Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2022
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 001-33666
Archrock, Inc.
(Exact name of registrant as specified in its charter)
Delaware
74-3204509
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
9807 Katy Freeway, Suite 100, Houston, Texas 77024
(Address of principal executive offices, zip code)
(281) 836-8000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of exchange on which registered
Common stock, $0.01 par value per share
AROC
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Number of shares of the common stock of the registrant outstanding as of October 26, 2022: 155,611,630 shares.
TABLE OF CONTENTS
Page
Forward-Looking Statements
3
Part I. Financial Information
Item 1. Financial Statements
4
Unaudited Condensed Consolidated Balance Sheets
Unaudited Condensed Consolidated Statements of Operations
5
Unaudited Condensed Consolidated Statements of Comprehensive Income
6
Unaudited Condensed Consolidated Statements of Equity
7
Unaudited Condensed Consolidated Statements of Cash Flows
9
Notes to Unaudited Condensed Consolidated Financial Statements
10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
24
Item 3. Quantitative and Qualitative Disclosures About Market Risk
32
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
33
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
34
Signatures
35
2
FORWARD–LOOKING STATEMENTS
This Quarterly Report on Form 10–Q (this “Form 10–Q”) contains “forward–looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this Form 10–Q are forward–looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including, without limitation, our business growth strategy and projected costs; future financial position; the sufficiency of available cash flows to fund continuing operations and pay dividends; the expected amount of our capital expenditures; anticipated cost savings; future revenue, gross margin and other financial or operational measures related to our business; the future value of our equipment; and plans and objectives of our management for our future operations. You can identify many of these statements by words such as “believe,” “expect,” “intend,” “project,” “anticipate,” “estimate,” “will continue” or similar words or the negative thereof.
Such forward–looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this Form 10–Q. Although we believe that the expectations reflected in these forward–looking statements are based on reasonable assumptions, no assurance can be given that these expectations will prove to be correct. Known material factors that could cause our actual results to differ materially from the expectations reflected in these forward–looking statements include the risk factors described in our Annual Report on Form 10–K for the year ended December 31, 2021 (the “Form 10–K) and those set forth from time to time in our filings with the United States Securities and Exchange Commission (the “SEC”), which are available through our website at www.archrock.com and through the SEC’s website at www.sec.gov.
All forward–looking statements included in this Form 10–Q are based on information available to us on the date of this Form 10–Q. Except as required by law, we undertake no obligation to publicly update or revise any forward–looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward–looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this Form 10–Q.
PART I. FINANCIAL INFORMATION
(in thousands, except par value and share amounts)
September 30, 2022
December 31, 2021
Assets
Current assets:
Cash and cash equivalents
$
2,042
1,569
Accounts receivable, net of allowance of $1,487 and $2,152, respectively
127,334
104,931
Inventory
84,091
72,869
Other current assets
6,817
7,201
Total current assets
220,284
186,570
Property, plant and equipment, net
2,214,666
2,226,526
Operating lease right-of-use assets
16,089
17,491
Intangible assets, net
39,019
47,887
Contract costs, net
32,598
25,418
Deferred tax assets
37,001
47,879
Other assets
37,051
28,384
Assets of discontinued operations
8,893
9,811
Total assets
2,605,601
2,589,966
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable
89,602
38,920
Accrued liabilities
97,021
82,517
Deferred revenue
7,707
3,817
Total current liabilities
194,330
125,254
Long-term debt
1,498,895
1,530,825
Operating lease liabilities
14,286
15,940
Deferred tax liabilities
1,076
1,136
Other liabilities
19,330
17,505
Liabilities of discontinued operations
7,868
Total liabilities
1,735,785
1,698,528
Commitments and contingencies (Note 8)
Stockholders' equity:
Preferred stock: $0.01 par value per share, 50,000,000 shares authorized, zero issued
—
Common stock: $0.01 par value per share, 250,000,000 shares authorized, 163,412,780 and 161,482,852 shares issued, respectively
1,633
1,615
Additional paid-in capital
3,453,720
3,440,059
Accumulated deficit
(2,497,002)
(2,463,114)
Accumulated other comprehensive loss
(984)
Treasury stock: 7,801,150 and 7,417,401 common shares, at cost, respectively
(88,535)
(86,138)
Total stockholders' equity
869,816
891,438
Total liabilities and stockholders' equity
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
(in thousands, except per share amounts)
Three Months Ended
Nine Months Ended
September 30,
2022
2021
Revenue:
Contract operations
170,497
158,911
500,451
488,810
Aftermarket services
43,171
36,255
126,246
97,402
Total revenue
213,668
195,166
626,697
586,212
Cost of sales (excluding depreciation and amortization):
71,694
61,280
204,550
184,032
35,833
30,652
106,181
83,925
Total cost of sales (excluding depreciation andamortization)
107,527
91,932
310,731
267,957
Selling, general and administrative
30,500
28,839
85,964
80,000
Depreciation and amortization
39,953
45,280
124,348
135,185
Long-lived and other asset impairment
4,154
5,121
16,217
15,154
Restructuring charges
313
1,953
Interest expense
25,177
25,508
74,879
82,711
Gain on sale of assets, net
(12,695)
(15,393)
(33,755)
(29,549)
Other (income) expense, net
(585)
337
(52)
(1,634)
Income before income taxes
19,637
13,229
48,365
34,435
Provision for income taxes
4,266
3,925
14,527
12,210
Net income
15,371
9,304
33,838
22,225
Basic and diluted earnings per common share
0.10
0.06
0.21
0.14
Weighted average common shares outstanding:
Basic
153,550
152,158
153,168
151,615
Diluted
153,687
152,297
153,297
151,769
(in thousands)
Other comprehensive income, net of tax:
Interest rate swap gain, net of reclassifications toearnings
585
574
2,547
Amortization of dedesignated interest rate swap
431
410
Total other comprehensive income, net of tax
1,016
984
2,978
Comprehensive income
10,320
34,822
25,203
(in thousands, except shares and per share amounts)
Accumulated
Additional
Other
Common Stock
Paid-in
Comprehensive
Treasury Stock
Shares
Amount
Capital
Deficit
Loss
Total
Balance at June 30, 2022
163,385,390
3,450,603
(2,489,814)
(7,740,919)
(88,504)
873,918
Treasury stock purchased
(3,636)
(31)
Cash dividends ($0.145 per common share
(22,559)
Shares issued under employee stockpurchase plan ("ESPP")
27,390
167
Stock-based compensation, net of forfeitures
2,998
(56,595)
Net proceeds from issuance of common stock
(48)
Balance at September 30, 2022
163,412,780
(7,801,150)
Balance at June 30, 2021
161,339,554
1,613
3,434,224
(2,433,553)
(3,044)
(7,278,449)
(85,419)
913,821
(92,540)
(663)
(22,506)
Shares issued under ESPP
