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 March 31, 2020
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 April 28, 2020: 152,925,708 shares.
TABLE OF CONTENTS
Page
GLOSSARY
3
FORWARD-LOOKING STATEMENTS
4
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
5
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
6
Condensed Consolidated Statements of Comprehensive Income
7
Condensed Consolidated Statements of Equity
8
Condensed Consolidated Statements of Cash Flows
9
Notes to Condensed Consolidated Financial Statements (unaudited)
10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3. Quantitative and Qualitative Disclosures About Market Risk
37
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
39
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities
40
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
41
SIGNATURES
42
2
The following terms and abbreviations appearing in the text of this report have the meanings indicated below.
2013 Plan
Archrock, Inc. 2013 Stock Incentive Plan
2019 Form 10-K
Archrock, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2019
2020 Plan
Archrock, Inc. 2020 Stock Incentive Plan
2021 Notes
$350.0 million of 6% senior notes due April 2021, issued in March 2013
2022 Notes
$350.0 million of 6% senior notes due October 2022, issued in April 2014
2027 Notes
$500.0 million of 6.875% senior notes due April 2027, issued in March 2019
2028 Notes
$500.0 million of 6.25% senior notes due April 2028, issued in December 2019
Archrock, our, we, us
Archrock, Inc., individually and together with its wholly-owned subsidiaries
ASC 606 Revenue
Accounting Standards Codification Topic 606 Revenue from Contracts with Customers
ASC 842 Leases
Accounting Standards Codification Topic 842 Leases
ASU 2016-13
Accounting Standards Update No. 2016-13—Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
ASU 2018-13
Accounting Standards Update No. 2018-13—Fair Value Measurement (Topic 820): Changes to the Disclosure Requirements for Fair Value Measurement
ASU 2019-12
Accounting Standards Update No. 2019-12—Income Taxes (Topic 740)—Simplifying the Accounting for Income Taxes
ASU 2020-04
Accounting Standards Update No. 2020-04—Reference Rate Reform (Topic 848)—Facilitation of the Effects of Reference Rate Reform on Financial Reporting
CARES Act
Coronavirus Aid, Relief, and Economic Security Act, Public Law No. 116-136, a tax stimulus and economic stabilization bill signed into law on March 27, 2020
COVID-19
Coronavirus disease 2019
Credit Facility
$1.25 billion asset-based revolving credit facility due November 2024, as governed by Amendment No. 2 to Credit Agreement, dated November 8, 2019, which amended that Credit Agreement, dated as of March 30, 2017
EBITDA
Earnings before interest, taxes, depreciation and amortization
Elite Acquisition
Transaction completed on August 1, 2019 pursuant to the Asset Purchase Agreement entered into with Elite Compression on June 23, 2019
Elite Compression
Elite Compression Services, LLC
ERP
Enterprise Resource Planning
Exchange Act
Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards Board
Financial Statements
Condensed consolidated financial statements included in Part I Item 1 of this Quarterly Report on Form 10-Q
GAAP
U.S. generally accepted accounting principles
Hilcorp
Hilcorp Energy Company
JDH Capital
JDH Capital Holdings, L.P.
LIBOR
London Interbank Offered Rate
March 2020 Disposition
Sale completed in March 2020 of certain contract operations customer service agreements, compressors and other assets
NOL
Net operating loss
OTC
Over-the-counter, as related to aftermarket services parts and components
Partnership
Archrock Partners, L.P., together with its subsidiaries
ROU
Right-of-use, as related to the lease model under ASC 842 Leases
SEC
U.S. Securities and Exchange Commission
Securities Act
Securities Act of 1933, as amended
SG&A
Selling, general and administrative
Spin-off
Spin-off completed in November 2015 of our international contract operations, international aftermarket services and global fabrication businesses into a standalone public company operating as Exterran Corporation
U.S.
United States of America
This Quarterly Report on 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 Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Exchange Act, including, without limitation, statements regarding the effects of the COVID-19 pandemic on our business, operations, customers and financial condition; 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 Quarterly Report on 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 2019 Form 10-K and in Part II Item 1A “Risk Factors” of this Quarterly Report on Form 10-Q, and those set forth from time to time in our filings with 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 Quarterly Report on Form 10-Q are based on information available to us on the date of this Quarterly Report on 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 Quarterly Report on Form 10-Q.
Item 1. Financial Statements
ARCHROCK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
(unaudited)
–––
March 31, 2020
December 31, 2019
Assets
Current assets:
Cash and cash equivalents
$
3,221
3,685
Accounts receivable, trade, net of allowance of $2,523 and $2,210, respectively
138,623
144,865
Inventory
72,931
74,467
Other current assets
8,969
9,186
Total current assets
223,744
232,203
Property, plant and equipment, net
2,561,923
2,559,398
Operating lease ROU assets
19,156
17,901
Goodwill, net
—
100,598
Intangible assets, net
73,261
77,471
Contract costs, net
41,314
42,927
Deferred tax assets
55,175
36,642
Other assets
29,661
29,934
Noncurrent assets associated with discontinued operations
12,605
12,901
Total assets
3,016,839
3,109,975
Liabilities and Equity
Current liabilities:
Accounts payable, trade
62,289
60,215
Accrued liabilities
86,015
67,845
Deferred revenue
8,841
10,683
Total current liabilities
157,145
138,743
Long-term debt
1,811,455
1,842,549
Operating lease liabilities
17,184
16,094
Deferred tax liabilities
857
1,289
Other liabilities
22,207
16,829
Noncurrent liabilities associated with discontinued operations
8,519
8,508
Total liabilities
2,017,367
2,024,012
Commitments and contingencies (Note 21)
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, 159,756,498 and 158,636,918 shares issued, respectively
1,598
1,587
Additional paid-in capital
3,415,784
3,412,509
Accumulated other comprehensive loss
(7,173)
(1,387)
Accumulated deficit
(2,328,069)
(2,244,877)
Treasury stock: 6,830,407 and 6,702,602 common shares, at cost, respectively
(82,668)
(81,869)
Total equity
999,472
1,085,963
Total liabilities and equity
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended
March 31,
2020
2019
Revenue:
Contract operations
206,974
182,507
Aftermarket services
42,723
53,652
Total revenue
249,697
236,159
Cost of sales (excluding depreciation and amortization):
78,651
74,735
34,991
43,902
Total cost of sales (excluding depreciation and amortization)
113,642
118,637
30,626
28,989
Depreciation and amortization
49,822
44,106
Long-lived asset impairment
6,195
3,092
Goodwill impairment
99,830
Restatement and other charges
421
Restructuring charges
1,728
Interest expense
29,665
23,617
Transaction-related costs
180
(Gain) loss on sale of assets, net
(4,116)
16
Other income, net
(555)
(221)
Income (loss) before income taxes
(77,140)
17,322
Benefit from income taxes
(15,953)
(2,407)
Income (loss) from continuing operations
(61,187)
19,729
Loss from discontinued operations, net of tax
(273)
Net income (loss)
19,456
Basic and diluted net income (loss) per common share
(0.41)
0.15
Weighted average common shares outstanding:
Basic
150,550
128,209
Diluted
128,255
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Other comprehensive loss, net of tax:
Interest rate swap loss, net of reclassifications to earnings
(5,786)
(3,225)
Total other comprehensive loss
Comprehensive income (loss)
(66,973)
16,231
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(in thousands, except share and per share amounts)
