ARCHROCK, INC. 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
Recent Business Developments 2022 Notes Redemption
On
COVID-19 Pandemic
During the six months ended
The key driver of our business is the production of
Substantial spending cuts for 2020 have been announced by our customers as a
result of the significant declines in oil and natural gas prices and demand;
however, the timing of the full impact of the spending cuts on production
remains difficult to predict, as do 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 annual
operating, corporate and capital costs by between
The impact of the COVID-19 pandemic on our 2020 results is primarily visible in
the
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Operating Highlights
The following table summarizes our available and operating horsepower and utilization (in thousands, except percentages):
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Total available horsepower (at period end)(1) 4,203 4,096 4,203 4,096
Total operating horsepower (at period end)(2) 3,613 3,611 3,613 3,611
Average operating horsepower 3,752 3,587 3,826 3,567
Horsepower utilization:
Spot (at period end) 86 % 88 % 86 % 88 %
Average 86 % 88 % 87 % 88 %
(1) Defined as idle and operating horsepower. New compressors completed by a
third party manufacturer that have been delivered to us are included in the
fleet.
(2) Defined as horsepower that is operating under contract and horsepower that is
idle but under contract and generating revenue such as standby revenue.
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, debt extinguishment loss, 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):
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Net income (loss) $ (30,381) $ 11,423 $ (91,568) $ 30,879
Selling, general and administrative 28,745 28,618 59,371 57,607
Depreciation and amortization 48,849 45,482 98,671 89,588
Long-lived asset impairment 55,210 8,632 61,405 11,724
Goodwill impairment - - 99,830 -
Restatement and other charges - 24 - 445
Restructuring charges 2,408 - 4,136 -
Interest expense 25,778 25,954 55,443 49,571
Debt extinguishment loss 3,971 3,653 3,971 3,653
Transaction-related costs - 2,687 - 2,867
(Gain) loss on sale of assets, net 2,189 (1,801) (1,927) (1,785)
Other income, net (438) (209) (993) (430)
Provision for (benefit from) income taxes (8,091) 1,191 (24,044) (1,216)
Loss from discontinued operations, net of tax - - - 273
Gross margin $ 128,240 $ 125,654 $ 264,295 $ 243,176 Financial Results of Operations
Summary of Results
Revenue. Revenue was
The decrease in revenue during the six months ended
See "Contract Operations" and "Aftermarket Services" below for further details.
Net income (loss). We had a net loss of
The change from net income to net loss during the three months ended
The change from net income to net loss during the six months ended
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Three Months Ended
Contract Operations
(dollars in thousands)
Three Months Ended
June 30, Increase
2020 2019 (Decrease)
Revenue $ 187,949 $ 186,258 1 %
Cost of sales (excluding depreciation and
amortization expense) 63,390 70,521 (10) %
Gross margin $ 124,559 $ 115,737 8 %
Gross margin percentage (1) 66 % 62 % 4 %
(1) Defined as gross margin divided by revenue.
During the three months ended
Gross margin and gross margin percentage increased during the three months ended
Aftermarket Services
(dollars in thousands)
Three Months Ended
June 30, Increase
2020 2019 (Decrease)
Revenue $ 32,367 $ 52,132 (38) %
Cost of sales (excluding depreciation and
amortization expense) 28,686 42,215 (32) %
Gross margin $ 3,681 $ 9,917 (63) %
Gross margin percentage 11 % 19 % (8) %
The decrease in revenue during the three months ended
Gross margin and gross margin percentage decreased during the three months ended
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Costs and Expenses
(dollars in thousands)
Three Months Ended
June 30,
2020 2019
Selling, general and administrative
48,849 45,482
Long-lived asset impairment 55,210 8,632
Restatement and other charges - 24
Restructuring charges 2,408 -
Interest expense 25,778 25,954
Debt extinguishment loss 3,971 3,653
Transaction-related costs - 2,687
(Gain) loss on sale of assets, net 2,189 (1,801) Other income, net
(438) (209)
Selling, general and administrative. SG&A was flat during the three months ended
Depreciation and amortization. The increase in depreciation and amortization
expense during the three months ended
Long-lived asset impairment. During the three months ended
The following table presents the results of our impairment review, as recorded to our contract operations segment (dollars in thousands):
Three Months Ended
June 30,
2020 2019
Idle compressors retired from the active fleet 450 160
Horsepower of idle compressors retired from the active fleet
184,000 41,000
Impairment recorded on idle compressors retired from the
active fleet $ 55,210 $ 8,632 Restructuring charges. We recorded
Interest expense. The slight decrease in interest expense during the three
months ended
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Debt extinguishment loss. We recorded a debt extinguishment loss of
Transaction-related costs. We incurred
(Gain) loss on sale of assets, net. The change in gain (loss) on sale of assets,
