensation expense and $2.4 million in payroll expenses.

Depreciation and Amortization. Depreciation and amortization was relatively flat, with a slight decrease of 0.5%, or $0.2 million, to $37.5 million for the three months ended September 30, 2020, as compared to $37.7 million for the three months ended September 30, 2019.

Loss on Disposal of Assets. Loss on the disposal of assets decreased 63.8%, or $19.9 million, to $11.3 million for the three months ended September 30, 2020, as compared to $31.2 million for the three months ended September 30, 2019. The decrease was primarily attributable to the decrease in utilization resulting in a reduction in the operational intensity on our equipment. Upon sale or retirement of property and equipment, including certain major components of our pressure pumping equipment that are replaced, the cost and related accumulated depreciation are removed from the balance sheet and the net amount is recognized as loss on disposal of assets.

Interest Expense. Interest expense decreased 92.2%, or $1.6 million, to $0.1 million for the three months ended September 30, 2020, as compared to $1.7 million for the three months ended September 30, 2019. The decrease in interest expense was primarily attributable to the decrease in our average debt balance during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. In three months ended September 30, 2020, the Company had a zero debt balance, and the interest expense in the three months ended September 30, 2020, relates to the amortization of our capitalized loan origination cost.

Other Expense. Other expense increased to $0.3 million for the three months ended September 30, 2020, as compared to $0.1 million for the three months ended September 30, 2019. The increase in other expense is attributable to the increase in our lender's commitment fees during the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

Income Taxes. Total income tax benefit was $7.7 million resulting in an effective tax rate of 20.9% for the three months ended September 30, 2020, as compared to income tax expense of $12.3 million or an effective tax rate of 26.4% for the three months ended September 30, 2019. The income tax benefit recorded in the three months ended September 30, 2020 is primarily attributable to the Company projecting a pre-tax loss in 2020 as compared to a pre-tax income in 2019. Furthermore, the change in the effective tax rate from 26.4% to 20.9% in the three months ended September 30, 2020 was primarily attributable to nondeductible expenses and discrete items such as stock compensation expense reducing the benefit recorded for the pre-tax loss.

The following table sets forth the results of operations for the periods presented:

(in thousands, except for percentages)

(1) Exclusive of depreciation and amortization.

(2) Inclusive of stock-based compensation.

(3) For definitions of the non-GAAP financial measures of Adjusted EBITDA and Adjusted EBITDA margin and reconciliation of Adjusted EBITDA to our most directly comparable financial measures calculated in accordance with GAAP, please read "How We Evaluate Our Operations". Included in our Adjusted EBITDA is idle fees of $41.1 million and $11.8 million for the nine months ended September 30, 2020 and 2019, respectively.

(4) The non-GAAP financial measure of Adjusted EBITDA margin for the pressure pumping segment is calculated by taking Adjusted EBITDA for the pressure pumping segment as a percentage of our revenue for the pressure pumping segment.

Nine Months Ended September 30, 2020 Compared to the Nine Months Ended September 30, 2019

Revenues. Revenues decreased 60.7%, or $982.6 million, to $634.9 million during the nine months ended September 30, 2020, as compared to $1,617.5 million during the nine months ended September 30, 2019. Our pressure pumping segment revenues decreased 60.5%, or $954.7 million, for the nine months ended September 30, 2020, as compared to the nine months ended September 30, 2019. The decreases were primarily attributable to the significant decrease in demand for pressure pumping services that led to a significant decrease in our hydraulic fracturing fleet utilization, as well as pricing discounts we provided to our customers following the depressed oil prices and slowdown in economic activity resulting from the COVID-19 pandemic. The decrease in demand for our pressure pumping services resulted in a significant decrease in our average effectively utilized fleet count to approximately 10.4 active fleets during the nine months ended September 30, 2020 from approximately 25.4 active fleets for the nine months ended September 30, 2019. Included in our revenue for the nine months ended September 30, 2020 and 2019 was revenue generated from idle fees charged to our customer of approximately $41.1 million and $11.8 million, respectively.