Accumulated
Common
Additional
Other
Treasury
Stock
Paid-in
Comprehensive
Amount
Shares
Capital
Income (Loss)
Deficit
Total
Balance at December 31, 2018
1,358
135,787,509
3,177,982
5,773
(2,263,677)
(79,862)
(6,381,605)
841,574
Treasury stock purchased
(857)
(87,036)
Cash dividends ($0.132 per common share)
(17,231)
Shares issued in employee stock purchase plan
29,728
218
Stock-based compensation, net of forfeitures
11
1,059,115
2,346
(15,434)
2,357
Comprehensive income
Net income
Balance at March 31, 2019
1,369
136,876,352
3,180,546
2,548
(2,261,452)
(80,719)
(6,484,075)
842,292
Balance at December 31, 2019
158,636,918
(6,702,602)
(799)
(90,594)
Cash dividends ($0.145 per common share)
(22,171)
1
56,417
201
202
1,063,163
3,074
(37,211)
3,084
Impact of ASU 2016-13 adoption
166
Comprehensive loss
Net loss
Balance at March 31, 2020
159,756,498
(6,830,407)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
273
Inventory write-downs
282
222
Amortization of operating lease ROU assets
781
712
Amortization of deferred financing costs
1,533
1,509
Amortization of debt discount
187
366
Interest rate swaps
196
(410)
Stock-based compensation expense
3,006
Non-cash restructuring charges
61
Provision for credit losses
752
428
(944)
Gain on March 2020 Disposition
(3,172)
Deferred income tax benefit
(15,966)
(2,883)
Amortization of contract costs
6,805
5,117
Deferred revenue recognized in earnings
(7,735)
(12,749)
Changes in assets and liabilities:
Accounts receivable, trade
4,803
(3,154)
1,068
3,724
(439)
15,165
(5,537)
(6,574)
Accounts payable and other liabilities
12,936
1,131
5,783
9,467
69
29
Net cash provided by operating activities
99,129
81,400
Cash flows from investing activities:
Capital expenditures
(71,946)
(132,697)
Proceeds from March 2020 Disposition
24,179
Proceeds from sale of property, plant and equipment and other assets
2,543
11,155
Proceeds from insurance and other settlements
1,083
238
Net cash used in investing activities
(44,141)
(121,304)
Cash flows from financing activities:
Borrowings of long-term debt
227,500
690,000
Repayments of long-term debt
(259,500)
(629,000)
Payments for debt issuance costs
(596)
(7,521)
Proceeds from (payments for) settlement of interest rate swaps that include financing elements
(88)
393
Dividends paid to stockholders
Proceeds from stock issued under employee stock purchase plan
Purchases of treasury stock
Net cash provided by (used in) financing activities
(55,452)
36,002
Net decrease in cash and cash equivalents
(464)
(3,902)
Cash and cash equivalents, beginning of period
5,610
Cash and cash equivalents, end of period
1,708
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Basis of Presentation
We are an energy infrastructure company with a pure-play focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the oil and natural gas 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 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.
The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with 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 includes all adjustments, consisting of normal recurring adjustments, which are necessary to present fairly 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 2019 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. Certain prior year amounts have been reclassified to conform to the current year presentation.
2. Recent Accounting Developments
Accounting Standards Updates Implemented
Credit Losses
In June 2016, the FASB issued ASU 2016-13, which changes the impairment model for financial assets measured at amortized cost and certain other instruments, and requires entities to use a new current expected credit loss model that results in recognition of expected losses over the contractual life of an asset. We adopted ASU 2016-13 on January 1, 2020 using the modified retrospective approach. The adoption resulted in a $0.2 million decrease in our allowance for credit losses and a corresponding pre-tax cumulative effect adjustment to retained earnings in our condensed consolidated balance sheet at January 1, 2020. Comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
Our financial assets measured at amortized cost consist of cash equivalents and trade receivables from revenue transactions within the scope of ASC 606 Revenue. We believe our temporary cash investments have a zero loss expectation because we maintain minimal balances in our cash investment accounts and have no history of loss. 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.
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. Judgement is used to determine the expected credit loss for customers that do not share similar risk characteristics with other customers, based on customer specific items such as legal proceedings, past experience with the customer and/or ongoing customer negotiations.
The following table summarizes the changes in the allowance for credit losses balance during the three months ended March 31, 2020 (in thousands):
2,210
Impact of adoption of ASU 2016-13 on January 1, 2020
(216)
Write-offs charged against allowance
(223)
2,523
Fair Value Measurements
On January 1, 2020, we adopted ASU 2018-13, which amends the required fair value measurements disclosures related to valuation techniques and inputs used, uncertainty in measurement and changes in measurements applied. These amendments resulted in new, prospective disclosures of the range and weighted average of the significant unobservable inputs used to develop our Level 3 fair value measurements related to our idle and previously-culled compressors. The adoption of ASU 2018-13 had no impact on our condensed consolidated financial statements.
Income Taxes
On January 1, 2020, we adopted ASU 2019-12, which simplifies the accounting for income taxes by, among other things, removing certain exceptions related to the incremental approach for intraperiod tax allocation, the year-to-date loss methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities on outside basis differences. ASU 2019-12 also clarifies other aspects of the accounting for income taxes in order to improve consistency of application. The adoption of ASU 2019-12 had no impact on our condensed consolidated financial statements.
Accounting Standards Updates Not Yet Implemented
Reference Rate Reform
In March 2020, the FASB issued ASU 2020-04, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued as a result of reference rate reform. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. Entities may elect to apply the amendments for contract modifications as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020. We are currently assessing the impact that ASU 2020-04 may have on our interest rate swap agreements, Credit Facility and other transactions that may be affected by reference rate reform.
3. Business Transactions
On March 1, 2020, we completed the sale of certain contract operations customer service agreements and approximately 200 compressors, comprising approximately 35,000 horsepower, used to provide compression services under those agreements as well as other assets used to support the operations. We allocated customer and contract-related intangible assets and goodwill based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We recognized a gain on the sale of $3.2 million in gain (loss) on sale of assets, net in our condensed consolidated statements of operations during the three months ended March 31, 2020.
On August 1, 2019, we completed the Elite Acquisition whereby we acquired from Elite Compression substantially all of its assets, including a fleet of predominantly large compressors comprising approximately 430,000 horsepower, vehicles, real property and inventory, and certain liabilities for aggregate consideration consisting of $214.0 million in cash and 21.7 million shares of common stock with an acquisition date fair value of $225.9 million. The cash portion of the acquisition was funded with borrowings on the Credit Facility.
