Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Financial Statements, the notes thereto, and the other financial information appearing elsewhere in this 2021 Form 10-K. The following discussion includes forward-looking statements that involve certain risks and uncertainties. See “Forward-Looking Statements” and Part I Item 1A “Risk Factors” in this 2021 Form 10-K.
This section primarily discusses 2021 and 2020 items and comparisons between these years. For a discussion of changes from 2019 to 2020 and other financial information related to 2019, refer to Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2020 filed with the SEC on February 23, 2021.
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., in terms of total compression fleet horsepower, and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. Our business supports a must-run service that is essential to the production, processing, transportation and storage of natural gas. The natural gas that we help transport satisfies demand from electricity generation, heating and cooking and the industrial and manufacturing sectors. Our geographic diversity, technically experienced personnel and large fleet of natural gas compression equipment enable us to provide reliable contract operations services to our customers.
We operate in two business segments:
Significant 2021 Transactions
July 2021 Dispositions
In July 2021, we completed sales of certain contract operations customer service agreements and approximately 575 compressors, comprising approximately 100,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We received cash consideration of $60.3 million for the sales and recorded gains on the sales of $13.0 million during the year ended December 31, 2021. The proceeds received from the sales were used to repay borrowings outstanding under our Credit Facility. See Note 4 (“Business Transactions”) to our Financial Statements for further details of these transactions.
February 2021 Disposition
In February 2021, we completed the sale of certain contract operations customer service agreements and approximately 300 compressors, comprising approximately 40,000 horsepower, used to provide compression services under those agreements as well as other assets used to support the operations. We recorded a gain on the sale of $6.0 million during the year ended December 31, 2021. See Note 4 (“Business Transactions”) to our Financial Statements for further details of this transaction.
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Amendment No. 3 to our Credit Facility
In February 2021, we amended our Credit Facility to, among other things, reduce the aggregate revolving commitment from $1.25 billion to $750.0 million and adjust the maximum Senior Secured Debt to EBITDA and Total Debt to EBITDA ratios. We incurred $1.8 million in transaction costs and wrote off $4.9 million of unamortized deferred financing costs as a result of Amendment No. 3. See Note 14 (“Long-Term Debt”) to our Financial Statements for further details of this amendment.
At-the-Market Continuous Equity Offering Program
In February 2021, we entered into an ATM Agreement whereby we may sell, from time to time, shares of our common stock for an aggregate offering price of up to $50.0 million. We use the proceeds of these offerings for general corporate purposes. During the year ended December 31, 2021, we sold 357,148 shares of common stock for net proceeds of $3.4 million pursuant to this agreement. See Note 16 (“Equity”) to our Financial Statements for further details of this agreement.
Trends and Outlook
The key driver of our business is the production of U.S. natural gas and crude oil. Approximately 77% of our operating fleet is deployed for midstream natural gas gathering applications, with the remaining fleet being used in gas lift applications to enhance crude oil production. Changes in natural gas and crude oil production spending therefore typically result in changes in demand for our services.
Spending on natural gas and crude oil exploration and production typically declines when there is a significant and prolonged reduction in natural gas and crude oil prices or significant instability in energy markets, and increases during periods of rising prices and market stability. As our business is so closely aligned with production and is typically less directly impacted by commodity prices, we are not exposed to the volatility often faced in shorter-cycle oil field service businesses.
COVID-19 Pandemic
Beginning in the first quarter of 2020, the COVID-19 pandemic caused a deterioration in global macroeconomic conditions, including a collapse in the demand for natural gas and crude oil coupled with an oversupply of crude oil, which led to substantial spending cuts by our customers and a decline in natural gas and crude oil production. This global response to the pandemic adversely impacted our revenue and cash flows. Though demand and commodity prices have shown improvement since the lows reached in the second quarter of 2020, the potential for additional surges and variants of the disease remains and as such, uncertainty still exists around the timing and potential for a full economic recovery.
Our customers substantially cut spending and activity beginning in the second quarter of 2020 as a result of the significant declines in natural gas and crude oil prices and demand and consequently, our horsepower, utilization and revenue experienced declines and remained at lower levels in 2021, as compared to early 2020 and periods prior, in both our contract operations and aftermarket services businesses. In addition to the decline in revenue, the impact of the COVID-19 pandemic on our results is primarily visible in the $99.8 million non-cash impairment of goodwill and the impairment’s resulting $22.7 million tax benefit in the first quarter of 2020. Cost of sales, SG&A, long-lived and other asset impairment and restructuring charges have also been significantly impacted. See “Financial Results of Operations” below and Note 9 (“Goodwill”), Note 18 (“Long-Lived and Other Asset Impairment”), Note 19 (“Restructuring Charges”) and Note 20 (“Income Taxes”) to our Financial Statements for further discussion.
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Current Trends
In 2019, increased global demand for U.S. natural gas and crude oil production contributed to increased production for both resources and record U.S. natural gas production. Production fell sharply, however, in the second quarter of 2020 as a result of the global response to the COVID-19 pandemic, and remained at depressed levels until the latter half of 2021, at which point production rose relatively consistently through the remainder of the year. According to the EIA’s February 2022 Short-Term Energy Outlook, average U.S. dry natural gas and crude oil production in 2021, 2020 and 2019 were as follows:
Year Ended December 31,
Average dry natural gas production (Bcf/d) 93.6 91.3 92.0
Average crude oil production (MMb/d) 11.2 11.3 12.2
The increases in production in 2019 resulted in strong demand for our compression services in that year and into the first quarter of 2020. Additionally, we increased our investment in new fleet units in 2019 to take advantage of improved market conditions. As a result of this increased demand and investment, our contract operations revenue and average operating horsepower increased 15% and 10%, respectively, in 2019. In 2020, however, the decrease in demand and production brought on by the COVID-19 pandemic drove revenue and average operating horsepower to below 2019 levels, where they remained through all of 2021, as producers limited drilling and completion activity to achieve maintenance levels of production and cash flows in the course of the pandemic.