22,425
175
97,426
1
2,899
(31,199)
2,900
Comprehensive income:
Other comprehensive income
Balance at September 30, 2021
161,459,405
1,614
3,437,298
(2,446,755)
(2,028)
(7,402,188)
(86,082)
904,047
Unaudited Condensed Consolidated Statements of Equity (continued)
(in thousands, except share and per share amounts)
Balance at December 31, 2021
161,482,852
(7,417,401)
(276,342)
(2,397)
Cash dividends ($0.435 per common share)
(67,726)
66,236
462
1,416,672
14
9,021
(107,407)
9,035
447,020
4,178
4,182
Balance at December 31, 2020
160,014,960
1,600
3,424,624
(2,401,988)
(5,006)
(7,052,769)
(83,673)
935,557
(277,316)
(2,409)
(66,992)
66,541
546
1,020,756
8,731
(72,103)
8,741
357,148
3,397
3,401
8
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Inventory write-downs
1,040
621
Amortization of operating lease right-of-use assets
2,407
2,922
Amortization of debt issuance costs
3,864
8,839
Amortization of debt premium
(1,504)
Interest rate swaps
631
2,866
Stock-based compensation expense
Provision for credit losses
(28)
151
(5,535)
(10,604)
Gain on sale of business
(28,220)
(18,945)
Deferred income tax provision
13,624
11,778
Amortization of contract costs
14,211
15,523
Deferred revenue recognized in earnings
(15,709)
(8,081)
Changes in operating assets and liabilities:
Accounts receivable, net
(29,130)
(2,133)
(8,339)
(5,994)
697
1,326
Contract costs
(22,486)
(11,481)
Accounts payable and other liabilities
37,251
33,626
19,614
8,167
96
(88)
Net cash provided by operating activities
166,332
208,725
Cash flows from investing activities:
Capital expenditures
(171,032)
(70,881)
Proceeds from sale of property, equipment and other assets
13,348
24,683
Proceeds from sale of business
99,785
83,075
Proceeds from insurance and other settlements
3,353
977
Investments in unconsolidated entities
(12,000)
Net cash (used in) provided by investing activities
(66,546)
37,854
Cash flows from financing activities:
Borrowings of long-term debt
579,483
522,751
Repayments of long-term debt
(611,983)
(695,751)
Payments of debt issuance costs
(2,451)
Payments for settlement of interest rate swaps that include financing elements
(1,334)
(3,283)
Dividends paid to stockholders
Proceeds from stock issued under ESPP
Purchases of treasury stock
Net cash used in financing activities
(99,313)
(244,188)
Net increase in cash and cash equivalents
473
2,391
Cash and cash equivalents, beginning of period
1,097
Cash and cash equivalents, end of period
3,488
NOTE 1. GENERAL
Description of Business
Archrock, Inc. (individually and together with its wholly owned subsidiaries, “we,” “our” or us”) is an energy infrastructure company with a primary focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the energy industry throughout the United States (the “U.S.”) and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. We operate in two business segments: contract operations and aftermarket services. Our predominant segment, contract operations, primarily includes designing, sourcing, owning, installing, operating, servicing, repairing and maintaining our owned fleet of natural gas compression equipment to provide natural gas compression services to our customers. In our aftermarket services business, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with U.S. Generally Accepted Accounting Policies (“GAAP”) and the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP are not required in these interim financial statements and have been condensed or omitted. Management believes that the information furnished reflects all normal recurring adjustments necessary to fairly present our consolidated financial position, results of operations and cash flows for the periods indicated. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements presented in our Form 10–K, which contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year.
All intercompany accounts and transactions have been eliminated in consolidation. In the Notes to Unaudited Condensed Consolidated Financial Statements, all dollar and share amounts in tabulations are in thousands of dollars and shares, respectively, unless otherwise indicated.
NOTE 2. DISPOSITIONS
In September 2022, we completed the sale of certain contract operations customer service agreements and approximately 390 compressors, comprising approximately 100,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We allocated customer–related and contract–based intangible assets based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We received cash consideration of $44.3 million for the sale and recorded a gain on the sale of $11.5 million during the three months and nine months ended September 30, 2022.
In May 2022, we completed the sale of certain contract operations customer service agreements and approximately 380 compressors, comprising approximately 70,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We allocated customer–related and contract–based intangible assets based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We received cash consideration of $55.5 million for the sale and recorded a gain on the sale of $16.7 million during the nine months ended September 30, 2022.
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
NOTE 3. INVENTORY
Inventory is comprised of the following:
Parts and supplies
67,459
63,628
Work in progress
16,632
9,241
NOTE 4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is comprised of the following:
Compression equipment, facilities and other fleet assets
3,243,488
3,273,770
Land and buildings
44,056
43,540
Transportation and shop equipment
90,116
92,490
Computer hardware and software
77,357
76,908
5,518
6,229
Property, plant and equipment
3,460,535
3,492,937
Accumulated depreciation
(1,245,869)
(1,266,411)
NOTE 5. EQUITY INVESTMENTS
Investments in which we are deemed to exert significant influence, but not control, are accounted for using the equity method of accounting, except in cases where the fair value option is elected. For such investments where we have elected the fair value option, the election is irrevocable and is applied on an investment–by–investment basis at initial recognition.
In April 2022, we agreed to acquire for cash a 25% equity interest in Ecotec International Holdings, LLC. (“ECOTEC”), a company specializing in methane emissions detection, monitoring and management. We have elected the fair value option to account for this investment (see Note 16). As of September 30, 2022, our ownership interest in ECOTEC is 19%, which is included in Other assets in our unaudited condensed consolidated balance sheets.
Changes in the fair value of this investment are recognized in Other (income) expense, net in our unaudited condensed consolidated statements of operations.
NOTE 6. HOSTING ARRANGEMENTS
We have hosting arrangements that are service contracts related to the cloud migration of our Enterprise Resource Planning (“ERP”) system and cloud services for our mobile workforce, telematics and inventory management tools.
As of September 30, 2022 and December 31, 2021, we had $15.1 million and $12.7 million, respectively, of capitalized implementation costs related to these hosting arrangements included in Other assets in our unaudited condensed consolidated balance sheets. Accumulated amortization was $2.1 million and $0.7 million as of September 30, 2022 and December 31, 2021, respectively.