Revenues from services other than pressure pumping decreased 68.5%, or $27.9 million, to $12.8 million for the nine months ended September 30, 2020, as compared to $40.7 million for the nine months ended September 30, 2019. The decrease in revenue from services other than pressure pumping was primarily attributable to the significant reduction in utilization experienced by our coiled tubing operations, which was driven by lower E&P completions activity following the depressed oil prices and impact of the COVID-19 pandemic.

Cost of Services. Cost of services decreased 59.8%, or $696.0 million, to $468.6 million for the nine months ended September 30, 2020, as compared to $1,164.7 million during the nine months ended September 30, 2019. Cost of services in our pressure pumping segment decreased $673.2 million for the nine months ended September 30, 2020, as compared to the nine months ended September 30, 2019. These decreases were primarily attributable to the significantly lower activity levels resulting from the depressed oil prices and economic slowdown caused by the COVID-19 pandemic that negatively impacted E&P completions activity. As a percentage of pressure pumping segment revenues (including idle fees), pressure pumping cost of services increased to 73.6% for the nine months ended September 30, 2020, as compared to 71.7% for the nine months ended September 30, 2019. The increase in our cost of services percentage was primarily attributable to pricing pressure on our services resulting in customer discounts, partially offset by the idle fees revenue. Excluding idle fees revenue of $41.1 million and $11.8 million recorded during the nine months ended September 30, 2020 and 2019, respectively, our pressure pumping cost of services as a percentage of pressure pumping revenues for nine months ended September 30, 2020 and 2019, was approximately 78.8% and 72.3%, respectively.

General and Administrative Expenses. General and administrative expenses decreased 9.3%, or $6.9 million, to $67.1 million for the nine months ended September 30, 2020, as compared to $74.0 million for the nine months ended September 30, 2019. The net decrease was primarily attributable to a decrease in (i) severance expense of $1.5 million associated with the resignation of a former executive, (ii) retention bonus of $5.1 million associated with personnel who joined us in 2019 as part of the Pioneer Pressure Pumping Acquisition, (iii) insurance expense of $1.3 million and (iv) $0.2 million in remaining other general and administrative expenses, partially offset by a net increase of approximately $1.2 million paid in advisory and professional fees.

Depreciation and Amortization. Depreciation and amortization increased 10.9%, or $11.6 million, to $117.8 million for the nine months ended September 30, 2020, as compared to $106.3 million for the nine months ended September 30, 2019. The increase was primarily attributable to the overall increase in our fixed asset base in 2020, resulting primarily from an increase in our pressure pumping fleet capacity by 3.8% to 1,469,000 HHP as of September 30, 2020.

Impairment Expense. During the nine months ended September 30, 2020, the depressed market conditions, crude oil prices and negative near-term outlook for the utilization of certain of our equipment, resulted in the Company recording an impairment expense of $16.7 million, of which $9.4 million relates to goodwill impairment and $7.2 million relates to property and equipment impairment. There was no impairment expense during the nine months ended September 30, 2019.

Loss on Disposal of Assets. Loss on the disposal of assets decreased 51.1%, or $41.7 million, to $39.9 million for the nine months ended September 30, 2020, as compared to $81.6 million for nine months ended September 30, 2019. The decrease is primarily attributable to the decrease in utilization resulting in a reduction in the operational intensity on our equipment. Upon sale or retirement of property and equipment, including certain major components of our pressure pumping equipment that are replaced, the cost and related accumulated depreciation are removed from the balance sheet and the net amount is recognized as loss on disposal of assets.