Similar decreases in demand as a result of the pandemic were seen in our aftermarket services business, where we experienced a rise in customer deferrals of maintenance activities throughout 2020 and the beginning of 2021, before demand picked up in the second quarter of 2021 and continued to improve through the remainder of the year.
Outlook
The EIA forecasts the following year-over-year changes in its February 2022 Short-Term Energy Outlook:
Increase (Decrease)
U.S. dry natural gas production 3 % 2 %
U.S. crude oil production 7 % 5 %
U.S. natural gas domestic consumption 2 % (1) %
Liquefied natural gas exports 16 % 7 %
Overall, natural gas and crude oil production is expected to increase in 2022 and 2023, returning to pre-COVID-19 levels in 2023, as U.S. onshore activity continues the rise it began in mid-2021. Accordingly, we anticipate demand for our compression services to also increase as we move into 2022.
Longer term, per the EIA’s 2021 Annual Energy Outlook, the EIA expects dry natural gas production to increase 12%, 17% and 33% through 2025, 2030 and 2050, respectively. Natural gas provides an affordable and reliable solution that we believe will play a prominent role in a cleaner energy mix, even as energy generation from renewables increases. We believe that the U.S. natural gas compression services industry continues to have growth potential over time due to, among other things, increased natural gas production in the U.S. from unconventional sources, aging producing natural gas fields that will require more compression to continue producing the same volume of natural gas and expected increased demand for natural gas in the U.S. for power generation, industrial uses and exports, including liquefied natural gas exports and exports of natural gas via pipeline to Mexico. We expect that such an increase in demand for U.S. natural gas will in turn lead to continued strong demand for compression services.
Regarding our aftermarket services business, the base of owned compression in the U.S. has increased over the past several years, which we believe will help sustain our aftermarket services business over the long term.
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Key Challenges and Uncertainties
In addition to general market conditions in the oil and gas industry – those caused by the COVID-19 pandemic and otherwise – and competition in the natural gas compression industry, we believe the following represent the key challenges and uncertainties we will face in the future.
Capital Requirements and the Availability of External Sources of Capital. We have funded a significant portion of our capital expenditures and acquisitions through borrowings under the Credit Facility and have issued a substantial amount of debt, which could limit our ability to fund future planned capital expenditures. Current conditions could limit our ability to access the debt and equity markets to raise capital on affordable terms in 2022 and beyond. If we are not successful in raising capital within the time period required or at all, we may not be able to fund these capital expenditures, which could impair our ability to grow or maintain our business.
Cost Management.In anticipation of lower customer activity levels in response to the COVID-19 pandemic, we implemented a plan in the second quarter of 2020 to significantly reduce our annual operating, corporate and capital costs, many aspects of which we continued to execute on throughout 2021 and expect to continue in the foreseeable future. In addition, in order to improve our operations and further reduce operating expenses, we are investing significant resources into a process and technology transformation project that has, among other things, replaced our existing ERP, supply chain and inventory management systems and expanded the remote monitoring capabilities of our compression fleet. Cost management continues to be challenging, however, and there is no guarantee that our efforts will result in a reduction in our operating expenses. Natural gas production growth and resulting demand for our services, once resumed in full, could cause us to experience increased operating expenses as we hire employees and incur additional expenses needed to support the rebound in market demand.
Further, we depend on suppliers for the materials, parts, equipment and lube oil necessary to our operations, which exposes us to volatility in prices. Significant price increases for these inputs could adversely affect our operating profits. Supply chain bottlenecks resulting from the COVID-19 pandemic could also adversely affect our ability to obtain, or increase the cost of, such items. While we generally attempt to mitigate the impact of increased prices through strategic purchasing decisions, diversification of our supplier base, where possible, and the passing along of increased costs to customers, there may be a time delay between the increased commodity prices and the ability to increase the price of our services.
Labor. We believe that our ability to hire, train and retain qualified personnel will continue to be important. Although we have been able to historically satisfy our personnel needs, retaining employees in our industry continues to be a challenge. Our ability to grow and to continue our current level of service to our customers will depend in part on our success in hiring, training and retaining our employees, including those employees impacted by our headcount reduction and furloughs through the course of the COVID-19 pandemic. Further, the cost of labor has increased and may continue to increase in the future with increases in demand, which will require us to incur additional costs.
Later-Cycle Market Participant. Compression service providers have traditionally been a later-cycle participant as energy markets fluctuate. As such, we anticipate that any significant change in the demand for our contract operations services will generally lag a change in drilling activity. Increased natural gas and crude oil production in 2018 and 2019 contributed to increased new orders for our compression services during those years and into the first quarter of 2020, the revenue gains from which were realized in 2019 and the first quarter of 2020. In the second quarter of 2020, however, customer demand dropped sharply in response to the COVID-19 pandemic, and the associated decrease in our revenue occurred almost immediately.
Dry natural gas production, one of the key drivers of our business, increased 10% in 2019, decreased 1% in 2020, increased 3% in 2021, and is expected to increase 12% in 2022 through 2025. We believe that, similar to the rapid drops in customer demand and associated revenue experienced in 2020, our revenue will increase closely behind the pickup in customer demand as the COVID-19 pandemic runs its course. Long term, we expect to return to the more traditional cycle in which production growth increases demand for compression services, which results in increases in revenue and gross margin, though on a lag of several quarters or more.