Included in Selling, general and administrative in our unaudited condensed consolidated statements of operations is amortization of $0.6 million and $0.1 million during the three months ended September 30, 2022 and 2021, respectively, and $1.5 million and $0.3 million during the nine months ended September 30, 2022 and 2021, respectively.
11
NOTE 7. LONG–TERM DEBT
Long–term debt is comprised of the following:
Credit Facility
202,000
234,500
6.25% senior notes due April 2028
Principal outstanding
800,000
Unamortized debt premium
11,031
12,536
Unamortized debt issuance costs
(9,158)
(10,406)
801,873
802,130
6.875% senior notes due April 2027
500,000
(4,978)
(5,805)
495,022
494,195
Our $750.0 million asset–based revolving Credit Facility, as amended (the “Credit Facility”), matures in November 2024. As of September 30, 2022, there were $5.8 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%. The weighted average annual interest rate on the outstanding balance under our Credit Facility, excluding the effect of interest rate swaps, was 5.5% and 2.6% at September 30, 2022 and December 31, 2021, respectively. We incurred $0.5 million of commitment fees on the daily unused amount of the Credit Facility in each of the three months ended September 30, 2022 and 2021 and $1.5 million in each of the nine months ended September 30, 2022 and 2021.
As of September 30, 2022, we were in compliance with all covenants under our Credit Facility agreement. As a result of the Credit Facility’s financial ratio requirements, $486.4 million of the $542.2 million of undrawn capacity was available for additional borrowings as of September 30, 2022.
In February 2021, we amended our Credit Facility to, among other things, reduce the aggregate revolving commitment from $1.25 billion to $750.0 million and adjust certain financial ratios. We wrote off $4.9 million of unamortized deferred financing costs as a result of the amendment, which was recorded to interest expense in our unaudited condensed consolidated statements of operations during the nine months ended September 30, 2021.
NOTE 8. COMMITMENTS AND CONTINGENCIES
Insurance Matters
Our business can be hazardous, involving unforeseen circumstances such as uncontrollable flows of natural gas or well fluids and fires or explosions. As is customary in our industry, we review our safety equipment and procedures and carry insurance against some, but not all, risks of our business. Our insurance coverage includes property damage, general liability and commercial automobile liability and other coverage we believe is appropriate. We believe that our insurance coverage is customary for the industry and adequate for our business, however, losses and liabilities not covered by insurance would increase our costs.
Additionally, we are substantially self–insured for workers’ compensation and employee group health claims in view of the relatively high per–incident deductibles we absorb under our insurance arrangements for these risks. Losses up to the deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. We are also self–insured for property damage to our offshore assets.
12
In August 2021, Hurricane Ida caused operational disruptions, damage to compressors and a temporary shutdown of facilities in Louisiana that negatively impacted our financial performance. At December 31, 2021, we had an insurance recovery receivable of $2.8 million related to the facility and compressor damages, which we received in cash during the three months ended March 31, 2022. In September 2022, we received $0.4 million of business interruption insurance recovery proceeds, which resolved the remainder of our insurance claims related to Hurricane Ida.
Tax Matters
We are subject to a number of state and local taxes that are not income–based. As many of these taxes are subject to audit by the taxing authorities, it is possible that an audit could result in additional taxes due. We accrue for such additional taxes when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the liability. As of September 30, 2022 and December 31, 2021, we had $3.9 million and $5.8 million, respectively, accrued for the outcomes of non–income–based tax audits. We do not expect that the ultimate resolutions of these audits will result in a material variance from the amounts accrued. We do not accrue for unasserted claims for tax audits unless we believe the assertion of a claim is probable, it is probable that it will be determined that the claim is owed and we can reasonably estimate the claim or range of the claim. We believe the likelihood is remote that the impact of potential unasserted claims from non–income–based tax audits could be material to our consolidated financial position, but it is possible that the resolution of future audits could be material to our consolidated results of operations or cash flows.
In 2021, one of our sales and use tax audits advanced from the audit review phase to the contested hearing phase. As of both September 30, 2022 and December 31, 2021, we had $0.6 million accrued for this audit.
Litigation and Claims
In the ordinary course of business, we are involved in various pending or threatened legal actions. While we are unable to predict the ultimate outcome of these actions, we believe that any ultimate liability arising from any of these actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to pay dividends. However, because of the inherent uncertainty of litigation and arbitration proceedings, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to pay dividends.
NOTE 9. STOCKHOLDERS’ EQUITY
Equity Distribution Agreement
During the nine months ended September 30, 2022, we sold 447,020 shares of common stock for net proceeds of $4.2 million pursuant to an Equity Distribution agreement, dated February 23, 2021, entered into with Wells Fargo Securities, LLC and BofA Securities, Inc., as sales agents, relating to the at–the–market offer and sale of shares of our common stock from time to time (the “Equity Distribution Agreement”). During the nine months ended September 30, 2021, we sold 357,148 shares of common stock under this program for net proceeds of $3.4 million.
13
Cash Dividends
The following table summarizes our dividends declared and paid in each of the quarterly periods of 2022 and 2021:
Dividends per
Common Share
Dividends Paid
Q3
0.145
22,559
Q2
22,494
Q1
22,673
Q4
22,351
22,506
22,331
22,155
On October 27, 2022, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock to be paid on November 15, 2022 to stockholders of record at the close of business on November 8, 2022.
Accumulated Other Comprehensive Loss
Components of comprehensive income (loss) are net income (loss) and all changes in equity during a period except those resulting from transactions with owners. Our accumulated other comprehensive loss consists of changes in the fair value of our interest rate swap derivative instruments, net of tax. See Note 15 for further details on our interest rate swap derivative instruments.
The following table presents the changes in accumulated other comprehensive loss, net of tax:
Beginning accumulated other comprehensive loss
Loss recognized in other comprehensiveincome
(458)
(405)
(529)
Loss reclassified from accumulated othercomprehensive loss to interest expense
1,474
1,389
3,507
Total other comprehensive income
Ending accumulated other comprehensive loss
NOTE 10. REVENUE FROM CONTRACTS WITH CUSTOMERS
The following table presents our revenue from contracts with customers by segment (see Note 18) and disaggregated by revenue source:
Contract operations:
0 ― 1,000 horsepower per unit
38,967
41,576
121,298
134,413
1,001 ― 1,500 horsepower per unit
72,463
66,138
208,161
201,454
Over 1,500 horsepower per unit
58,818
51,018
170,297
152,360
Other (1)
249
179
695
583
Total contract operations revenue (2)
Aftermarket services:
Services
23,528
19,249
66,666
53,149
Over–the–counter (“OTC”) parts and components sales
19,643
17,006
59,580
44,253
Total aftermarket services revenue (3)
Performance Obligations
As of September 30, 2022, we had $282.3 million of remaining performance obligations related to our contract operations segment, which will be recognized through 2027 as follows:
2023
2024
2025
2026
2027
Remaining performance obligations
99,377
122,031
46,882
12,870
919
192
282,271
We do not disclose the aggregate transaction price for the remaining performance obligations for aftermarket services as there are no contracts with customers with an original contract term that is greater than one year.