The Elite Acquisition was accounted for using the acquisition method, which requires, among other things, assets acquired and liabilities assumed to be recorded at their fair value on the acquisition date. The excess of the consideration transferred over those fair values is recorded as goodwill. The following table summarizes the purchase price allocation based on the estimated fair values of the acquired assets and liabilities as of the acquisition date (in thousands):
Accounts receivable
9,007
7,987
608
Property, plant and equipment
286,158
682
Goodwill
Intangible assets
40,237
(2,079)
(2,973)
(326)
Purchase price
439,899
Our valuation methodology and significant inputs for fair value measurements are detailed by asset class below. The fair value measurements for property, plant and equipment and intangible assets are based on significant inputs that are not observable in the market and therefore represent Level 3 measurements.
12
The goodwill resulting from the acquisition is attributable to the expansion of our services in various regions in which we currently operate and was allocated to our contract operations segment. All of the goodwill recorded for this acquisition is expected to be deductible for U.S. federal income tax purposes.
Property, Plant and Equipment
The property, plant and equipment is primarily comprised of compression equipment that will be depreciated on a straight-line basis over an estimated average remaining useful life of 15 years. The fair value of the property, plant and equipment was determined using the cost approach, whereby we estimated the replacement cost of the assets by evaluating recent purchases of similar assets or published data, and then adjusted replacement cost for physical deterioration and functional and economic obsolescence, as applicable.
Intangible Assets
The intangible assets consist of customer relationships that have an estimated useful life of 15 years. The amount of intangible assets and their associated useful life were determined based on the period over which the assets are expected to contribute directly or indirectly to our future cash flows. The fair value of the identifiable intangible assets was determined using the multi-period excess earnings method, which is a specific application of the discounted cash flow method, an income approach, whereby we estimated and then discounted the future cash flows of the intangible asset by adjusting overall business revenue for attrition, obsolescence, cost of sales, operating expenses, taxes and the required returns attributable to other contributory assets acquired. Significant estimates made in arriving at expected future cash flows included our expected customer attrition rate and the amount of earnings attributable to the assets. To discount the estimated future cash flows, we utilized a discount rate that was at a premium to our weighted average cost of capital to reflect the less liquid nature of the customer relationships relative to the tangible assets acquired.
Unaudited Pro Forma Financial Information
Unaudited pro forma financial information for the three months ended March 31, 2019 was derived by adjusting our historical financial statements in order to give effect to the assets and liabilities acquired in the Elite Acquisition. The Elite Acquisition is presented in this unaudited pro forma financial information as though the acquisition occurred as of January 1, 2019, and reflects the following:
The unaudited pro forma financial information below is presented (in thousands) for informational purposes only and is not necessarily indicative of our results of operations that would have occurred had the transaction been consummated at the beginning of the period presented, nor is it necessarily indicative of future results.
March 31, 2019
Revenue
254,564
20,967
The results of operations attributable to the assets and liabilities acquired in the Elite Acquisition have been included in our condensed consolidated financial statements as part of our contract operations segment since the date of acquisition.
13
4. Discontinued Operations
In 2015 we completed the Spin-off. In order to effect the Spin-off and govern our relationship with Exterran Corporation after the Spin-off, we entered into several agreements with Exterran Corporation which include, but are not limited to, the tax matters agreement. The tax matters agreement governs the respective rights, responsibilities and obligations of Exterran Corporation and us with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and certain other matters regarding taxes. Subject to the provisions of this agreement, we and Exterran Corporation agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing.
As of March 31, 2020 and December 31, 2019, we had $8.5 million, respectively, of unrecognized tax benefits (including interest and penalties) related to Exterran Corporation operations prior to the Spin-off recorded to noncurrent liabilities associated with discontinued operations in our condensed consolidated balance sheets. We had an offsetting indemnification asset of $8.5 million related to these unrecognized tax benefits recorded to noncurrent assets associated with discontinued operations as of March 31, 2020 and December 31, 2019, respectively.
The following table presents the balance sheet for our discontinued operations (in thousands):
4,086
4,393
Total assets associated with discontinued operations
Total liabilities associated with discontinued operations
The following table presents the statements of operations for our discontinued operations (in thousands):
(10)
(1,432)
Provision for income taxes
1,705
5. Inventory
Inventory consisted of the following (in thousands):
Parts and supplies
63,889
66,121
Work in progress
9,042
8,346
14
6. Property, Plant and Equipment, Net
Property, plant and equipment, net consisted of the following (in thousands):
Compression equipment, facilities and other fleet assets
3,659,907
3,653,930
Land and buildings
51,031
50,743
Transportation and shop equipment
114,465
116,057
Computer hardware and software
93,734
93,695
17,587
15,308
3,936,724
3,929,733
Accumulated depreciation
(1,374,801)
(1,370,335)
7. Leases
Operating Leases
We determine if an arrangement is a lease at inception. Following ASC 842, we determine lease classification and recognize ROU assets and liabilities on the lease commencement date based on the present value of lease payments over the lease term. As the discount rate implicit in the lease is rarely readily determinable, we estimate our incremental borrowing rate using information available at commencement date in determining the present value of the lease payments. The lease term includes options to extend when we are reasonably certain to exercise the option. Short-term leases, those with an initial term of 12 months or less, are not recorded on the balance sheet. Variable costs such as our proportionate share of actual costs for utilities, common area maintenance, property taxes and insurance are not included in the lease liability and are recognized in the period in which they are incurred. Operating lease expense for lease payments is recognized on a straight-line basis over the term of the lease.
The facility leases discussed below, of which we are the lessee, contain lease and nonlease components for which we have elected to account for as a single lease component, as the nonlease components are not significant to the total consideration of the contract and separating the nonlease component would have no effect on lease classification. As it relates to our contract operations services agreements in which we are the lessor, the services nonlease component is predominant over the compression package lease component and therefore recognition of these agreements will continue to follow the ASC 606 Revenue guidance.
We have operating leases and subleases for office space, temporary housing, storage and shops. Our leases have remaining lease terms of less than one year to 11 years and most include options to extend the lease term, at our discretion, for an additional three to five years. We are not, however, reasonably certain that we will exercise any of the options to extend and as such, they have not been included in the remaining lease terms.