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Customer deferrals. Our aftermarket services revenue decreased in 2020 and 2019 as customers deferred near-term maintenance activities. We saw a decrease in these deferrals beginning in the second quarter of 2021, and we believe the large installed base of owned compression in the U.S. supports the long-term fundamentals of the aftermarket services business, however, the timing of a full recovery is difficult to predict, particularly in light of the economic downturn caused by the COVID-19 pandemic. In the meantime, we remain focused on cost management and the higher margin business within our aftermarket services operations.
Increasing customer focus on free cash flow. Prior to the COVID-19 pandemic, many of our customers had begun transitioning their business model to focus on sustainable free cash flow generation rather than growth, and the COVID-19 pandemic has further fueled this change in focus. We expect this transition to have a positive impact on the industry in the long term, as we anticipate the change will reduce volatility through cycles and improve the financial strength of our customers. In the near term, however, we can expect this transition, combined with the impact of the COVID-19 pandemic, to result in a modest natural gas production growth rate, to which demand for our products and services is closely aligned.
Demand for natural gas-powered compression. Demand for our services is dependent on the demand for natural gas in the markets we serve. Although the EIA currently forecasts natural gas demand will grow through 2050, technological advances and accelerated adoption of renewable sources of energy could reduce demand for natural gas in our markets and have an adverse effect on our business. In addition, increased focus of our customers on reducing emissions from, or the use of, combustion engines in compression could increase demand for electric motor-driven compressors or require us to make modifications to our existing natural gas-powered units.
Operating Highlights
Year Ended December 31,
Total available horsepower (at period end)(1) 3,878 4,120 4,395
Total operating horsepower (at period end)(2) 3,247 3,388 3,926
Horsepower utilization:
Spot (at period end) 84 % 82 % 89 %
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.
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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, debt extinguishment loss, transaction-related costs, (gain) loss on sale of assets, net, other (income) expense, 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.
The following table reconciles net income (loss) to gross margin:
Year Ended December 31,
Goodwill impairment — 99,830 —
Restatement and other charges — — 445
Restructuring charges 2,903 8,450 —
Debt extinguishment loss — 3,971 3,653
Transaction-related costs — — 8,213
Loss from discontinued operations, net of tax — — 273
Results of Operations: Summary of Results
Revenue
Revenue was $781.5 million and $875.0 million during the years ended December 31, 2021 and 2020, respectively. The decrease in revenue was due to declines in revenue from both our contract operations and aftermarket services businesses. See “Contract Operations” and “Aftermarket Services” below for further details.
Net Income (Loss)
We had net income of $28.2 million and a net loss of $68.4 million during the years ended December 31, 2021 and 2020, respectively. The change from net loss in 2020 to net income in 2021 was primarily driven by decreases in goodwill impairment, long-lived and other asset impairment, depreciation and amortization, restructuring charges and debt extinguishment loss, as well as increases in gain on sale of assets, net and other income, net. These changes were partially offset by decreases in gross margin of our contract operations and aftermarket services businesses and the change from a benefit from to a provision for income taxes.
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Results of Operations: Year Ended December 31, 2021 Compared to Year Ended December 31, 2020
Contract Operations
Year Ended December 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Gross margin percentage (1) 62 % 65 % (3) %
(1) Defined as gross margin divided by revenue.
Revenue decreased primarily due to returns of horsepower amidst the market downturn that began in early 2020, as well as the strategic disposition of horsepower in 2020 and 2021.
Gross margin decreased due to the decrease in revenue, however, the decline was partially mitigated by the decrease in cost of sales. The lower operating horsepower discussed above drove a decrease in maintenance, freight and other operating expenses. Offsetting these decreases were (i) increases in start-up and other operating expense, which resulted from an increase in unit redeployment as customers returned to operations from standby status, and lube oil expense, which was primarily due to an increase in commodity price and increased volumes associated with unit redeployment, and (ii) a decrease in our sales and use tax benefit, which resulted from audit settlements in 2020 and no comparable settlements in 2021.
Aftermarket Services
Year Ended December 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Gross margin percentage 14 % 15 % (1) %
Revenue decreased by $5.2 million due to the sale of our turbocharger business in July 2020, and was further reduced by a decrease in service activities, which was primarily driven by customer deferral of maintenance activities amidst the market downturn. These decreases were partially offset by an increase in parts sales that resulted from an increase in customer demand in the second half of 2021.
Gross margin decreased due to the decrease in revenue, however, the decline was partially mitigated by the decrease in cost of sales. The decrease in cost of sales was driven by the decrease in service activities and the sale of our turbocharger business. These decreases to costs of sales were partially offset by the increase in parts sales.
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Costs and Expenses
Year Ended December 31,
Long-lived and other asset impairment 21,397 79,556
Goodwill impairment — 99,830
Restructuring charges 2,903 8,450
Debt extinguishment loss — 3,971
Gain on sale of assets, net (30,258) (10,643)
Selling, general and administrative. The increase in SG&A was primarily due to a $4.1 million increase in sales and use tax that was mainly driven by audit settlements in 2020 and no comparable settlements in 2021, a $1.3 million increase in information technology expenses, which largely consisted of costs related to our process and technology transformation project, and a $0.8 million increase in professional expenses. These increases were partially offset by a $3.6 million decrease in our provision for credit losses and a $1.4 million decrease in compensation and benefits.
Depreciation and amortization. The decrease in depreciation and amortization was primarily due to a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives, the impact of compression and other asset impairments and sales and a decrease in amortization expense as certain intangible assets reached the end of their useful lives. These decreases were partially offset by increases in depreciation expense associated with fixed asset additions and the write-off of compression and building assets damaged by Hurricane Ida in 2021.