Contract Assets and Liabilities
Contract Assets
As of September 30, 2022 and December 31, 2021, our receivables from contracts with customers, net of allowance for credit losses, were $118.9 million and $84.7 million, respectively.
Allowance for Credit Losses
Trade accounts receivable are due from companies of varying size engaged principally in oil and natural gas activities throughout the U.S. We review the financial condition of customers prior to extending credit and generally do not obtain collateral for trade receivables. Payment terms are on a short-term basis and in accordance with industry practice. We consider this credit risk to be limited due to these companies’ financial resources, the nature of the products and services we provide and the terms of our customer agreements.
15
Due to the short-term nature of our trade receivables, we consider the amortized cost to be the same as the carrying amount of the receivable, excluding the allowance for credit losses. We recognize an allowance for credit losses when a receivable is recorded, even when the risk of loss is remote. We utilize an aging schedule to determine our allowance for credit losses and measure expected credit losses on a collective (pool) basis when similar risk characteristics exist. We rely primarily on ratings assigned by external rating agencies and credit monitoring services to assess credit risk and aggregate customers first by low, medium or high risk asset pools, and then by delinquency status. We also consider the internal risk associated with geographic location and the services we provide to the customer when determining asset pools. If a customer does not share similar risk characteristics with other customers, we evaluate the customer’s outstanding trade receivables for expected credit losses on an individual basis. Trade receivables evaluated individually are not included in our collective assessment. Each reporting period, we reassess our customers’ risk profiles and determine the appropriate asset pool classification, or perform individual assessments of expected credit losses, based on the customers’ risk characteristics at the reporting date.
The contractual life of our trade receivables is primarily 30 days based on the payment terms specified in the contract. Contract operations services are generally billed monthly at the beginning of the month in which service is being provided. Aftermarket services billings typically occur when parts are delivered or service is completed. Loss rates are separately determined for each asset pool based on the length of time a trade receivable has been outstanding. We analyze two years of internal historical loss data, including the effects of prepayments, write-offs and subsequent recoveries, to determine our historical loss experience. Our historical loss information is a relevant data point for estimating credit losses, as the data closely aligns with trade receivables due from our customers. Ratings assigned by external rating agencies and credit monitoring services consider past performance and forecasts of future economic conditions in assessing credit risk. We routinely update our historical loss data to reflect our customers’ current risk profile, to ensure the historical data and loss rates are relevant to the pool of assets for which we are estimating expected credit losses.
Our allowance for credit losses balance changed as follows during the nine months ended September 30, 2022:
2,152
Write-offs charged against allowance
(637)
1,487
Contract Liabilities
Freight billings to customers for the transport of compression assets, customer–specified modifications of compression assets and milestone billings on aftermarket services often result in a contract liability. As of September 30, 2022 and December 31, 2021, our contract liabilities were $8.3 million and $4.4 million, respectively.
During the nine months ended September 30, 2022, we deferred revenue of $19.6 million and recognized deferred revenue of $15.7 million. The revenue recognized during the period primarily related to freight billings and milestone billings on aftermarket services.
NOTE 11. STOCK–BASED COMPENSATION
We grant various forms of stock–based compensation to our employees and non–employee directors. These stock–based awards can consist of stock options, stock appreciation rights, restricted stock awards, restricted stock units (“RSUs”), performance–based RSUs, other stock–based awards and dividend equivalent rights. We recognize stock–based compensation expense related to restricted stock awards, RSUs, performance–based RSUs and shares issued under our ESPP.
16
The following table presents the stock–based compensation expense recognized in our unaudited condensed consolidated statements of operations:
Equity award expense
Liability award expense
127
904
1,121
Total stock-based compensation expense
3,022
3,027
9,939
9,862
The following table presents our restricted stock activity in the nine months ended September 30, 2022:
Weighted
Average
Grant Date
Fair Value
Per Share
Non-vested restricted stock, December 31, 2021
2,578
10.35
Granted
1,861
9.03
Vested
(1,152)
10.25
Canceled
(244)
9.28
Non-vested restricted stock, September 30, 2022 (1)
3,043
9.67
As of September 30, 2022, there was $17.1 million of unrecognized stock–based compensation expense which is expected to be recognized over a weighted average period of 1.9 years.
NOTE 12. LONG–LIVED AND OTHER ASSET IMPAIRMENT
We review long–lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressors from our active fleet, indicate that the carrying amount of an asset may not be recoverable.
We periodically review the future deployment of our idle compression assets for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. Based on these reviews, we determine that certain idle compressors should be retired from the active fleet. The retirement of these units from the active fleet triggers a review of these assets for impairment and as a result of our review, we may record an asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit is estimated based on the expected net sale proceeds compared to other fleet units we recently sold, a review of other units recently offered for sale by third parties or the estimated component value of the equipment we plan to use.
In connection with our review of our idle compression assets, we evaluate for impairment idle units that were culled from our fleet in prior years and are available for sale. Based on that review, we may reduce the expected proceeds from disposition and record additional impairment to reduce the book value of each unit to its estimated fair value.
17
The following table presents the results of our compression fleet impairment review as recorded in our contract operations segment:
Idle compressors retired from the active fleet
25
60
100
Horsepower of idle compressors retired from the activefleet
23,000
24,000
61,000
Impairment recorded on idle compressors retired fromthe active fleet
4,149
5,120
16,205
14,964
See Note 16 for additional information.
NOTE 13. INCOME TAXES
Valuation Allowance
The amount of our deferred tax assets considered realizable could be adjusted if projections of future taxable income are reduced or objective negative evidence in the form of a three–year cumulative loss is present or both. Should we no longer have a level of sustained profitability, excluding nonrecurring charges, we will have to rely more on our future projections of taxable income to determine if we have an adequate source of taxable income for the realization of our deferred tax assets, namely net operating loss, interest limitation and tax credit carryforwards. This may result in the need to record a valuation allowance against all or a portion of our deferred tax assets.