Balance sheet information related to our operating leases was as follows (in thousands):
Classification
ROU assets
Lease liabilities
Current
3,211
3,037
Noncurrent
Total lease liabilities
20,395
19,131
15
The components of lease cost were as follows (in thousands):
Operating lease cost
1,031
974
Short-term lease cost
129
173
Variable lease cost
349
382
Total lease cost
1,529
Cash flow and non-cash information related to our operating leases were as follows (in thousands):
Operating cash flows - cash paid for amounts included in the measurement of operating lease liabilities
1,351
1,311
Operating lease ROU assets obtained in exchange for new lease liabilities
2,037
617
Other supplemental information related to our operating leases was as follows:
Weighted average remaining lease term (in years)
8.3
8.2
Weighted average discount rate
5.1
%
5.3
Remaining maturities of lease liabilities governed under ASC 842 Leases as of March 31, 2020 were as follows (in thousands):
2,808
2021
3,955
2022
2,855
2023
2,550
2024
2,159
2025
1,930
Thereafter
8,942
Total lease payments
25,199
Less: Interest
(4,804)
Total lease liabilities under ASC 842 Leases
8. Goodwill
Our goodwill was recognized in connection with the Elite Acquisition and represents the excess of consideration transferred over the fair value of the assets and liabilities acquired. All of the goodwill was allocated to our contract operations reporting unit. We review the carrying amount of our goodwill in the fourth quarter of every year, or whenever indicators of potential impairment exist, to determine if the carrying amount of our contract operations reporting unit exceeds its fair value, including the goodwill. During the first quarter, the COVID-19 pandemic caused a significant deterioration in global macroeconomic conditions, including a collapse in the demand for oil coupled with an oversupply of oil, which commenced substantial spending cuts by our customers and a decline in production. This global response to the pandemic significantly impacted our market capitalization and estimates of future revenues and cash flows as of March 31, 2020, which triggered the need to perform a quantitative test of the fair value of our contract operations reporting unit as of March 31, 2020. The quantitative test determined that the carrying amount of our contract operations reporting unit exceeded its fair value and we recorded a full impairment loss on goodwill as a result.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions, which have a significant impact on the fair value determined. We determine the fair value of our reporting unit using an equal weighting of both the expected present value of future cash flows and a market approach. The present value of future cash flows is estimated using our most recent forecast and the weighted average cost of capital. The market approach uses a market multiple on the earnings before interest expense, provision for income taxes and depreciation and amortization expense of comparable peer companies. Significant estimates for our reporting unit included in our impairment analysis are our cash flow forecasts, our estimate of the market’s weighted average cost of capital and market multiples.
The following table presents the change in the carrying amount of goodwill during the quarter ended March 31, 2020 (in thousands):
Dispositions
(768)
Impairment loss
(99,830)
9. Hosting Arrangements
In the fourth quarter of 2018 we began a process and technology transformation project that will, among other things, upgrade or replace our existing ERP, supply chain and inventory management systems and expand the remote monitoring capabilities of our compression fleet. Included in this project are hosting arrangements that are service contracts related to the cloud migration of our ERP system and cloud services for our new mobile workforce, telematics and inventory management tools.
Certain costs incurred for the implementation of our hosting arrangements that are service contracts are capitalized and amortized on a straight-line basis over the term of the respective contract. Amortization begins in the period in which an individual component becomes ready for its intended use. As of March 31, 2020 and December 31, 2019, we capitalized $6.5 million and $5.5 million, respectively, of implementation costs related to our hosting arrangements that are service contracts to other assets in our condensed consolidated balance sheets. Accumulated amortization was $0.1 million at March 31, 2020. We recorded $0.1 million of amortization expense to SG&A in our condensed consolidated statements of operations during the three months ended March 31, 2020.
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10. Long-Term Debt
Long-term debt consisted of the following (in thousands):
481,000
513,000
500,000
Less: Deferred financing costs, net of amortization
(7,851)
(8,090)
492,149
491,910
(7,723)
(7,999)
492,277
492,001
350,000
Less: Debt discount, net of amortization
(1,860)
(2,046)
(2,111)
(2,316)
346,029
345,638
As of March 31, 2020, there were $13.7 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.5%. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 3.4% and 4.3% at March 31, 2020 and December 31, 2019, respectively. We incurred $0.7 million and $0.5 million in commitment fees on the daily unused amount of the Credit Facility during the three months ended March 31, 2020 and 2019, respectively.
We must maintain certain consolidated financial ratios as defined in our Credit Facility agreement. As a result of these ratio requirements, $651.4 million of the $755.3 million of undrawn capacity was available for additional borrowings as of March 31, 2020. As of March 31, 2020, we were in compliance with all covenants under the Credit Facility agreement.
11. Accumulated Other Comprehensive Income (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 income (loss) consists of changes in the fair value of our interest rate swap derivative instruments, net of tax, which are designated as cash flow hedges.
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The following table presents the changes in accumulated other comprehensive income (loss) of our derivative cash flow hedges, net of tax, during the three months ended March 31, 2020 and 2019 (in thousands):
Beginning accumulated other comprehensive income (loss)
Loss recognized in other comprehensive loss, net of tax benefit of $1,590 and $0, respectively (1)
(5,983)
(2,299)
(Gain) loss reclassified from accumulated other comprehensive income (loss) to interest expense, net of tax benefit of $51 and $0, respectively (1)
197
(926)
Other comprehensive loss
Ending accumulated other comprehensive income (loss)
See Note 18 (“Derivatives”) for further details on our interest rate swap derivative instruments.
12. Equity
Cash Dividends
The following table summarizes our dividends declared and paid in each of the quarterly periods of 2020 and 2019:
Declared Dividends
Dividends Paid
per Common Share
Q1
0.145
22,171
0.132
17,231
Q2
17,206
Q3
22,062
Q4
22,031
On April 24, 2020, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock to be paid on May 18, 2020 to stockholders of record at the close of business on May 11, 2020.
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13. Revenue from Contracts with Customers
The following table presents our revenue from contracts with customers disaggregated by revenue source (in thousands):
Contract operations (1):
0 - 1,000 horsepower per unit
66,740
63,739
1,001 - 1,500 horsepower per unit
84,852
74,340
Over 1,500 horsepower per unit
54,591
43,425
Other (2)
791
1,003
Total contract operations (3)
Aftermarket services (1):
Services
25,450
33,521
OTC parts and components sales
17,273
20,131
Total aftermarket services (4)
Performance Obligations
As of March 31, 2020, we had $470.5 million of remaining performance obligations related to our contract operations segment. We have elected to apply the practical expedient to not consider the effects of the time value of money, as the expected time between the transfer of services and payment for such services is less than one year. The remaining performance obligations will be recognized through 2025 as follows (in thousands):
Remaining performance obligations
244,368
157,208
60,034
7,422
1,355
119
470,506
As of March 31, 2020, we elected to apply the practical expedient to 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
As of March 31, 2020 and December 31, 2019, our receivables from contracts with customers, net of allowance for credit losses, were $133.5 million and $139.4 million, respectively.
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 March 31, 2020 and December 31, 2019, our contract liabilities were $9.4 million and $11.4 million, respectively, which were included in deferred revenue and other liabilities in our condensed consolidated balance sheets. The decrease in the contract liability balance during the three months ended March 31, 2020 was primarily due to revenue deferral of $5.8 million, partially offset by $7.7 million recognized as revenue during the period, each primarily related to freight billings and aftermarket services.
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14. Long-Lived 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.
The following table presents the results of our impairment review as recorded to our contract operations segment (dollars in thousands):
Idle compressors retired from the active fleet
85
Horsepower of idle compressors retired from the active fleet
23,000
15,000
Impairment recorded on idle compressors retired from the active fleet
During the three months ended March 31, 2020, we determined that the impairment of our contract operations reporting unit’s goodwill was an indicator of potential impairment of the carrying amount of our long-lived assets, including our compressor fleet and associated customer and contract-based intangible assets. Accordingly, we performed a quantitative impairment test of our long-lived assets, by which we determined that they were not impaired as of March 31, 2020.