Long-lived and other asset impairment. We periodically review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. In addition, we evaluate for impairment idle units that have been culled from our compression fleet in prior years and are available for sale. See Note 18 (“Long-Lived and Other Asset Impairment”) to our Financial Statements for further details. The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment:
Year Ended December 31,
Idle compressors retired from the active fleet 230 730
Also during the year ended December 31, 2020, we impaired $1.7 million of capitalized implementation and unamortized prepaid costs related to the mobile workforce component of our process and technology transformation project. See Note 12 (“Hosting Arrangements”) to our Financial Statements for further details.
Goodwill impairment. During the year ended December 31, 2020, we recorded goodwill impairment of $99.8 million due to the decline in the fair value of our contract operations reporting unit. See Note 9 (“Goodwill”) to our Financial Statements for further details.
Restructuring charges. Restructuring charges of $2.9 million and $8.5 million during the years ended December 31, 2021 and 2020, respectively, primarily consisted of severance and property disposal costs related to our restructuring activities. See Note 19 (“Restructuring Charges”) to our Financial Statements for further details.
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Interest expense. The increase in interest expense was primarily due to an increase in the weighted average effective interest rate and the $4.9 million write-off of unamortized deferred financing costs related to Amendment No. 3, which were largely offset by a decrease in the average outstanding balance of long-term debt.
Debt extinguishment loss. We recorded a debt extinguishment loss of $4.0 million during the year ended December 31, 2020 as a result of the redemption of the 2022 Notes. See Note 14 (“Long-Term Debt”) to our Financial Statements for further details.
Gain on sale of assets, net. Our net gain on the sale of assets during the year ended December 31, 2021 was primarily the result of $13.0 million of gains recognized on the July 2021 Dispositions, the $6.0 million gain on the February 2021 Disposition, $9.3 million of gains recognized on other compression asset sales during 2021 and $3.3 million of gains recognized on other transportation and shop asset sales during the period.
Our net gain on the sale of assets during the year ended December 31, 2020 was primarily due to the $9.3 million gain on the July 2020 Disposition, the $3.2 million gain on the March 2020 Disposition and gains of $3.7 million on sales of other transportation and shop equipment. These gains were offset by a $5.1 million loss on other compression assets sold during 2020.
Other income, net. The increase in other income, net was primarily due to an insurance settlement of $2.8 million related to damages caused by Hurricane Ida to facilities and compressors, as well as a $0.4 million decrease in indemnification expense remitted pursuant to our tax matters agreement with Exterran Corporation.
Provision for (Benefit from) Income Taxes
Year Ended December 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Provision for (benefit from) income taxes $ 10,744 $ (17,537) (161) %
Effective tax rate 28 % 20 % 8 %
The change from a benefit from to a provision for income taxes was primarily due to the tax effect of the increase in book income during the year ended December 31, 2021 compared to the year ended December 31, 2020. See Note 20 (“Income Taxes”) to our Financial Statements for further details.
Liquidity and Capital Resources
Overview
Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets. Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under our Credit Facility. Our cash flow is affected by numerous factors including prices and demand for our services, oil and natural gas exploration and production spending, conditions in the financial markets and other factors. Beginning in the first quarter of 2020, the COVID-19 pandemic caused a deterioration in global macroeconomic conditions, which adversely impacted our estimates of future revenues and cash flows. However, we have no near-term maturities and believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our future liquidity needs.
We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity 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.
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Cash Requirements
Our contract operations business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of compression equipment required for us to provide those contract operations services to our customers. Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:
• growth capital expenditures;
• maintenance capital expenditures;
• interest on our outstanding debt obligations; and
• dividend payments to our stockholders.
Capital Expenditures
Growth Capital Expenditures. The majority of our growth capital expenditures are related to the acquisition cost of new compressors when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new compressor is expected to generate economic returns that exceed our cost of capital over the compressor’s expected useful life. In addition to newly-acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures. These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.
Growth capital expenditures were $37.2 million and $79.1 million during the years ended December 31, 2021 and 2020, respectively. The decrease in growth capital expenditures from 2020 to 2021 was the result of a previously-planned decrease in spending in 2020, which was based on an expected deceleration in the growth rate of natural gas production, and further reductions in spend in response to the decreased customer demand that resulted from the COVID-19 pandemic.
Maintenance Capital Expenditures. Maintenance capital expenditures are related to major overhauls of significant components of a compression package, such as the engine, compressor and cooler, which return the components to a like-new condition, but do not modify the application for which the compression package was designed.
Maintenance capital expenditures were $47.3 million and $32.0 million during the years ended December 31, 2021 and 2020, respectively. The increase in maintenance capital expenditures from 2020 to 2021 was the result of an increase in scheduled maintenance activities due to maintenance cycle requirements as well as additional make-ready investment as we return idle equipment to work to meet customer demand.
Projected Capital Expenditures. We currently plan to spend approximately $213 million to $235 million in capital expenditures during 2022, primarily consisting of approximately $150 million for growth capital expenditures and approximately $55 million to $75 million for maintenance capital expenditures. We anticipate increased 2022 capital expenditures, particularly growth capital expenditures, as compared to 2021 due to increased investment in new compression equipment as a result of higher customer demand.
Dividends
On January 27, 2022, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock, or approximately $22.6 million, which was paid on February 15, 2022 to stockholders of record at the close of business on February 8, 2022. Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.
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Contractual Obligations
Our material contractual obligations as of December 31, 2021 consisted of the following:
In addition, we had $19.6 million of unrecognized tax benefits (including discontinued operations) recorded as liabilities related to uncertain tax positions at December 31, 2021, which we are uncertain as to if or when such amounts may be settled. We had a liability of $2.2 million recorded for potential penalties and interest (including discontinued operations) related to these unrecognized tax benefits.