Effective Tax Rate
The year-to-date effective tax rate for the nine months ended September 30, 2022 differed significantly from our statutory rate primarily due to unrecognized tax benefits and the limitation on executive compensation.
Unrecognized Tax Benefits
As of September 30, 2022, we believe it is reasonably possible that $2.7 million of our unrecognized tax benefits, including penalties, interest and discontinued operations, will be reduced prior to September 30, 2023 due to the settlement of audits or the expiration of statutes of limitations or both. However, due to the uncertain and complex application of the tax regulations, it is possible that the ultimate resolution of these matters may result in liabilities that could materially differ from this estimate.
Impact of New Legislation
On August 16, 2022, President Biden signed into law the Inflation Reduction Act (Public Law Number 117–169). This legislation is expected to have an immaterial impact to our unaudited condensed consolidated financial statements.
18
NOTE 14. EARNINGS PER COMMON SHARE
Basic net income (loss) per common share is computed using the two–class method, which is an earnings allocation formula that determines net income (loss) per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Under the two–class method, basic net income (loss) per common share is determined by dividing net income (loss), after deducting amounts allocated to participating securities, by the weighted average number of common shares outstanding for the period. Participating securities include unvested restricted stock and stock–settled restricted stock units that have nonforfeitable rights to receive dividends or dividend equivalents, whether paid or unpaid. During periods of net loss, only distributed earnings (dividends) are allocated to participating securities, as participating securities do not have a contractual obligation to participate in our undistributed losses.
Diluted net income (loss) per common share is computed using the weighted average number of common shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options, performance–based RSUs and stock to be issued pursuant to our ESPP unless their effect would have been anti–dilutive.
The following table shows the calculation of net income attributable to common stockholders, which is used in the calculation of basic and diluted earnings per common share, potential shares of common stock that were included in computing diluted earnings per common share and the potential shares of common stock issuable that were excluded from computing diluted earnings per common share as their inclusion would have been anti–dilutive:
Allocation of earnings to participating securities
(294)
(456)
(1,114)
(909)
Net income attributable to common stockholders
15,077
8,848
32,724
21,316
Weighted average common shares outstanding used inbasic earnings per common share
Effect of dilutive securities:
Restricted stock units
131
138
125
152
ESPP shares
Weighted average common shares outstanding used indiluted earnings per common share
On exercise of options where exercise price is greater than average market price for the period
27
NOTE 15. DERIVATIVES AND HEDGING
We are exposed to market risks associated with changes in the variable interest rate of our Credit Facility. We have used derivative instruments, in the form of interest rate swaps, to manage our exposure to fluctuations in this variable interest rate and thereby minimize the risks and costs associated with financial activities. We do not use derivative instruments for trading or other speculative purposes.
In March 2022, our $300.0 million notional value of interest rate swaps expired. We previously entered into these swaps to offset changes in expected cash flows due to fluctuations in the associated variable interest rates and designated them as cash flow hedges. There was no nonperformance by any counterparty during the terms of the interest rate swaps and no collateral was posted for the instruments.
19
Prior to expiration, during the third quarter of 2021, we dedesignated $125.0 million notional value of our interest rate swaps. The fair value of this interest rate swap immediately prior to dedesignation was a liability of $1.6 million. The associated amount in accumulated other comprehensive loss related to this interest rate swap was amortized into interest expense over the remaining term of the swap through March 2022. Changes in the fair value of the dedesignated interest rate swap after dedesignation and prior to expiration were recorded in interest expense.
The remaining $175.0 million notional value of our interest rate swaps were designated as (highly effective) cash flow hedging instruments until their expiration. Changes in the fair value of cash flow hedging instruments are recognized as a component of other comprehensive income (loss) until the hedged transaction affects earnings. At that time, amounts are reclassified into earnings to interest expense, the same statement of operations line item to which the earnings effect of the hedged item is recorded. Cash flows from derivatives designated as hedges are classified in our unaudited condensed consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions unless the derivative contract contains a significant financing element, in which case, the cash settlements for those derivatives are classified as cash flows from financing activities.
The following table presents the effect of our derivative instruments on our unaudited condensed consolidated statements of operations:
Total amount of interest expense in which the effects of cash flow hedges and undesignated interest rate swaps are recorded
Interest rate swaps designated as cash flow hedginginstruments:
Pre-tax loss recognized in other comprehensiveincome
(581)
(512)
(670)
Pre-tax loss reclassified from accumulated othercomprehensive loss into interest expense
(1,867)
(1,758)
(4,440)
Interest rate swaps not designated as hedginginstruments:
Gain recognized in interest expense
532
523
20
The following table presents the effect of our derivative instruments on our unaudited condensed consolidated balance sheets:
Interest rate swaps designated as cash flow hedging instruments
727
Interest rate swaps not designated as hedging instruments
Total derivative liabilities
1,250
Please see Note 9 and Note 16 for additional details on our derivative instruments.
16. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Investment in ECOTEC
During the nine months ended September 30, 2022, we acquired a 19% equity interest in ECOTEC. We have elected the fair value option to account for this investment. The investment is valued at its transaction price, unless and until there is a significant change in the investment, such as an impairment or an additional investment. The investment’s fair value is reviewed periodically and is classified as a Level 3 measurement. As of September 30, 2022, the fair value of our investment in ECOTEC was as follows:
12,000
Interest Rate Swaps
Prior to their expiration in the first quarter of 2022, our interest rate swap derivative instruments were valued quarterly based on the income approach (discounted cash flows) using market observable inputs, including LIBOR forward curves. These fair value measurements were classified as Level 2. The following table presents our derivative position measured at fair value on a recurring basis, with pricing levels as of the date of valuation:
Derivative liabilities
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the three months and nine months ended September 30, 2022, we recorded nonrecurring fair value measurements of $4.1 million and $16.2 million, respectively, related to our idle compressors (see Note 12). Our estimate of the compressors’ fair value was primarily based on the expected net sale proceeds compared with other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. We discounted the expected proceeds, net of selling and other carrying costs, using a weighted average disposal period of four years. The fair value of our compressors impaired in 2022 and 2021 was as follows:
Impaired compressors
1,548
4,380
21
These fair value measurements are classified as Level 3. The significant unobservable inputs used to develop the above fair value measurements were weighted by the relative fair value of the compressors being measured. Additional quantitative information related to our significant unobservable inputs follows:
Range
Weighted Average (1)
Estimated net sale proceeds:
As of September 30, 2022
$0 - $621 per horsepower
$44 per horsepower
As of December 31, 2021
$35 per horsepower
Other Financial Instruments
The carrying amounts of our cash, accounts receivable and accounts payable approximate fair value due to the short–term nature of these instruments.