15. Restructuring Charges
During the first quarter of 2020, we completed a series of restructuring activities to further streamline our organization and more fully align our teams to improve our customer service and profitability. We incurred severance costs of $1.7 million in connection with these restructuring activities during the three months ended March 31, 2020, which are reflected as restructuring charges in our condensed consolidated statements of operations.
The following table presents, by segment, the restructuring charges incurred during the three months ended March 31, 2020 (in thousands):
Contract
Aftermarket
Operations
Other (1)
Three months ended March 31, 2020
478
625
21
16. Income Taxes
On March 27, 2020, President Trump signed into law the CARES Act, which includes, among other things, refundable payroll tax credits, deferment of employer side social security payments, NOL carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act provisions did not have a material impact on our condensed consolidated financial statements. Future regulatory guidance under the CARES Act or additional legislation enacted by Congress in connection with the COVID-19 pandemic could impact our tax provision in future periods.
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 NOL carryforwards 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 three months ended March 31, 2020 differed from our statutory rate primarily due to an increase in unrecognized tax benefits. Our quarterly income tax provision is determined based on our estimated full year effective tax rate, adjusted for tax attributable to infrequent or unusual items, which are recognized on a discrete period basis in the income tax provision in the period in which they occur. Our year-to-date income tax provision included a $22.7 million tax benefit recorded discretely on the nonrecurring goodwill impairment loss of $99.8 million. See Note 8 (“Goodwill”) for further details on the goodwill impairment.
Unrecognized Tax Benefits
As of March 31, 2020, we believe it is reasonably possible that $2.6 million of our unrecognized tax benefits, including penalties, interest and discontinued operations, will be reduced prior to March 31, 2021 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.
17. Earnings per 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, no effect is given to participating securities because they do not have a contractual obligation to participate in our losses.
Diluted net income (loss) per common share is computed using the weighted average number of shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options, performance-based restricted stock units and stock to be issued pursuant to our employee stock purchase plan unless their effect would be anti-dilutive.
22
The following table shows net income (loss) used in the calculation of basic and diluted net income (loss) per common share (in thousands):
Less: Net income attributable to participating securities
(322)
(356)
Net income (loss) attributable to common stockholders
(61,509)
19,100
The following table shows the potential shares of common stock that were included in computing diluted net income (loss) per common share (in thousands):
Weighted average common shares outstanding including participating securities
152,601
130,238
Less: Weighted average participating securities outstanding
(2,051)
(2,029)
Weighted average common shares outstanding used in basic net income (loss) per common share
Net dilutive potential common shares issuable:
On exercise of options and vesting of performance-based restricted stock units
On settlement of employee stock purchase plan shares
Weighted average common shares outstanding used in diluted net income (loss) per common share
The following table shows the potential shares of common stock issuable that were excluded from computing diluted net income (loss) per common share as their inclusion would have been anti-dilutive (in thousands):
On exercise of options where exercise price is greater than average market value for the period
126
154
57
Net dilutive potential common shares issuable
212
18. Derivatives
We are exposed to market risks associated with changes in the variable interest rate of the Credit Facility. We use derivative instruments 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.
23
The following interest rate swaps, entered into to offset changes in expected cash flows due to fluctuations in the associated variable interest rates, were outstanding at March 31, 2020 (in millions):
Expiration Date
Notional Value
May 2020
100
March 2022
300
400
The counterparties to our derivative agreements are major financial institutions. We monitor the credit quality of these financial institutions and do not expect nonperformance by any counterparty, although such nonperformance could have a material adverse effect on us. We have no collateral posted for the derivative instruments.
We have designated these interest rate swaps as cash flow hedging instruments. Changes in the fair value of the interest rate swaps 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 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 this case, the cash settlements for these derivatives are classified as cash flows from financing activities.
We expect the hedging relationship to be highly effective as the interest rate swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate. We perform quarterly qualitative prospective and retrospective hedge effectiveness assessments unless facts and circumstances related to the hedging relationships change such that we can no longer assert qualitatively that the cash flow hedge relationships were and continue to be highly effective. We estimate that $4.3 million of the deferred pre-tax loss attributable to interest rate swaps included in accumulated other comprehensive loss at March 31, 2020 will be reclassified into earnings as interest expense at then-current values during the next 12 months as the underlying hedged transactions occur.
As of March 31, 2020, the weighted average effective fixed interest rate on our interest rate swaps was 1.8%.
The following table presents the effect of our derivative instruments designated as cash flow hedging instruments on our condensed consolidated balance sheets (in thousands):
Total derivative assets
(4,317)
(593)
(4,764)
(1,175)
Total derivative liabilities
(9,081)
(1,768)
The following tables present the effect of our derivative instruments designated as cash flow hedging instruments on our condensed consolidated statements of operations (in thousands):
Pre-tax loss recognized in other comprehensive loss
(7,573)
Pre-tax gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense
(248)
926
Total amount of interest expense in which the effects of cash flow hedges are recorded
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See Note 11 (“Accumulated Other Comprehensive Income (Loss)”) and Note 19 (“Fair Value Measurements”) for further details on our derivative instruments.
19. Fair Value Measurements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
On a quarterly basis, our interest rate swap derivative instruments are valued based on the income approach (discounted cash flow) using market observable inputs, including LIBOR forward curves. These fair value measurements are classified as Level 2. The following table presents our derivative asset and liability measured at fair value on a recurring basis, with pricing levels as of the date of valuation (in thousands):
Derivative asset
Derivative liability
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
In the first quarter of 2020, we determined that the significant deterioration in global macroeconomic conditions caused by the COVID-19 pandemic was an indicator of potential impairment of our goodwill, and we performed a quantitative impairment test as of March 31, 2020 that resulted in a $99.8 million impairment of our goodwill. Significant estimates used in our impairment analysis included cash flow forecasts, our estimate of the market’s weighted average cost of capital and market multiples, which are Level 3 inputs. See Note 8 (“Goodwill”) for further details of the valuation methodology used in connection with the goodwill impairment.
Compressors
During the three months ended March 31, 2020, we recorded nonrecurring fair value measurements related to our idle and previously-culled compressors. Our estimate of the compressors’ fair value was primarily based on the expected net sale proceeds compared to 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. These fair value measurements are classified as Level 3.
The fair value of our impaired compressors at March 31, 2020 and December 31, 2019 was as follows:
Impaired compressors
253
5,859
The 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
Estimated net sale proceeds (1)
$0 - $372 per horsepower
$21 per horsepower
25
See Note 14 (“Long-Lived Asset Impairment”) for further details.
Other Financial Instruments
The carrying amounts of our cash, receivables and payables approximate fair value due to the short-term nature of those instruments.