Interest Expense. Interest expense decreased 61.1%, or $3.5 million, to $2.2 million for the nine months ended September 30, 2020, as compared to $5.7 million for the nine months ended September 30, 2019. The decrease in interest expense was primarily attributable to the decrease in our average debt balance during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

Other Expense. There was no significant change in other expense. Other expense was $0.6 million for the nine months ended September 30, 2020, as compared to $0.5 million for the nine months ended September 30, 2019.

Income Taxes. Total income tax benefit was $15.1 million resulting in an effective tax rate of 19.3% for the nine months ended September 30, 2020, as compared to income tax expense of $44.5 million or an effective tax rate of 24.1% for the nine months ended September 30, 2019. The income tax benefit recorded in the nine months ended September 30, 2020 is primarily attributable to the Company projecting a pre-tax loss in 2020 as compared to a pre-tax income in 2019. Furthermore, the change in the effective tax rate from 24.1% to 19.3% in the nine months ended September 30, 2020 was primarily attributable to nondeductible expenses and discrete items such as stock compensation expense reducing the benefit recorded for the pre-tax loss.

Liquidity and Capital Resources

Our liquidity is currently provided by (i) existing cash balances, (ii) operating cash flows and (iii) borrowings under our revolving credit facility (“ABL Credit Facility”), if any. Our primary uses of cash will be to continue to fund our operations, support growth opportunities and satisfy future debt payments, if any. Our borrowing base, as redetermined monthly, is tied to 85.0% of eligible accounts receivable. Changes to our operational activity levels have an impact on our total eligible accounts receivable, which could result in significant changes to our borrowing base and therefore our availability under our ABL Credit Facility. Our remaining monthly availability under our ABL Credit Facility will be adversely impacted if the current depressed oil and gas market conditions do not improve.

The global public health crisis associated with the COVID-19 pandemic has and is anticipated to continue to have an adverse effect on global economic activity for the immediate future and has resulted in travel limitations, business closures and the institution of quarantining and other restrictions on movement and certain business operations in many communities. The slowdown and restrictions in global economic activity attributable to COVID-19 has resulted in a dramatic decline in the demand for energy which directly impacts our industry and the Company. In addition, global crude oil prices experienced a collapse starting in early March 2020. As a result of these developments, the Company experienced a material adverse impact on the oilfield services we provide and our revenue, results of operations and cash flows.

During the second quarter of 2020 and through July 2020 when demand for our services was significantly depressed following the rapidly rising health crisis associated with the COVID-19 pandemic and the energy industry disruptions led by depressed WTI crude oil prices, the Company experienced a decrease in its liquidity. However, the gradual recovery in the oil and gas industry and reduction in the COVID-19 infection rate experienced in the third quarter of 2020 have led to a gradual recovery in the demand for our pressure pumping services. Combined with our cost reduction initiatives, we have slowly increased our liquidity position and expect our liquidity to continue to gradually increase, if market conditions improve. Current market conditions resulting from the COVID-19 pandemic are rapidly changing and additional impacts to the business may arise that we are not aware of currently and the depressed oil and gas industry may take a longer time to recover than anticipated, thereby significantly impacting our revenue, results of operations and cash flows for a longer period of time.

As of September 30, 2020, we had no borrowings under our ABL Credit Facility, and our total liquidity was approximately $85.9 million, consisting of cash and cash equivalents of $54.3 million and $31.6 million of availability under our ABL Credit Facility.

As of October 31, 2020, our total liquidity was approximately $110.6 million, consisting of cash and cash equivalents of $66.7 million and $43.9 million of availability under our ABL Credit Facility.

There can be no assurance that operations and other capital resources will provide cash in sufficient amounts to maintain planned or future levels of capital expenditures. Future cash flows are subject to a number of variables, and are highly dependent on the drilling, completion, and production activity by our customers, which in turn is highly dependent on oil and natural gas prices. Depending upon market conditions and other factors, we may issue equity and debt securities or take other actions necessary to fund our business or meet our future long-term liquidity requirements.