The carrying amount of borrowings outstanding under our Credit Facility approximates fair value due to the variable interest rate. The measurement of the fair value of these outstanding borrowings is a Level 3 measurement.
The fair value of our fixed rate debt is estimated using yields observable in active markets, which are Level 2 inputs, and was as follows:
Carrying amount of fixed rate debt (1)
1,296,895
1,296,325
Fair value of fixed rate debt
1,155,760
1,361,000
NOTE 17. RELATED PARTY TRANSACTIONS
Old Ocean Reserves, LP (“Old Ocean Reserves”), formerly JDH Capital Holdings, L.P., an affiliate of our customer Hilcorp Energy Company (“Hilcorp”), has the right to designate one director to serve on our board of directors as long as Old Ocean Reserves or its successors (together with its affiliates) owns at least 7.5% of our outstanding common stock. As of September 30, 2022, Old Ocean Reserves owned 10.8% of our outstanding common stock. Jason C. Rebrook, Chief Executive Officer and Director of Harvest Midstream Company, a Hilcorp affiliate, has served as Old Ocean Reserves’ representative director since July 2020.
Revenue from Hilcorp was $9.2 million and $9.5 million during the three months ended September 30, 2022 and 2021, respectively, and $27.8 million and $28.6 million during the nine months ended September 30, 2022 and 2021, respectively. Accounts receivable, net due from Hilcorp was $3.2 million and $3.7 million as of September 30, 2022 and December 31, 2021, respectively.
NOTE 18. SEGMENT INFORMATION
We manage our business segments primarily based on the type of product or service provided. We have two segments: contract operations and aftermarket services. Our contract operations segment primarily provides natural gas compression services to meet specific customer requirements. Our aftermarket services segment provides a full range of services to support the compression needs of customers, from parts sales and normal maintenance services to full operation of a customer’s owned assets. All of our operations are located in the U.S.
22
We evaluate the performance of our segments based on gross margin, defined as revenue less cost of sales (excluding depreciation and amortization) for each segment. Segment revenue includes only sales to external customers.
Summarized financial information for our reporting segments is shown below:
Contract
Aftermarket
Operations
Three months ended September 30, 2022
Revenue
Gross margin
98,803
7,338
106,141
Three months ended September 30, 2021
97,631
5,603
103,234
Nine months ended September 30, 2022
295,901
20,065
315,966
Nine months ended September 30, 2021
304,778
13,477
318,255
The following table reconciles total gross margin to income before income taxes:
Total gross margin
Less:
NOTE 19. SUBSEQUENT EVENTS
On October 3, 2022, we acquired an additional equity interest in ECOTEC, which increased our total ownership interest to 23%.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included in this Form 10–Q, as well as our Form 10–K.
OVERVIEW
We are an energy infrastructure company with a primary focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the energy industry throughout the U.S. and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. We operate in two business segments: contract operations and aftermarket services. Our contract operations services primarily include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining our owned fleet of natural gas compression equipment to provide natural gas compression services to our customers. In our aftermarket services business, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.
Recent Business Developments
Dispositions
In September 2022, we completed the sale of certain contract operations customer service agreements and approximately 390 compressors, comprising approximately 100,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We received cash consideration of $44.3 million for the sale and recorded a gain on the sale of $11.5 million during the three months and nine months ended September 30, 2022.
In May 2022, we completed the sale of certain contract operations customer service agreements and approximately 380 compressors, comprising approximately 70,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We received cash consideration of $55.5 million for the sale and recorded a gain on the sale of $16.7 million during the nine months ended September 30, 2022.
In April 2022, we agreed to acquire for cash a 25% equity interest in ECOTEC, a company specializing in methane emissions monitoring and management. As of September 30, 2022, our equity interest was 19%. See Note 5 in our Notes to Unaudited Condensed Consolidated Financial Statements for additional information about this investment.
Operating Highlights
Total available horsepower (at period end)(1)
3,747
3,913
Total operating horsepower (at period end)(2)
3,196
Average operating horsepower
3,355
3,225
3,304
3,298
Horsepower utilization:
Spot (at period end)
89
%
82
88
86
Non–GAAP Financial Measures
Management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include the non–GAAP financial measure of gross margin.
We define gross margin as total revenue less cost of sales (excluding depreciation and amortization). Gross margin is included as a supplemental disclosure because it is a primary measure used by our management to evaluate the results of revenue and cost of sales (excluding depreciation and amortization), which are key components of our operations. We believe gross margin is important because it focuses on the current operating performance of our operations and excludes the impact of the prior historical costs of the assets acquired or constructed that are utilized in those operations, the indirect costs associated with our selling, general & administrative (“SG&A”) activities, our financing methods and income taxes. In addition, depreciation and amortization may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs of current operating activity. As an indicator of our operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income (loss) as determined in accordance with GAAP. Our gross margin may not be comparable to a similarly–titled measure of other entities because other entities may not calculate gross margin in the same manner.
Gross margin has certain material limitations associated with its use as compared to net income (loss). These limitations are primarily due to the exclusion of SG&A, depreciation and amortization, impairments, restructuring charges, interest expense, gain on sale of assets, net, other (income) expense, net and provision for income taxes. Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue. Additionally, because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue and SG&A is necessary to support our operations and required corporate activities. To compensate for these limitations, management uses this non–GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.
The following table reconciles net income to gross margin:
RESULTS OF OPERATIONS
Summary of Results
Revenue was $213.7 million and $195.2 million during the three months ended September 30, 2022 and 2021, respectively, and $626.7 million and $586.2 million during the nine months ended September 30, 2022 and 2021, respectively. The increases in consolidated revenue during these periods were primarily due to increased revenue from both our contract operations business and aftermarket services business. See “Contract Operations” and “Aftermarket Services” below for further details.
Net income was $15.4 million and $9.3 million during the three months ended September 30, 2022 and 2021, respectively. The increase was primarily driven by a higher gross margin from both our aftermarket services business and our contract operations business and decreased depreciation and amortization expense, partially offset by increased SG&A and lower gain on sale of assets, net.
Net income was $33.8 million and $22.2 million during the nine months ended September 30, 2022 and 2021, respectively. The increase was primarily driven by a higher gross margin from our aftermarket services business, decreased depreciation and amortization expense and interest expense and an increased gain on sale of assets, net, partially offset by a lower gross margin from our contract operations business and higher SG&A.