The carrying amount of borrowings outstanding under our Credit Facility approximates fair value due to its variable interest rate. 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. The following table presents the carrying amount and fair value of our fixed rate debt (in thousands):
Carrying amount of fixed rate debt (1)
1,330,455
1,329,549
Fair value of fixed rate debt
1,067,000
1,400,000
20. Stock-Based Compensation
Stock-based compensation expense consisted of the following during the three months ended March 31, 2020 and 2019 (in thousands):
Equity awards
Liability awards
(548)
966
Total stock-based compensation expense
2,458
3,323
The following table presents restricted stock, restricted stock unit, performance-based restricted stock unit and cash-settled performance unit activity during the three months ended March 31, 2020 (shares in thousands):
Weighted
Average
Grant Date
Fair Value
Per Share
Non-vested awards, December 31, 2019
2,022
10.25
Granted
1,412
9.47
Vested
(314)
9.44
Canceled
(52)
10.23
Non-vested awards, March 31, 2020 (1)
3,068
9.97
As of March 31, 2020, we expect $21.5 million of unrecognized compensation cost related to unvested restricted stock, stock-settled restricted stock units, performance units, cash-settled restricted stock units and cash-settled performance units to be recognized over the weighted average period of 2.2 years.
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The 2020 Plan was adopted in April 2020 and provides for the granting of stock options, restricted stock, restricted stock units, stock appreciation rights, performance awards, other stock-based awards and dividend equivalent rights to employees, directors and consultants of Archrock. Under the 2020 Plan, the maximum number of shares of common stock available for issuance is 8,500,000. Each stock-settled award granted under the 2020 Plan reduces the number of shares available for issuance by one share. No additional grants may be made under the 2013 Plan following the adoption of the 2020 Plan. Previous grants made under the 2013 Plan continue to be governed by that plan and the applicable award agreements.
21. Commitments and Contingencies
Performance Bonds
In the normal course of business we have issued performance bonds to various state authorities that ensure payment of certain obligations. We have also issued a bond to protect our 401(k) retirement plan against losses caused by acts of fraud or dishonesty. The bonds have expiration dates in 2020 through the fourth quarter of 2022 and maximum potential future payments of $2.2 million. As of March 31, 2020, we were in compliance with all obligations to which the performance bonds pertain.
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 March 31, 2020 and December 31, 2019, we accrued $2.4 million and $2.5 million, respectively, 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.
Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. The tax contingencies mentioned above relate to tax matters for which we are responsible in managing the audit. As of March 31, 2020 and December 31, 2019, we recorded an indemnification liability (including penalties and interest), in addition to the tax contingency above, of $2.6 million and $2.8 million, respectively, for our share of non-income-based tax contingencies related to audits being managed by Exterran Corporation.
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.
27
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.
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.
22. Related Party Transactions
In connection with the closing of the Elite Acquisition, we issued 21.7 million shares of our common stock to JDH Capital, an affiliate of our customer Hilcorp. As long as JDH Capital, together with affiliates of Hilcorp, owns at least 7.5% of our outstanding common stock, it will have the right to designate one director to our Board of Directors. On August 1, 2019, Jeffery D. Hildebrand, founder and executive chairman of Hilcorp, was elected to our Board of Directors. Mr. Hildebrand receives no compensation for his role as a director. As of March 31, 2020, JDH Capital owned 14.2% of our outstanding common stock.
Revenue from Hilcorp and affiliates was $10.7 million and $5.5 million during the three months ended March 31, 2020 and 2019, respectively. Accounts receivable, net due from Hilcorp and affiliates were $4.1 million and $5.1 million as of March 31, 2020 and December 31, 2019, respectively.
23. Segments
We manage our business segments primarily based on the type of product or service provided. We have two segments which we operate within the U.S.: contract operations and aftermarket services. The contract operations segment primarily provides natural gas compression services to meet specific customer requirements. The 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.
We evaluate the performance of our segments based on gross margin for each segment. Revenue includes only sales to external customers.
The following table presents revenue and gross margin by segment during the three months ended March 31, 2020 and 2019 (in thousands):
Gross margin
128,323
7,732
136,055
Three months ended March 31, 2019
107,772
9,750
117,522
28
The following table reconciles total gross margin to income (loss) before income taxes (in thousands):
Total gross margin
Less:
24. Subsequent Events
2022 Notes Redemption
On April 1, 2020, the 2022 Notes were redeemed at 100% of their $350.0 million aggregate principal amount plus accrued and unpaid interest of $10.5 million with borrowings from the Credit Facility. A debt extinguishment loss of approximately $4.0 million related to the redemption will be recognized in the second quarter of 2020.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q and in conjunction with our 2019 Form 10-K.
Overview
We are an energy infrastructure company with a pure-play focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the oil and natural gas 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
On April 1, 2020, we repaid the 2022 Notes with borrowings from our Credit Facility. See Note 24 (“Subsequent Events”) to our Financial Statements for further details of this transaction.
COVID-19 Pandemic
During the three months ended March 31, 2020 and continuing through the date of this filing, the COVID-19 pandemic has caused a deterioration in global macroeconomic conditions, including a collapse in the demand for oil coupled with an oversupply of oil, which has commenced substantial spending cuts by our customers and a decline in production. This global response to the pandemic has significantly impacted our market capitalization and estimates of future revenues and cash flows.
The key driver of our business is the production of U.S. crude oil and natural gas. Approximately 70% of our operating fleet is deployed for midstream natural gas gathering applications with the remaining fleet being used in wellhead and gas lift applications to enhance oil production. Changes in oil and natural gas production spending therefore typically result in changes in demand for our services. According to the EIA’s April 2020 Short-Term Energy Outlook, both crude oil and dry natural gas production are now expected to decline in 2020 and 2021 as the result of the decrease in commodity prices and demand. U.S. crude oil production is estimated to decrease 4% in 2020 and decline an additional 6% in 2021. U.S. dry natural gas production is estimated to decrease 1% in 2020 and decline an additional 5% in 2021, though with a rise estimated to begin in the second half of 2021 in response to higher prices.
Substantial spending cuts for 2020 have been announced by our customers as a result of the significant and estimated declines in oil and natural gas prices and demand, however, the timing of the impact of the spending cuts on production remain difficult to predict, as does the magnitude and duration of the pandemic and resulting economic downturn. In anticipation of lower customer activity levels, we implemented a plan in the second quarter of 2020 to reduce our 2020 operating, corporate and capital costs by between $75 million and $85 million. Horsepower, utilization and revenue are also expected to decline in 2020 as compared to 2019 in both our contract operations and aftermarket services businesses.
The impact of the COVID-19 pandemic on our first quarter 2020 results is primarily visible in the $99.8 million non-cash impairment of our goodwill and the impairment’s resulting impact on income taxes. See Note 8 (“Goodwill”) and Note 16 (“Income Taxes”) to our Financial Statements for further discussion.