Sources of Cash
Revolving Credit Facility
During the years ended December 31, 2021 and 2020, our Credit Facility had an average daily balance of $295.3 million and $704.5 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 2.6% and 2.7% at December 31, 2021 and 2020, respectively. As of December 31, 2021, there were $8.9 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%. We executed two amendments to our facility during the three-year period ended December 31, 2021; see Note 14 (“Long-Term Debt”) to our Financial Statements for details of these amendments.
Certain Facility Terms. Our Credit Facility matures in November 2024 and has an aggregate revolving commitment of $750.0 million. Portions of the Credit Facility up to $50.0 million are available for the issuance of swing line loans and $50.0 million is available for the issuance of letters of credit. Subject to certain conditions, including approval by the lenders, we are able to increase the aggregate commitments under the Credit Facility by up to an additional $250.0 million. The Credit Facility borrowing base consists of eligible accounts receivable, inventory and compressors.
Covenants. Our Credit Facility agreement requires that we meet certain financial ratios (see Note 14 (“Long-Term Debt”) to our Financial Statements) and contains various additional covenants including, but not limited to, mandatory prepayments from the net cash proceeds of certain asset transfers, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay distributions. As a result of the financial ratio requirements, $502.5 million of the $506.6 million of undrawn capacity was available for additional borrowings as of December 31, 2021. We were in compliance with all other covenants under our Credit Facility agreement.
Senior Notes
As of both December 31, 2021 and 2020, we had a principal balance of $1.3 billion of outstanding senior notes that consisted of the following:
• $800.0 million of 6.25% senior notes due in April 2028 and
See Note 14 (“Long-Term Debt”) to our Financial Statements for further details of these notes.
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At-the-Market Continuous Equity Offering Program
Under our ATM Agreement, we may sell, from time to time, shares of our common stock having an aggregate offering price of up to $50.0 million. The agreement terminates upon the earlier of (i) the sale of all shares of common stock subject to the agreement or (ii) the termination of the agreement by us or by each of the sales agents. Any sales agent may also terminate the agreement but only with respect to itself. We use the net proceeds of these offerings for general corporate purposes. During the year ended December 31, 2021, we sold 357,148 shares of common stock for net proceeds of $3.4 million pursuant to the ATM Agreement. See Note 16 (“Equity”) to our Financial Statements for further details of this agreement.
Other Sources of Cash
Business Dispositions and Other Asset Sales. We received proceeds of $112.9 million and $52.6 million from business dispositions and other asset sales during the years ended December 31, 2021 and 2020, respectively. We typically use the proceeds from these sales to repay borrowings outstanding under our Credit Facility, however, we are not able to estimate the timing of asset sales nor the amount of proceeds to be received and as such, we do not rely on asset sale proceeds as a future source of capital.
Cash Flows
Our cash flows, as reflected in our consolidated statements of cash flows, are summarized below:
Year Ended December 31,
Net cash provided by (used in):
Net increase (decrease) in cash and cash equivalents $ 472 $ (2,588)
Operating Activities. The decrease in net cash provided by operating activities was primarily due to reduced cash inflows from revenue, deferred revenue, accounts receivable, contract costs and the receipt of cash proceeds from sales and use tax audit settlements in 2020 with no comparable settlements in 2021, as well as increased cash outflow for inventory. Partially offsetting these decreases in operating cash were decreased cash outflows for cost of sales, accounts payable and other liabilities, SG&A expenses and restructuring charges, and the receipt of additional cash proceeds from the July 2020 Disposition in 2021.
Investing Activities. The change from net cash used in to net cash provided by investing activities was primarily due to a $60.3 million increase in proceeds from business dispositions and other sales of property, plant and equipment and a $42.4 million decrease in capital expenditures.
Financing Activities. Net cash used in financing activities was relatively unchanged primarily due to several offsetting items, including an increase of $3.1 million in net repayments of long-term debt, which was offset by $3.4 million of net proceeds from the issuance of common stock under our ATM Agreement during 2021 and a $2.8 million decrease in payments for debt issuance costs.
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Critical Accounting Estimates
We describe our significant accounting policies more fully in Note 2 (“Basis of Presentation and Significant Accounting Policies”) to our Financial Statements. As disclosed in Note 2, the preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures of contingent assets and liabilities. We evaluate our estimates and accounting policies on an ongoing basis and base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. The results of this process form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and these differences can be material to our financial condition, results of operations and cash flows.
Depreciation
Property, plant and equipment, net at December 31, 2021 was $2.2 billion and depreciation expense was $167.6 million for the year ended December 31, 2021. Property, plant and equipment are carried at cost and depreciated using the straight-line basis over the estimated useful life of the asset.
Our estimate of useful lives and salvage values are based on assumptions and judgments that reflect both historical experience and expectations regarding future use of our assets, including wear and tear, obsolescence, technical standards, market demand and geographic location. The use of different assumptions and judgments in the calculation of depreciation, especially those involving useful lives, would likely result in significantly different net book values and results of operations.
The estimated useful life of an asset is monitored to determine its appropriateness, especially when business circumstances change. For example, changes in technology, excessive wear and tear, or unanticipated government actions may result in a shorter estimated useful life than originally anticipated. In these cases, we would depreciate the remaining net book value over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis. Likewise, if the estimated useful life is increased, the adjustment to the useful life would decrease depreciation expense per year on a prospective basis.
Impairment of Assets
During the year ended December 31, 2021, we recorded long-lived and other asset impairment of $21.4 million.
Impairment Assessments of Property, Plant and Equipment and Identifiable Intangible Assets
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. An impairment loss may exist when the estimated undiscounted cash flows expected from the use of the asset and its eventual disposition are less than its carrying amount. Determining whether the carrying amount of an asset is recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the asset subject to review. These forecasts are uncertain as they require significant assumptions about future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and specific times, it is not possible to reasonably quantify the impact of changes in these assumptions.