Three Months Ended September 30, 2022 Compared to Three Months Ended September 30, 2021
Contract Operations
Increase
(Decrease)
Cost of sales (excluding depreciation and amortization)
Gross margin percentage (1)
58
61
(3)
Revenue in our contract operations business increased primarily due to an increase in average operating horsepower and higher rates in response to improving market conditions, partially offset by the impact of the strategic dispositions in 2021 and 2022. Average operating horsepower for the three months ended September 30, 2022 increased when compared with the three months ended September 30, 2021 before adjusting for the dispositions.
Despite the increase in revenue, the increase in gross margin in our contract operations business was partially offset by our increase in cost of sales. Start–up, maintenance, lube oil and other operating expenses increased, driven by higher pricing throughout our supply chain, as well as increased volumes associated with unit redeployment as customer activity accelerated. Partially offsetting these cost increases was the decrease in expense attributable to the horsepower sold in 2021 and 2022.
Aftermarket Services
31
Gross margin percentage
Revenue in our aftermarket services business increased primarily due to higher parts sales and service activities, as the market recovery drove an increase in customer demand.
Gross margin increased in our aftermarket services business as a result of increased revenue partially offset by the associated increase in cost of sales, which was primarily driven by the same increases in parts sales and service activities.
26
Costs and Expenses
Effective tax rate
22%
30%
Selling, general and administrative. The increase in SG&A was primarily due to a $1.1 million increase in employee compensation costs and a $0.9 million increase in information technology expense related to increased amortization of capitalized implementation costs and increased service agreement costs related to the substantial completion of our process and technology transformation project at the end of 2021.
Depreciation and amortization. The decrease in depreciation and amortization expense was primarily due to the impact of assets reaching the end of their depreciable lives and compression and other asset sales, partially offset by the impact of fixed asset additions.
Long-lived and other asset impairment. We periodically review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. We also evaluate for impairment our idle units that have been culled from our compression fleet in prior years and are available for sale. During the three months ended September 30, 2022 and 2021, we recognized $4.2 million and $5.1 million, respectively, of impairment charges to write down these compressors to their fair value. See Note 12 in our Notes to Unaudited Condensed Consolidated Financial Statements for additional information about these impairment charges. The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment:
Horsepower of idle compressors retired from the active fleet
Impairment recorded on idle compressors retired from the active fleet
Interest expense. The decrease in interest expense was due to a lower average outstanding balance of long–term debt, partially offset by a higher average interest rate as a result of the expiration of our interest rate swaps in the first quarter of 2022.
Gain on sale of assets, net. The net gain on sale of assets during the three months ended September 30, 2022 was primarily the result of the $11.5 million of gain recognized on the September 2022 disposition of assets and gains of $1.2 million recognized on sales of other compression, transportation and shop assets during the period.
The net gain on sale of assets during the three months ended September 30, 2021 was primarily the result of the $13.0 million of gain recognized on the July 2021 disposition of assets and gains of $2.2 million recognized in on other compression asset sales during the period.
Provision for income taxes. The increase in provision for income taxes was primarily due to the tax effect of the increase in book income during the three months ended September 30, 2022 compared with the three months ended September 30, 2021.
Nine Months Ended September 30, 2022 Compared to Nine Months Ended September 30, 2021
59
62
Revenue in our contract operations business increased primarily due to higher rates and an increase in average operating horsepower in response to improving market conditions, partially offset by the impact of the strategic dispositions in 2021 and 2022. Average operating horsepower for the nine months ended September 30, 2022 increased when compared with the nine months ended September 30, 2021 before adjusting for the dispositions.
Despite the increase in revenue, the decrease in gross margin in our contract operations business reflects the impact of a larger increase in cost of sales. Start–up, maintenance, lube oil and other operating expenses increased, driven by higher pricing throughout our supply chain, as well as increased volumes associated with unit redeployment as customer activity accelerated. Partially offsetting these cost increases was the decrease in expense attributable to the horsepower sold in 2021 and 2022.
30
49
Gross margin in our aftermarket services business increased due to an increase in revenue and despite an increase in cost of sales, which was primarily driven by the same increases in parts sales and service activities.
28
Other (income), net
35%
Selling, general and administrative. The increase in SG&A was primarily due to a $2.0 million increase in sales and use tax resulting from audit settlements reached during the nine months ended September 30, 2021, a $1.7 million increase in information technology expense related to increased amortization of capitalized implementation costs and increased service agreement costs related to the substantial completion of our process and technology transformation project at the end of 2021, a $0.9 million increase in employee compensation costs and a $0.9 million increase in higher travel and meeting expenses.
Depreciation and amortization. The decrease in depreciation and amortization expense was primarily due to the impact of assets reaching the end of their depreciable lives, compression and other asset sales and impairments, partially offset by the impact of fixed asset additions.
Long-lived and other asset impairment. We periodically review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. We also evaluate for impairment our idle units that have been culled from our compression fleet in prior years and are available for sale. During the nine months ended September 30, 2022 and 2021, we recognized $16.2 million and $15.2 million, respectively, of impairment charges to write down these compressors to their fair value. See Note 12 in our Notes to Unaudited Condensed Consolidated Financial Statements for additional information about these impairment charges. The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment:
Interest expense. The decrease in interest expense was due to the $4.9 million write–off of unamortized deferred financing costs related to the amendment of our Credit Facility in the first quarter of 2021 and a lower average outstanding balance of long–term debt, offset by a higher average interest rate as a result of the expiration of our interest rate swaps in the first quarter of 2022.
Gain on sale of assets, net. The net gain on sale of assets during the nine months ended September 30, 2022 was primarily the result of the $28.2 million of gains recognized on the May 2022 and September 2022 dispositions of assets and gains of $5.6 million recognized on sales of other compression, transportation and shop assets during the period.
The net gain on sale of assets during the nine months ended September 30, 2021 was primarily the result of the $19.0 million of gains recognized on the February 2021 and July 2021 dispositions of assets and gains of $8.6 million recognized on other compression asset sales during the period.
29
Provision for income taxes. The increase in provision for income taxes was primarily due to the tax effect of the increase in book income during the nine months ended September 30, 2022 compared with the nine months ended September 30, 2021.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets. Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under our Credit Facility. Our cash flow is affected by numerous factors including prices and demand for our services, oil and natural gas exploration and production spending, conditions in the financial markets and other factors. We have no near-term maturities and believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our future liquidity needs.