Our ABL Credit Facility, as amended, has a total borrowing capacity of $300 million (subject to the Borrowing Base limit), with a maturity date of December 19, 2023. The ABL Credit Facility has a borrowing base of 85% of monthly eligible accounts receivable less customary reserves (the "Borrowing Base"). The Borrowing Base as of September 30, 2020 was approximately $35.3 million and was approximately $47.6 million as of October 31, 2020. The ABL Credit Facility includes a Springing Fixed Charge Coverage Ratio to apply when excess availability is less than the greater of (i)10% of the lesser of the facility size or the Borrowing Base or (ii) $22.5 million. Under this facility we are required to comply, subject to certain exceptions and materiality qualifiers, with certain customary affirmative and negative covenants, including, but not limited to, covenants pertaining to our ability to incur liens, indebtedness, changes in the nature of our business, mergers and other fundamental changes, disposal of assets, investments and restricted payments, amendments to our organizational documents or accounting policies, prepayments of certain debt, dividends, transactions with affiliates, and certain other activities. Borrowings under the ABL Credit Facility are secured by a first priority lien and security interest in substantially all assets of the Company.

Borrowings under the ABL Credit Facility accrue interest based on a three-tier pricing grid tied to availability, and we may elect for loans to be based on either LIBOR or base rate, plus the applicable margin, which ranges from 1.75% to 2.25% for LIBOR loans and 0.75% to 1.25% for base rate loans, with a LIBOR floor of zero. The weighted average interest rate for our ABL Credit Facility for the nine months ended September 30, 2020 was 3.6%.

In July 2017, the United Kingdom's Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. At the present time, the ABL Credit Facility is subject to LIBOR rates but has a term that extends beyond the end of 2021 when LIBOR will be phased out. We have not yet pursued any technical amendment or other contractual alternative to address this matter. We are currently evaluating the potential impact of eventual replacement of the LIBOR interest rate.

Future Sources and Use of Cash and Contractual Obligations

Future capital expenditures are projected to be primarily related to maintenance capital expenditures to support our active assets depending on fleet utilization, customer demand and market conditions. We anticipate our capital expenditures will be funded by existing cash, cash flows from operations, and if needed, borrowings under our ABL Credit Facility. Our cash flows from operations will be generated from services we provide to our customers and idle fees if a customer (Pioneer) decides to idle committed fleets and we are not able to deploy the idled fleets to another customer. During times when there is a significant reduction in overall demand for our services, the idle fees could represent a material portion of our revenues and cash flows from operations. Our maintenance capital expenditures are dependent on our operational activity and the intensity on the equipment, among other factors, which could vary throughout the year. In addition, we have option agreements with our equipment manufacturer to purchase additional 108,000 HHP of DuraStim® hydraulic fracturing equipment through July 31, 2022. We believe the cost to acquire the DuraStim® hydraulic fracturing equipment will be comparable to our previously purchased DuraStim® hydraulic fracturing equipment. In the current economic environment, it is not probable we would exercise these options before they expire.

During the nine months ended September 30, 2020, we repaid all our borrowings under our ABL Credit Facility of approximately $130.0 million with cash flows from operations and our available cash. Our objective is to maintain a conservative leverage ratio.

In the normal course of business, we enter into various contractual obligations and routine growth and maintenance capital expenditures that impact our future liquidity. There were no other known future material contractual obligations as of September 30, 2020.

Cash and Cash Flows

The following table sets forth the historical cash flows for the nine months ended September 30, 2020 and 2019:

($ in thousands)

Cash Flows From Operating Activities

Net cash provided by operating activities was $118.0 million for the nine months ended September 30, 2020, compared to net cash provided by operating activities of $307.6 million for the nine months ended September 30, 2019. The net decrease of $189.6 million was primarily due to the decrease in our activity levels resulting from the decrease in the demand for our services, driven by the depressed crude oil prices and economic impact of the COVID-19 pandemic on our industry, and partially offset with the timing of collections of our receivables from customers and payments to vendors. Our effectively utilized fleet count decreased to approximately 10.4 active fleets during the nine months ended September 30, 2020 from approximately 25.4 active fleets for the nine months ended September 30, 2019.