Compression Fleet. The fair value of a compressor 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. See Note 18 (“Long-Lived and Other Asset Impairment”) and Note 23 (“Fair Value Measurements”) to our Financial Statements for further details of our fleet asset impairments.
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Impairment Assessment of Goodwill
In the first quarter of 2020, the global response to the COVID-19 pandemic significantly impacted our market capitalization and estimates of future revenues and cash flows, which triggered the need to perform a quantitative test of the fair value of our contract operations reporting unit. The fair value calculation required us to make significant estimates to determine future cash flows, including future revenues, costs and capital requirements and the appropriate risk-adjusted discount rate by which to discount the estimated future cash flows. See Note 2 (“Basis of Presentation and Significant Accounting Policies”) and Note 9 (“Goodwill”) for further details of the assessment performed on our goodwill in 2020.
Income Taxes
Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We operate in the U.S. only and, as a result, are subject to income taxes in the U.S. only. Significant judgments and estimates are required in determining consolidated income tax expense.
Deferred income taxes arise from temporary differences between the financial statements and the tax basis of assets and liabilities. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and changes in accounting policies and incorporate assumptions, including the amount of future U.S. federal and state pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative income (loss) before income taxes.
Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on our financial position, results of operations or cash flows. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various state and local jurisdictions.
The accounting standard for income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. We adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the liabilities. Such differences are reflected as increases or decreases to income tax expense in the period in which the new information becomes available.
Recent Accounting Developments
See Note 3 (“Recent Accounting Developments”) to our Financial Statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk associated with changes in the variable interest rate of our Credit Facility. We use derivative instruments to manage our exposure to fluctuations in this variable interest rate, however, our interest rate swaps mature in the first quarter of 2022, at which time all borrowings under the Credit Facility will be subject to variable interest rates.
After taking into consideration our interest rate swaps, we did not have any debt subject to variable interest rates as of December 31, 2021. Not considering our interest rate swaps, a 1% increase in the effective interest rate on the outstanding balance under our Credit Facility at December 31, 2021 would have resulted in an annual increase in our interest expense of $2.3 million.
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See Note 22 (“Derivatives”) to our Financial Statements for further information regarding our interest rate swaps.
Item 8. Financial Statements and Supplementary Data
The information specified by this Item is presented in Part IV Item 15 of this 2021 Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this 2021 Form 10-K, 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 December 31, 2021, 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.
Management’s Annual Report on Internal Control Over Financial Reporting
As required by Exchange Act Rules 13a-15(c) and 15d-15(c), our management, including the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on the results of management’s evaluation described above, management concluded that our internal control over financial reporting was effective as of December 31, 2021.
The effectiveness of internal control over financial reporting as of December 31, 2021 was audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in its report found within this 2021 Form 10-K.
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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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Archrock, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Archrock, Inc. and subsidiaries (the “Company”) as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2021, of the Company and our report dated February 23, 2022, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
Houston, Texas
February 23, 2022
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Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required in Part III Item 10 of this 2021 Form 10-K is incorporated by reference to the sections entitled “Election of Directors,” “Governance” and “Stock Ownership” in our definitive proxy statement to be filed with the SEC within 120 days of the end of our fiscal year.
Item 11. Executive Compensation
The information required in Part III Item 11 of this 2021 Form 10-K is incorporated by reference to the sections entitled “Governance” and “Compensation Discussion and Analysis” in our definitive proxy statement to be filed with the SEC within 120 days of the end of our fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Portions of the information required in Part III Item 12 of this 2021 Form 10-K are incorporated by reference to the section entitled “Stock Ownership” in our definitive proxy statement to be filed with the SEC within 120 days of the end of our fiscal year.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information as of December 31, 2021, with respect to the Archrock compensation plans under which our common stock is authorized for issuance, aggregated as follows:
Number of Securities
to be Issued Upon Weighted Average Number of Securities
Exercise of Exercise Price of Remaining Available for
Outstanding Options, Outstanding Options, Future Issuance Under
Warrants and Rights Warrants and Rights Equity Compensation Plans
(a) (b) (c)
(3) Performance-based restricted stock units do not have an exercise price.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required in Part III Item 13 of this 2021 Form 10-K is incorporated by reference to the section entitled “Governance” in our definitive proxy statement to be filed with the SEC within 120 days of the end of our fiscal year.
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Item 14. Principal Accountant Fees and Services
The information required in Part III Item 14 of this 2021 Form 10-K is incorporated by reference to the section entitled “Ratification of the Appointment of the Independent Registered Public Accounting Firm” in our definitive proxy statement to be filed with the SEC within 120 days of the end of our fiscal year.
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Documents filed as a part of this 2021 Form 10-K
1. Financial Statements.The following financial statements are filed as a part of this 2021 Form 10-K.
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Comprehensive Income F-5
Consolidated Statements of Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
2.Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or the information is set forth in the consolidated financial statements or notes thereto within Item 8 “Financial Statements and Supplementary Data.”
3. Exhibits
Exhibit No. Description
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Exhibit No. Description
4.3 Description of Common Stock
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Exhibit No. Description
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Exhibit No. Description
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Exhibit No. Description
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Exhibit No. Description
10.73† Form of Second Amendment to Severance Benefit Agreement
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Exhibit No. Description
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Exhibit No. Description
10.99† Form of Letter Agreement
10.100† Form of Archrock, Inc. Award Notice and Agreement for Restricted Stock
21.1* List of Subsidiaries of Archrock, Inc.
23.1* Consent of Deloitte & Touche LLP
101.1* Interactive data files pursuant to Rule 405 of Regulation S-T
† Management contract or compensatory plan or arrangement.
* Filed herewith.
** Furnished, not filed.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Archrock, Inc.
/s/ D. Bradley Childers
D. Bradley Childers
President and Chief Executive Officer
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POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints D. Bradley Childers, Douglas S. Aron, Donna A. Henderson and Stephanie C. Hildebrandt, and each of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done as fully to all said attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 23, 2022.