We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity or debt securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, may be material, will be upon terms and prices as we may determine and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
Cash Requirements
Our contract operations business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of compression equipment required for us to provide those contract operations services to our customers. Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:
Capital Expenditures
Growth Capital Expenditures. The majority of our growth capital expenditures are related to the acquisition cost of new compressors when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new compressor is expected to generate economic returns that exceed our cost of capital over the compressor’s expected useful life. In addition to newly-acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures. These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.
Maintenance Capital Expenditures. Maintenance capital expenditures are related to major overhauls of significant components of a compression package, such as the engine, compressor and cooler, which return the components to a like-new condition, but do not modify the application for which the compression package was designed.
Projected Capital Expenditures. We currently plan to spend approximately $230 million to $235 million in capital expenditures during 2022, primarily consisting of approximately $150 million for growth capital expenditures and approximately $70 million to $75 million for maintenance capital expenditures. The increase in 2022 capital expenditures, particularly growth capital expenditures, as compared to 2021 is due to increased investment in new compression equipment as a result of higher customer demand.
Dividends
On October 27, 2022, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock to be paid on November 15, 2022 to stockholders of record at the close of business on November 8, 2022. Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.
Sources of Cash
Revolving Credit Facility
During the nine months ended September 30, 2022 and 2021, our Credit Facility had an average debt balance of $228.9 million and $310.9 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 5.5% and 2.6% at September 30, 2022 and December 31, 2021, respectively. As of September 30, 2022, there were $5.8 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%.
As of September 30, 2022, we were in compliance with all covenants under our Credit Facility. As a result of the facility’s financial ratio requirements, $486.4 million of the $542.2 million of undrawn capacity was available for additional borrowings as of September 30, 2022.
During the nine months ended September 30, 2022 and 2021, we sold 447,020 and 357,148 shares of common stock for net proceeds of $4.2 million and $3.4 million, respectively, pursuant to the Equity Distribution Agreement.
Cash Flows
Our cash flows, as reflected in our unaudited condensed consolidated statements of cash flows, are summarized below:
Net cash provided by (used in):
Operating activities
Investing activities
Financing activities
Operating Activities
The decrease in net cash provided by operating activities was primarily due to increased cash outflow for cost of sales, contract costs, and SG&A, as well as decreased cash inflow from accounts receivable. Partially offsetting these decreases in operating cash were increased cash inflow from revenue and deferred revenue.
Investing Activities
The change in net cash used in (provided by) investing activities was primarily due to a $100.2 million increase in capital expenditures and the $12.0 million investment made in unconsolidated entities during the nine months ended September 30, 2022. These cash outflows were partially offset by an increase of $5.4 million in proceeds from business dispositions and other sales of property, plant and equipment and an increase of $2.4 million in insurance and other settlements.
Financing Activities
The decrease in net cash used in financing activities was primarily due to $32.5 million of net repayments of long–term debt during the nine months ended September 30, 2022 compared with $173.0 million of net repayments of long–term debt during the nine months ended September 30, 2021.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks associated with changes in the variable interest rate of our Credit Facility. We have previously used derivative instruments to manage our exposure to fluctuation in this variable interest rate; however, our interest rate swaps expired in the first quarter of 2022, and all borrowings under our Credit Facility are now subject to variable interest rates.
A 1% increase in the effective interest rate on our Credit Facility’s outstanding balance at September 30, 2022 would have resulted in an annual increase in our interest expense of $2.0 million.
ITEM 4. CONTROLS AND PROCEDURES
This Item 4 includes information concerning the controls and controls evaluation referred to in the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a–14 of the Exchange Act included in this Form 10–Q as Exhibits 31.1 and 31.2.
Management’s Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to management to allow timely decisions regarding required disclosures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act), which are designed to provide reasonable assurance that we are able to record, process, summarize and report the information required to be disclosed in our reports under the Exchange Act within the time periods specified in the rules and forms of the SEC. Based on the evaluation, as of September 30, 2022 our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to management, and made known to our principal executive officer and principal financial officer, on a timely basis to ensure that it is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Changes in Internal Control over Financial Reporting
In the first quarter of 2022, we implemented a new ERP system, which replaced our existing core financial systems, resulting in changes to our financial close processes and procedures. As a result of the implementation, certain internal controls over financial reporting were automated, modified or implemented. While we believe the new ERP system will enhance our internal controls, there are inherent risks in implementing any new system, and we will continue to evaluate these control changes as part of our assessment of control design and effectiveness throughout 2022.
There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) that occurred during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
There have been no material changes or updates to the risk factors previously disclosed in our Form 10–K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES BY ISSUER AND USE OF PROCEEDS
Purchase of Equity Securities by the Issuer and Affiliated Purchasers
The following table summarizes our purchases of equity securities during the nine months ended September 30, 2022:
Maximum
Number of Shares
Total Number of
That May Yet be
Shares Purchased
Purchased Under
Total Number
Price
as Part of Publicly
the Publicly
of Shares
Paid per
Announced Plans
Purchased (1)
Share
or Programs
July 1, 2022 — July 31, 2022
2,919
8.39
N/A
August 1, 2022 — August 31, 2022
717
8.25
September 1, 2022 — September 30, 2022
3,636
8.36
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
The exhibits listed below are filed or furnished as part of this report:
3.1
Composite Certificate of Incorporation of Archrock, Inc., as amended as of November 3, 2015, (incorporated by reference to Exhibit 3.3 to Archrock Inc.’s Annual Report on Form 10–K for the year ended December 31, 2015)
3.2
Third Amended and Restated Bylaws of Exterran Holdings, Inc., now Archrock, Inc. (incorporated by reference to Exhibit 3.1 of Archrock Inc.’s Current Report on Form 8–K filed on March 20, 2013)
3.3
Amendment No. 1 to Third Amended and Restated Bylaws of Archrock, Inc. (incorporated by reference to Exhibit 3.1 of Archrock Inc.’s Current Report on Form 8–K filed on May 5, 2020)
31.1*
Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes–Oxley Act of 2002
31.2*
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes–Oxley Act of 2002
32.1**
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002
32.2**
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002
101.1*
Interactive data files (formatted in Inline XBRL) pursuant to Rule 405 of Regulation S–T
104.1*
Cover page interactive data file (formatted in Inline XBRL) pursuant to Rule 406 of Regulation S–T
* Filed herewith
** Furnished, not filed
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
By:
/s/ Douglas S. Aron
Douglas S. Aron
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/ Donna A. Henderson
Donna A. Henderson
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
November 3, 2022