Cash Flows From Investing Activities

Net cash used in investing activities decreased to $82.2 million for the nine months ended September 30, 2020, from $387.6 million for the nine months ended September 30, 2019. The decrease was primarily attributable to the Company’s initiatives to significantly reduce growth and maintenance capital expenditures during the nine months ended September 30, 2020 following the depressed oil and gas market and decreased demand for our services. During the nine months ended September 30, 2019, the Company acquired and paid approximately $110.0 million for the purchase of 510,000 HHP, 4 coiled tubing units and maintenance yard (associated with the Pioneer Pressure Pumping Acquisition), and also made cash deposits of approximately $102.9 million to its equipment manufacturers for DuraStim® hydraulic fracturing equipment, including an option fees deposit.

Cash Flows From Financing Activities

Net cash used in financing activities was $130.6 million for the nine months ended September 30, 2020, and net cash provided by financing activities was $56.4 million for the nine months ended September 30, 2019. The net decrease in cash from financing activities during the nine months ended September 30, 2020 was primarily driven by the repayment of our outstanding borrowings under our ABL Credit Facility of $130.0 million, compared to net borrowings under our ABL Credit Facility of $60.0 million during the nine months ended September 30, 2019.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of September 30, 2020.

Critical Accounting Policies and Estimates

There have been no material changes during the nine months ended September 30, 2020 to the methodology applied by our management for critical accounting policies previously disclosed in our Form 10-K. Please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates" in our Form 10-K for a discussion of our critical accounting policies and estimates.

Recently Issued Accounting Standards

Disclosure concerning recently issued accounting standards is incorporated by reference to Note 2 of our Condensed Consolidated Financial Statements (Unaudited) contained in this Form 10-Q.

As of September 30, 2020, there have been no material changes in market risk from the information provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or “Quantitative and Qualitative Disclosures of Market Risk” in our Form 10-K.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that the information required to be disclosed by us in our reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15(b) under the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 2020, and notwithstanding the material weaknesses in our internal control over financial reporting described below, our management has concluded that our financial statements in this Quarterly Report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in accordance with GAAP.

Management’s Report on Internal Control over Financial Reporting

The management of ProPetro Holding Corp. is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. ProPetro Holding Corp. maintains a system of internal accounting controls designed to provide reasonable assurance, at a reasonable cost, that assets are safeguarded against loss or unauthorized use and that the financial records are adequate and can be relied upon to produce financial statements in accordance with GAAP. The internal control system is augmented by written policies and procedures, an internal audit program and the selection and training of qualified personnel. This system includes policies that require adherence to ethical business standards and compliance with all applicable laws and regulations.

There are inherent limitations to the effectiveness of any control system. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Also, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company will be detected. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. The Company intends to continually improve and refine its internal controls.

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our internal control over financial reporting as of December 31, 2019 based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on the evaluation under these criteria, management determined, based upon the existence of the material weaknesses identified and previously reported in our Form 10-K and described below, that we did not maintain effective internal control over financial reporting as of December 31, 2019. Due to the existence of the material weaknesses described below, our internal control over financial reporting remained ineffective as of September 30, 2020.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that a reasonable possibility exists that a material misstatement of our annual or interim financial statements would not be prevented or detected on a timely basis.

Control Environment

We have identified deficiencies in the principles associated with the control environment component of the COSO framework. Specifically, these control deficiencies constitute material weaknesses, either individually or in the aggregate, relating to the following COSO principles: (i) the organization demonstrates a commitment to integrity and ethical values, (ii) the board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control, (iii) management establishes, with board oversight, structures, reporting lines, and appropriate authorities and responsibilities in pursuit of objectives, (iv) the organization demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives, and (v) the organization holds individuals accountable for their internal control related responsibilities in the pursuit of objectives.