Signature Title
/s/ D. Bradley Childers President, Chief Executive Officer and Director
D. Bradley Childers (Principal Executive Officer)
/s/ Douglas S. Aron Senior Vice President and Chief Financial Officer
Douglas S. Aron (Principal Financial Officer)
/s/ Donna A. Henderson Vice President and Chief Accounting Officer
Donna A. Henderson (Principal Accounting Officer)
/s/ Anne-Marie N. Ainsworth Director
Anne-Marie N. Ainsworth
/s/ Gordon T. Hall Director
Gordon T. Hall
/s/ Frances Powell Hawes Director
Frances Powell Hawes
/s/ J.W.G. Honeybourne Director
J.W.G. Honeybourne
/s/ James H. Lytal Director
James H. Lytal
/s/ Leonard W. Mallett Director
Leonard W. Mallett
/s/ Jason C. Rebrook Director
Jason C. Rebrook
/s/ Edmund P. Segner, III Director
Edmund P. Segner, III
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Archrock, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Archrock, Inc. and subsidiaries (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, equity, and cash flows, for each of the three years in the period ended December 31, 2021, and the related notes listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2022 expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Long-Lived Asset Impairment- Refer to Note 18 to the financial statements.
Critical Audit Matter Description
Management’s evaluation of whether to retire compressor units from its active fleet takes into consideration the future deployment of the units that were not of the type, configuration, condition, make, or model that are cost efficient to maintain or operate. Once a compressor unit is retired from the active fleet, it is tested for impairment. As such, the timing of the identification of compressor units for removal could have a significant impact on the amount of any impairment charge. During the year ended December 31, 2021, the Company retired 230 units from the active fleet resulting in an
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asset impairment charge of $21.2 million. The determination of impairment requires management to make significant estimates and assumptions related to the timing of the identification of compressor units for removal. Changes in these assumptions could have a significant impact on the amount of impairment charged.
Auditing the decisions on when compressor units are retired from the active fleet required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s assumptions.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s determination of whether to retire compressor unit from the Company’s active fleet included the following, among others:
/s/ DELOITTE & TOUCHE LLP
Houston, Texas
February 23, 2022
We have served as the Company’s auditor since 2007.
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Archrock, Inc.
Consolidated Balance Sheets
(in thousands, except par value and share amounts)
December 31,
Assets
Current assets:
Cash and cash equivalents $ 1,569 $ 1,097
Noncurrent assets associated with discontinued operations 9,811 11,036
Liabilities and Equity
Current liabilities:
Deferred tax liabilities 1,136 725
Noncurrent liabilities associated with discontinued operations 7,868 7,868
Commitments and contingencies (Note 26)
Equity:
Accumulated other comprehensive loss (984) (5,006)
The accompanying notes are an integral part of these consolidated financial statements.
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Archrock, Inc.
Consolidated Statements of Operations
(in thousands, except per share amounts)
Year Ended December 31,
Revenue:
Cost of sales (excluding depreciation and amortization):
Goodwill impairment — 99,830 —
Restatement and other charges — — 445
Restructuring charges 2,903 8,450 —
Debt extinguishment loss — 3,971 3,653
Transaction-related costs — — 8,213
Loss from discontinued operations, net of tax — — (273)
Weighted average common shares outstanding:
The accompanying notes are an integral part of these consolidated financial statements.
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Archrock, Inc.
Consolidated Statements of Comprehensive Income
(in thousands)
Year Ended December 31,
Other comprehensive income (loss), net of tax:
Amortization of dedesignated interest rate swap 863 — —
Total other comprehensive income (loss), net of tax 4,022 (3,619) (7,160)
The accompanying notes are an integral part of these consolidated financial statements.
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Archrock, Inc.
Consolidated Statements of Equity
(in thousands, except share data)
Archrock Stockholders
Accumulated
Common Additional Other Treasury
Stock Paid-in Comprehensive Accumulated Stock
Amount Shares Capital Income (Loss) Deficit Amount Shares Total
Comprehensive income
Comprehensive loss
Comprehensive income
The accompanying notes are an integral part of these consolidated financial statements.
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Archrock, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
Cash flows from operating activities:
Loss from discontinued operations, net of tax — — 273
Goodwill impairment — 99,830 —
Amortization of operating lease ROU assets 3,880 3,477 2,931
Amortization of debt discount — 187 910
Amortization of debt premium (2,006) (84) —
Amortization of dedesignated interest rate swap 863 — —
Debt extinguishment loss — 3,971 3,653
Non-cash restructuring charges — 1,660 —
Gain on sale of business (18,945) (12,475) —
Change in assets and liabilities, net of acquisition:
Net cash used in discontinued operations — — (269)
Cash flows from investing activities:
Proceeds from sale of business 83,345 33,651 —
Proceeds from insurance and other settlements 1,085 2,709 3,696
Cash paid in Elite Acquisition — — (214,019)
Cash flows from financing activities:
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Net proceeds from issuance of common stock 3,401 — —
Proceeds from stock issued under ESPP 713 683 771
Contribution from Exterran Corporation — 678 —
Net increase (decrease) in cash and cash equivalents 472 (2,588) (1,925)
Cash and cash equivalents, beginning of period 1,097 3,685 5,610
Cash and cash equivalents, end of period $ 1,569 $ 1,097 $ 3,685
Supplemental disclosure of cash flow information:
Income taxes refunded (paid), net (247) (94) 1,973
Non-cash consideration received in July 2020 Disposition — 5,762 —
The accompanying notes are an integral part of these consolidated financial statements.
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ARCHROCK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
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.