net was primarily due to a
Provision for (Benefit from) Income Taxes
(dollars in thousands)
Three Months Ended
June 30, Increase
2020 2019 (Decrease)
Provision for (benefit from) income taxes
21 % 9 % 12 %
The change in provision for (benefit from) income taxes was primarily due to the
tax effect of the decrease in book income during the three months ended
Six Months EndedJune 30, 2020 Compared to Six Months EndedJune 30, 2019 Contract Operations (dollars in thousands) Six Months Ended June 30, Increase 2020 2019 (Decrease) Revenue$ 394,923 $ 368,765 7 % Cost of sales (excluding depreciation and amortization) 142,041 145,256 (2) % Gross margin$ 252,882 $ 223,509 13 % Gross margin percentage 64 % 61 % 3 %
During the six months ended
Gross margin and gross margin percentage increased during the six months ended
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Aftermarket Services
(dollars in thousands)
Six Months Ended
June 30, Increase
2020 2019 (Decrease)
Revenue $ 75,090 $ 105,784 (29) %
Cost of sales (excluding depreciation and amortization) 63,677 86,117 (26) %
Gross margin $ 11,413 $ 19,667 (42) %
Gross margin percentage 15 % 19 % (4) %
The decrease in revenue during the six months ended
Gross margin and gross margin percentage decreased during the six months ended
Costs and Expenses
(dollars in thousands)
Six Months Ended
June 30,
2020 2019
Selling, general and administrative $ 59,371 $ 57,607
Depreciation and amortization 98,671 89,588
Long-lived asset impairment 61,405 11,724
Goodwill impairment 99,830 -
Restatement and other charges - 445
Restructuring charges 4,136 -
Interest expense 55,443 49,571
Debt extinguishment loss 3,971 3,653
Transaction-related costs - 2,867
Gain on sale of assets, net (1,927) (1,785)
Other income, net (993) (430)
Selling, general and administrative. The increase in SG&A during the six months
ended
Depreciation and amortization. The increase in depreciation and amortization
expense during the six months ended
Long-lived asset impairment. During the six months ended
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The following table presents the results of our impairment review, as recorded to our contract operations segment (dollars in thousands):
Six Months Ended
June 30,
2020 2019
Idle compressor units retired from the active fleet 535 180
Horsepower of idle compressor units retired from the active fleet
207,000 56,000
Impairment recorded on idle compressor units retired from
the active fleet $ 61,405 $ 11,724
Restructuring charges. We recorded
Interest expense. The increase in interest expense during the six months ended
Debt extinguishment loss. We recorded a debt extinguishment loss of
Transaction-related costs. We incurred
Gain on sale of assets, net. The increase in gain on sale of assets, net was
primarily due to a
Other income, net. The increase in other income, net during the six months ended
Benefit from Income Taxes
(dollars in thousands)
Six Months Ended
June 30, Increase
2020 2019 (Decrease)
Benefit from income taxes
21 % (4) % 25 %
The increase in benefit from income taxes was primarily due to the tax effect of
the decrease in book income during the six months ended
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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 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. Beginning in the first quarter of 2020, 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 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:
growth capital expenditures, which are made to expand or to replace partially
? or fully depreciated assets or to expand the operating capacity or
revenue-generating capabilities of existing or new assets; and
maintenance capital expenditures, which are made to maintain the existing
? operating capacity of our assets and related cash flows, further extending the
useful lives of the assets.
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 decreased our planned capital expenditures for 2020, and
currently plan to spend a total of approximately
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Financial Resources
Credit Facility
During the six months ended
We must maintain certain consolidated financial ratios as defined in our Credit
Facility agreement. As of
2022 Notes Redemption
On
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):
Six Months Ended
June 30,
2020 2019
Net cash provided by (used in):
Operating activities $ 167,074 $ 148,663
Investing activities (82,688) (212,342)
Financing activities (85,866) 60,084
Net decrease in cash and cash equivalents
Operating Activities
The increase in net cash provided by operating activities during the six months
ended
Investing Activities
The decrease in net cash used in investing activities during the six months
ended
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Financing Activities
The change in net cash provided by (used in) financing activities during the six
months ended
Dividends
On
Off-Balance Sheet Arrangements
For information on our obligations with respect to letters of credit and performance bonds see Note 9 ("Long-Term Debt") and Note 20 ("Commitments and Contingencies"), respectively, to our Financial Statements.
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