Our senior management did not establish and promote a control environment with an appropriate tone of compliance and control consciousness throughout the entire Company. The Company did not sufficiently promote, monitor or enforce adherence to its Code of Conduct and Ethics. Additionally, the recently concluded expanded audit committee review found that there was a general lack of focus on promoting a culture of compliance within the Company. Results of poor tone at the top included: (i) certain whistleblower allegations were not properly investigated and elevated to the audit committee, (ii) the lack of an employee expense review and approval policy, (iii) two instances of non-compliance with the Company’s Insider Trading Policy, and (iv) instances of non-compliance with the Code of Conduct and Ethics policies.

This material weakness in the control environment contributed to material weaknesses in the following components of the COSO framework.

Information and Communication

We have identified deficiencies in the principles associated with the information and communication component of the COSO framework. Specifically, these control deficiencies constitute material weaknesses, either individually or in the aggregate, relating to the following COSO principles: (i) the organization internally communicates information, including objectives and responsibilities for internal control, necessary to support the functioning of internal control, and (ii) the organization communicates with external parties regarding matters affecting the functioning of internal control.

Factors contributing to the material weakness included miscommunication between management and the Board regarding the conditionality of certain contracts that resulted in the non-disclosure of such contract commitments and the impact of such commitments on the Company’s future liquidity.

Control Activities

We have identified deficiencies in the principles associated with the control activities component of the COSO framework. Specifically, these control deficiencies constitute material weaknesses, either individually or in the aggregate, relating to the following COSO principles: (i) the organization selects and develops control activities that contribute to the mitigation of risks to the achievement of objectives to acceptable levels and (ii) the organization deploys control activities through policies that establish what is expected and procedures that put policies into action.

The Company’s failure to maintain appropriate tone at the top had a pervasive impact, and as such, resulted in a risk that could have impacted virtually all financial statement account balances and disclosures.

The COSO component material weaknesses described above contributed to the following material weakness within our system of internal control over financial reporting at the control activity level.

Related Parties

We did not maintain controls designed to sufficiently identify, evaluate, and disclose related party transactions. As a result, two related party transactions were entered into that were not identified by the Company’s controls and given consideration of appropriate disclosure.

Remediation Plan and Status

Our remediation efforts to the identified material weaknesses are ongoing, and we will continue our initiatives to implement and document policies, procedures, and internal controls. The Board and management have implemented, among other items, the following measures to address the material weaknesses identified:

• Appointed new executive officers with extensive public company experience to improve the tone at the top, communication with the Board and compliance with policies within the Company.
• Enhanced certain of the Company’s policies, including the Code of Ethics and Conduct, Expense Reimbursement, Travel and Entertainment, and Delegation of Responsibilities and Authority. Additionally, the Company enhanced or implemented control activities to monitor compliance with such policies.
• Designed and implemented control activities related to the identification of, approval of, and disclosure of related party transactions.
• Designed and implemented control activities related to the identification and approval of potential conflicts of interest.
• Designed and implemented control activities related to the evaluation of whistleblower allegations.
• Formed a disclosure committee and appointed a Chief Disclosure Officer to provide improved corporate governance related to disclosures the Company provides to the public and other external parties.

Our remediation of the identified material weaknesses and strengthening our internal control environment is ongoing and will require a substantial effort. We will continue to evaluate the design and implementation and operating effectiveness of the new and existing controls that address all the material weaknesses we identified as of December 31, 2019. The material weaknesses cannot be considered remediated until the applicable controls have operated for a sufficient period of time and management has concluded, through testing for a period of time, that these controls are designed and operating effectively. Accordingly, we will continue to monitor and evaluate the effectiveness of our internal control over financial reporting in the areas affected by the material weaknesses described above.

Changes in Internal Control over Financial Reporting

Except as described above, there were no changes in our system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.