2. Basis of Presentation and Significant Accounting Policies
Basis of Presentation
Our Financial Statements include Archrock and its subsidiaries, all of which are wholly owned. All intercompany accounts and transactions have been eliminated in consolidation.
Our Financial Statements are prepared in accordance with GAAP and the rules and regulations of the SEC.The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Because of the inherent uncertainties in this process, actual future results could differ from those expected as of the reporting date. Management believes that the estimates and assumptions used are reasonable.
Significant Accounting Policies
Cash and Cash Equivalents
We consider all highly-liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Revenue Recognition
We recognize revenue when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we are entitled to receive in exchange for those goods or services. Sales and usage-based taxes that are collected from the customer are excluded from revenue.
Contract Operations
Natural gas compression services. Natural gas compression services are generally satisfied over time, as the customer simultaneously receives and consumes the benefits provided by these services. Our performance obligation is a series in which the unit of service is one month, as the customer receives substantially the same benefit each month from the services regardless of the type of service activity performed, which may vary. If the transaction price is based on a fixed fee, revenue is recognized monthly on a straight-line basis over the period that we are providing services to the customer. Amounts invoiced to customers for costs associated with moving our compression assets to a customer site are also included in the transaction price and are amortized over the initial contract term. We do 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.
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Variable consideration exists if customers are billed at a lesser standby rate when a unit is not running. We recognize revenue for such variable consideration monthly, as the invoice corresponds directly to the value transferred to the customer based on our performance completed to date. The rate for standby service is lower to reflect the decrease in costs and effort required to provide standby service when a unit is not running.
Billable Maintenance Service. We perform billable maintenance service on our natural gas compression equipment at the customer’s request on an as-needed basis. The performance obligation is satisfied and revenue is recognized at the agreed-upon transaction price at the point in time when service is complete and the customer has accepted the work performed and can obtain the remaining benefits of the service that the unit will provide.
Aftermarket Services
OTC Parts and Components Sales. For sales of OTC parts and components, the performance obligation is generally satisfied at the point in time when delivery takes place and the customer obtains control of the part or component. The transaction price is the fixed sales price for the part stated in the contract. Revenue is recognized upon delivery, as we have a present right to payment and the customer has legal title.
Maintenance, Overhaul and Reconfiguration Services. For our service activities, the performance obligation is satisfied over time, as the work performed enhances the customer-controlled asset and another entity would not have to substantially re-perform the work we completed if they were to fulfill the remaining performance obligation. The transaction price may be a fixed monthly service fee, a fixed quoted fee or entirely variable, calculated on a time and materials basis.
For service provided based on a fixed monthly fee, the performance obligation is a series in which the unit of service is one month. The customer receives substantially the same benefit each month from the service, regardless of the type of service activity performed, which may vary. As the progress towards satisfaction of the performance obligation is measured based on the passage of time, revenue is recognized monthly based on the fixed fee provided for in the contract.
For service provided based on a quoted fixed fee, progress towards satisfaction of the performance obligation is measured using an input method based on the actual amount of labor and material costs incurred. The amount of the transaction price recognized as revenue each reporting period is determined by multiplying the transaction price by the ratio of actual costs incurred to date to total estimated costs expected for the service. Significant judgment is involved in the estimation of the progress to completion. Any adjustments to the measure of the progress to completion is accounted for on a prospective basis. Changes to the scope of service is recognized as an adjustment to the transaction price in the period in which the change occurs.
Service provided based on time and materials is generally short-term in nature and labor rates and parts pricing is agreed upon prior to commencing the service. We apply an estimated gross margin percentage, which is fixed based on historical time and materials-based service, to actual costs incurred. We evaluate the estimated gross margin percentage at the end of each reporting period and adjust the transaction price as appropriate.
Contract Assets and Liabilities
We recognize a contract asset when we have the right to consideration in exchange for goods or services transferred to a customer when the right is conditioned on something other than the passage of time. We recognize a contract liability when we have an obligation to transfer goods or services to a customer for which we have already received consideration.
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Concentrations of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist of cash and cash equivalents and trade accounts receivable. 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.
At both December 31, 2021 and 2020, Chevron U.S.A. Inc. and Williams Partners accounted for 14%and 10% of our trade accounts receivable balance, respectively. The following table summarizes the activity in our allowance for credit losses:
Year Ended December 31,
Impact of adoption of ASU 2016-13 on January 1, 2020 — (216) —
Provision for credit losses (90) 3,525 2,567
Write-offs charged against allowance (1,128) (2,149) (1,809)
Inventory
Inventory consists of parts used for maintenance of natural gas compression equipment. Inventory is stated at the lower of cost and net realizable value using the average cost method.
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Property, Plant and Equipment
Property, plant and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives as follows:
Compression equipment, facilities and other fleet assets 3 to 30 years
Buildings 20 to 35 years
Transportation and shop equipment 3 to 10 years
Computer hardware and software 3 to 5 years
Other 3 to 10 years
Major improvements that extend the useful life of an asset are capitalized and depreciated over the estimated useful life of the major improvement, up to seven years. Repairs and maintenance are expensed as incurred.
Long-Lived Assets
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. An impairment loss exists when estimated undiscounted cash flows expected from the use of the asset and its eventual disposition are less than its carrying amount. Impairment losses are recognized in the period in which the impairment occurs and represent the excess of the asset carrying value over its fair value. Identifiable intangibles are amortized over the estimated useful life of the asset.
Leases
We determine if an arrangement is a lease at inception and 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.
Our facility leases, of which we are the lessee, contain lease and nonlease components, 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 service agreements in which we are a lessor, the services nonlease component is predominant over the compression package lease component and therefore recognition of these agreements follows the Accounting Standards Codification Topic 606 Revenue from Contracts with Customers guidance.
Goodwill