Operating Highlights
The following table summarizes our available and operating horsepower and horsepower utilization (in thousands, except percentages):
Total available horsepower (at period end)(1)
4,386
4,035
Total operating horsepower (at period end)(2)
3,883
3,561
Average operating horsepower
3,914
3,545
Horsepower utilization:
Spot (at period end)
89
88
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 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, restatement and other charges, restructuring charges, interest expense, transaction-related costs, gain (loss) on sale of assets, net, other income (loss), net, provision for (benefit from) income taxes and loss from discontinued operations, net of tax. 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.
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The following table reconciles net income (loss) to gross margin (in thousands):
Financial Results of Operations
Summary of Results
Revenue. Revenue was $249.7 million and $236.2 million during the three months ended March 31, 2020 and 2019, respectively. The increase in revenue was due to an increase in revenue from our contract operations business, partially offset by a decrease in revenue from our aftermarket services business. See “Contract Operations” and “Aftermarket Services” below for further details.
Net income (loss). We had a net loss of $61.2 million and net income of $19.5 million during the three months ended March 31, 2020 and 2019, respectively. The change from net income to net loss was primarily driven by goodwill impairment of $99.8 million and increases in interest expense, depreciation and amortization and long-lived asset impairment, partially offset by increases in gross margin from our contract operations business and benefit from income taxes and the change in (gain) loss on sale of assets, net.
Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019
Contract Operations
(dollars in thousands)
Increase
(Decrease)
Cost of sales (excluding depreciation and amortization expense)
Gross margin percentage (1)
62
59
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The increase in revenue during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to an increase in contract operations rates driven by increased customer demand in 2019 and $20.1 million of revenue associated with the compression assets acquired in the Elite Acquisition, partially offset by a decrease in average operating horsepower (excluding the horsepower acquired in the Elite Acquisition) driven by sales of compression assets completed since the first quarter of 2019.
Gross margin increased during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 primarily due to the increase in revenue mentioned above, partially offset by a smaller increase in cost of sales. The increase in cost of sales was primarily driven by increases in maintenance and lube oil expense associated with the horsepower acquired in the Elite Acquisition, as well as an increase in freight expense associated with mobilization and demobilization activity.
Gross margin percentage increased during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 primarily due to the increase in contract operations rates mentioned above.
Aftermarket Services
(20)
(21)
Gross margin percentage
The decrease in revenue during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to decreases in service activities and parts sales as customers continued the deferral of maintenance activities that began in the second quarter of 2019.
Gross margin decreased during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 due to the decrease in revenue mentioned above, partially offset by a slightly smaller decrease in cost of sales. The decrease in cost of sales was primarily driven by the decrease in service activities and parts sales.
Costs and Expenses
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Selling, general and administrative. The increase in SG&A during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to a $0.5 million increase in costs related to our process and technology transformation project, a $0.5 million increase in costs associated with software and cloud subscriptions not yet commenced in the first quarter of 2019, including those related to our technology transformation project and contracts acquired in the Elite Acquisition, a $0.5 million increase in sales and use tax and a $0.3 million increase in bad debt expense.
Depreciation and amortization. The increase in depreciation and amortization expense during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to an increase in depreciation expense associated with fixed assets acquired in the Elite Acquisition as well as other fixed asset additions during 2019, partially offset by a decrease in depreciation expense resulting from certain assets reaching the end of their depreciable lives as well as the impact of asset impairments and compression asset sales during 2019.
Long-lived asset impairment. During the three months ended March 31, 2020 and 2019, we reviewed the future deployment of our idle compressors for units that were not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. In addition, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale. See Note 14 (“Long-Lived Asset Impairment”) to our Financial Statements for further details.
The following table presents the results of our impairment review, as recorded to our contract operations segment (dollars in thousands):
Goodwill impairment. During the three months ended March 31, 2020, we recorded $99.8 million of goodwill impairment due to the decline in the fair value of our contract operations reporting unit. See Note 8 (“Goodwill”) to our Financial Statements for further details.
Restructuring charges. During the three months ended March 31, 2020, we recorded $1.7 million of severance costs related to restructuring activities completed in the first quarter of 2020. See Note 15 (“Restructuring Charges”) to our Financial Statements for further details.
Interest expense. The increase in interest expense during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was due to increases in the average outstanding balance of long-term debt and the weighted average effective interest rate.
(Gain) loss on sale of assets, net. The change in (gain) loss on sale of assets, net was primarily due to a $3.2 million gain on the March 2020 Disposition in the first quarter of 2020, which included a $4.8 million gain on the compression assets sold, as well as a $0.6 million increase in gains recognized on the sale of transportation and shop equipment in the three months ended March 31, 2020 as compared to the three months ended March 31, 2019.
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Benefit from Income Taxes
563
Effective tax rate
(14)
35
The increase in benefit from income taxes was primarily due to the tax effect of the decrease in book income during the three months ended March 31, 2020 compared to the three months ended March 31, 2019, partially offset by a reduction in a valuation allowance and the release of an unrecognized tax benefit due to the settlement of a tax audit recorded during the three months ended March 31, 2019. See Note 16 (“Income Taxes”) to our Financial Statements for further details of the tax impact on the decrease in book income.
Liquidity and Capital Resources
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 the 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. In the first quarter of 2020 and continuing through the date of this filing, the COVID-19 pandemic has caused a deterioration in global macroeconomic conditions, which has significantly impacted our estimates of future revenues and cash flows. However, we have no near-term maturities and do not expect borrowing availability under the Credit Facility to be significantly restricted by any of our covenants. We 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 securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
Capital 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:
The majority of our growth capital expenditures are related to the acquisition cost of new compressors that we add to our fleet. In addition to the cost of newly-acquired compressors, growth capital expenditures can also 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 latter 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 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 applications for which the compression package was designed.
We generally invest funds necessary to purchase fleet additions when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new equipment expenditure is expected to generate economic returns over its expected useful life that exceed our cost of capital. In response to the impact that we anticipate the COVID-19 pandemic will have on our customer demand, we have decreased our planned capital expenditures for 2020, and currently plan to spend a total of approximately $140 million to $170 million, primarily consisting of approximately $70 million to $90 million for growth capital expenditures and approximately $47 million to $53 million for maintenance capital expenditures.
Financial Resources
Revolving Credit Facility
During the three months ended March 31, 2020 and 2019, the Credit Facility had an average daily balance of $508.4 million and $808.8 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 3.4% and 4.3% at March 31, 2020 and December 31, 2019, respectively. As of March 31, 2020, there were $13.7 million letters of credit outstanding under the Credit Facility. We must maintain certain consolidated financial ratios as defined in our Credit Facility agreement. As a result of these ratio requirements, $651.4 million of the $755.3 million of undrawn capacity was available for additional borrowings as of March 31, 2020. As of March 31, 2020, we were in compliance with all covenants under the Credit Facility.
On April 1, 2020, the 2022 Notes were redeemed at 100% of their $350.0 million aggregate principal amount plus accrued and unpaid interest of $10.5 million with borrowings from the Credit Facility. A debt extinguishment loss of approximately $4.0 million related to the redemption will be recognized in the second quarter of 2020. See Note 24 (“Subsequent Events”) to our Financial Statements for further details.
Cash Flows
Our cash flows from operating, investing and financing activities, as reflected in our condensed consolidated statements of cash flows, are summarized below (in thousands):
Net cash provided by (used in):
Operating activities
Investing activities
Financing activities
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Operating Activities
The increase in net cash provided by operating activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to the increase in revenue from our contract operations business, the decrease in costs of sales of our aftermarket services business, an increase in accounts payable and other liabilities and a decrease in accounts receivable. These cash inflows were partially offset by the receipt of cash proceeds in the first quarter of 2019 pursuant to a settlement of certain sales and use tax audits and an increase in interest paid on our debt instruments in the first quarter of 2020 as compared to the first quarter of 2019.
Investing Activities
The decrease in net cash used in investing activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to a $60.8 million decrease in capital expenditures and the receipt of proceeds of $24.2 million from the March 2020 Disposition in the first quarter of 2020, partially offset by an $8.6 million decrease in proceeds from other sales of property, plant and equipment.
Financing Activities
The change in net cash provided by (used in) financing activities during the three months ended March 31, 2020 compared to the three months ended March 31, 2019 was primarily due to $32.0 million of net repayments of long-term debt in 2020 compared to $61.0 million of net borrowings in 2019 and a $4.9 million increase in dividends paid to stockholders, partially offset by a $6.9 million decrease in payments for debt issuance costs.
Dividends
On April 24, 2020, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock to be paid on May 18, 2020 to stockholders of record at the close of business on May 11, 2020. 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.
Off-Balance Sheet Arrangements
For information on our obligations with respect to letters of credit and performance bonds see Note 10 (“Long-Term Debt”) and Note 21 (“Commitments and Contingencies”), respectively, to our Financial Statements.
For quantitative and qualitative disclosures about market risk, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk” of our 2019 Form 10-K. Our exposures as of March 31, 2020 have not changed materially since December 31, 2019.
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 Quarterly Report 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 March 31, 2020 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
There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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The following risk factors became significant to us in the first quarter of 2020 and should be read in conjunction with the risk factors previously disclosed in our 2019 Form 10-K.
The COVID-19 pandemic is expected to significantly reduce demand for our services, and may have a material adverse impact on our financial condition, results of operations and cash flows.
The effects of the COVID-19 pandemic, including actions taken by businesses and governments, have resulted in a significant and swift reduction in U.S. economic activity. These effects have materially adversely affected the demand for oil and, to a lesser extent, natural gas, and are expected to have a negative impact on demand for our services and products. The collapse in the demand for oil caused by this unprecedented global health and economic crisis, coupled with oil oversupply, is expected to adversely impact the demand for our services, which in turn could adversely impact our financial condition, results of operations and cash flows.
While the magnitude and duration of potential social, economic and labor instability as a direct result of the COVID-19 pandemic cannot be estimated at this time, we are closely monitoring the effects of the pandemic on commodity demands and on our customers, as well as on our operations and employees. These effects may include adverse revenue and net income effects; disruptions to our operations and supply chain; customer shutdowns of oil and gas exploration and production; employee impacts from illness, school closures and other community response measures; and temporary inaccessibility or closures of our facilities or the facilities of our customers and suppliers.
The extent to which our operating and financial results are affected by the COVID-19 pandemic will depend on various factors and consequences beyond our control, such as the duration and scope of the pandemic; additional actions by businesses and governments in response to the pandemic; and the speed and effectiveness of responses to combat the virus. The COVID-19 pandemic, and the volatile regional and global economic conditions stemming from the pandemic, could also aggravate the other risk factors that we identify in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. The COVID-19 pandemic also may materially adversely affect our operating and financial results in a manner that is not currently known to us or that we do not currently consider to present significant risks to our operations.
Our ability to use NOLs to offset future income may be limited.
Our ability to use any NOLs generated by us could be substantially limited if we were to experience an “ownership change” as defined under Section 382 of the Code. In general, an “ownership change” would occur if our “5-percent stockholders,” as defined under Section 382 of the Code, including certain groups of persons treated as “5-percent stockholders,” collectively increased their ownership in us by more than 50 percentage points over a rolling three-year period. An ownership change can occur as a result of a public offering of our common stock, as well as through secondary market purchases of our common stock and certain types of reorganization transactions. We have experienced ownership changes, which may result in an annual limitation on the use of its pre-ownership change NOLs (and certain other losses and/or credits) equal to the equity value of our stock immediately before the ownership change, multiplied by the long-term tax-exempt rate for the month in which the ownership change occurs. Market volatility due to reduced demand from the COVID-19 pandemic and oil oversupply may cause increased interest in our common stock, which may result in an additional ownership change. Due to the COVID-19 pandemic, the U.S. Federal Reserve has lowered the long-term tax-exempt rate. Additionally, our equity value has decreased due to the above-mentioned impacts of the COVID-19 pandemic and oil oversupply. Both of these changes could further limit our use of pre-ownership change NOLs if we experienced an additional ownership change. Furthermore, the IRS has recently proposed regulations that would prevent us from using unrealized built-in gains to increase this limitation. If these regulations were finalized and we experienced an ownership change our ability to use our NOLs may be limited. Such a limitation could, for any given year, have the effect of increasing the amount of our U.S. federal income tax liability, which would negatively impact the amount of after-tax cash available for distribution to our stockholders and our financial condition.
The following table summarizes our repurchases of equity securities during the three months ended March 31, 2020:
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
Repurchased (1)
Share
or Programs
January 1, 2020 — January 31, 2020
90,594
8.82
N/A
February 1, 2020 — February 29, 2020
March 1, 2020 — March 31, 2020
None.
Not applicable.
Exhibit No.
Description
2.1
Asset Purchase Agreement, dated as of June 23, 2019, by and among Archrock Services, L.P., Archrock, Inc. and Elite Compression Services, LLC, incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed on June 24, 2019
2.2
Asset Purchase Agreement, dated as of June 23, 2019, by and between Archrock Services, L.P. and Harvest Four Corners, LLC, incorporated by reference to Exhibit 2.2 of the Registrant’s Current Report on Form 8-K filed on June 24, 2019
3.1
Composite Certificate of Incorporation of Archrock, Inc. (as amended as of November 3, 2015), incorporated by reference to Exhibit 3.3 to the Registrant’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 the Registrant’s Current Report on Form 8-K filed on March 20, 2013
4.1
Indenture, dated as of March 21, 2019, by and among Archrock Partners, L.P., Archrock Partners Finance Corp., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee, incorporated by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed on March 21, 2019
4.2
Indenture, dated as of December 20, 2019, by and among Archrock Partners, L.P., Archrock Partners Finance Corp., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee, incorporated by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed on December 20, 2019
10.1
Separation Agreement, dated effective as of January 31, 2020 between Archrock, Inc. and Sean K. Clawges, incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8 K filed on February 11, 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 pursuant to Rule 405 of Regulation S-T
104.1*
Cover page interactive data files pursuant to Rule 406 of Regulation S-T
* Filed herewith.
** Furnished, not filed.
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)
May 5, 2020