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 2020 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 DevelopmentsFebruary 2021 Disposition
On
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 has adversely impacted our revenue and cash flows. Though demand has shown modest improvement since the lows reached in the second quarter of 2020 as economies have reopened and vaccine rollout is underway globally, the potential for additional surges and variants of the disease remains and as such, uncertainty still exists around the timing and magnitude of a full economic recovery.
The key driver of our business is the production of
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. Our horsepower, utilization and revenue have experienced
declines and are expected to remain at lower levels into 2021 as compared to the
first quarter of 2020 and periods prior in both our contract operations and
aftermarket services businesses. However,
26
Table of Contents
The impact of the COVID-19 pandemic on our results is primarily visible in the
Operating Highlights
Three Months Ended
March 31,
(in thousands) 2021 2020
Total available horsepower (at period end)(1) 4,067 4,386
Total operating horsepower (at period end)(2) 3,329 3,883
Average operating horsepower 3,360 3,914
Horsepower utilization:
Spot (at period end) 82 % 89 %
Average 82 % 89 %
(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, restructuring charges, interest expense, (gain) loss on sale of assets, net, other (income) loss, net and provision for (benefit from) income taxes. Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue. Additionally, because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue and SG&A is necessary to support our operations and required corporate activities. To compensate for these limitations, management uses this non-GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.
27
Table of Contents
The following table reconciles net income (loss) to gross margin:
Three Months Ended
March 31,
(in thousands) 2021 2020
Net income (loss) $ 4,169 $ (61,187)
Selling, general and administrative 25,084 30,626
Depreciation and amortization 45,712 49,822
Long-lived and other asset impairment 7,073 6,195
Goodwill impairment - 99,830
Restructuring charges 897 1,728
Interest expense 31,245 29,665
Gain on sale of assets, net (11,032) (4,116)
Other income, net (1,889) (555)Provision for (benefit from) income taxes 7,024 (15,953) Gross margin
$ 108,283 $ 136,055
Financial Results of Operations: Summary of Results
Revenue
Revenue was
Net income (loss)
We had net income of
Financial Results of Operations: Three Months Ended
Contract Operations
Three Months Ended
March 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Revenue $ 166,034 $ 206,974 (20) %
Cost of sales (excluding depreciation
and amortization) 61,365 78,651 (22) %
Gross margin $ 104,669 $ 128,323 (18) %
Gross margin percentage (1) 63 % 62 % 1 %
(1) Defined as gross margin divided by revenue.
Revenue decreased primarily due to returns of horsepower and a decrease in contract operations rates amidst the market downturn, as well as the strategic disposition of horsepower in 2020.
28
Table of Contents
Gross margin also decreased due to this decrease in revenue, however, the decline was partially mitigated through aggressive cost control actions and the corresponding, and larger, decrease in cost of sales. Cost of sales benefited from the lower operating horsepower discussed above, which resulted in decreased maintenance, lube oil and mobilization expense. In addition, execution of the cost savings plan implemented in response to the COVID-19 pandemic drove a further reduction in operating costs.
Aftermarket Services
Three Months Ended
March 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Revenue $ 29,397 $ 42,723 (31) %
Cost of sales (excluding depreciation
and amortization) 25,783 34,991 (26) %
Gross margin $ 3,614 $ 7,732 (53) %
Gross margin percentage 12 % 18 % (6) %
Revenue decreased due to decreases in service activities and parts sales, which
were primarily driven by reduced customer demand and customer deferral of
maintenance activities amidst the market downturn, reduced customer activity
levels as a result of severe winter weather in the first quarter of 2021 and the
impact of the sale of our turbocharger business in
Gross margin also decreased due to this decrease in revenue, but benefited from a decrease in cost of sales, which was driven by the same decreases in service activities and parts sales discussed above. The decrease in gross margin percentage was largely due to pricing pressure as a result of the market decline.
Costs and Expenses
Three Months Ended
March 31,
(in thousands) 2021 2020
Selling, general and administrative
45,712 49,822
Long-lived and other asset impairment 7,073 6,195
Goodwill impairment - 99,830
Restructuring charges 897 1,728
Interest expense 31,245 29,665
Gain on sale of assets, net (11,032) (4,116)
Other income, net (1,889) (555)
Selling, general and administrative. The decrease in SG&A was primarily due to a
Depreciation and amortization. The decrease in depreciation and amortization expense was primarily due to a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives as well as the impact of compression asset impairments and sales during 2020, partially offset by an increase in depreciation expense associated with fixed asset additions during 2020.
29
Table of Contents
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 13 ("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:
Three Months Ended
March 31,
(dollars in thousands) 2021 2020
Idle compressors retired from the active fleet 70 85
Horsepower of idle compressors retired from the
active fleet 24,000 23,000
Impairment recorded on idle compressors retired
from the active fleet $ 7,012 $ 6,195
Restructuring charges. We recorded
Interest expense. The increase in interest expense was primarily due to the
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 was primarily due to a
Provision for (Benefit from) Income Taxes
Three Months Ended
March 31, Increase
(dollars in thousands) 2021 2020 (Decrease)
Provision for (benefit from) income taxes
63 % 21 % 42 %
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 three months ended
30
Table of Contents
Liquidity and Capital Resources
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 primarily consisted 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 when our idle equipment cannot be reconfigured to economically fulfill a project's requirements and the new compressor is expected to generate economic returns over its expected useful life that exceed our cost of capital. In addition to newly-acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures. These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.
Maintenance capital expenditures are related to major overhauls or significant components of a compression package such as the engine, compressor and cooler, which return the components to a like-new condition but do not modify the application for which the compression package was designed.
Projected Capital Spend
We currently plan to spend approximately
Financial 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 has 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.
31
Table of Contents
Credit Facility
During the three months ended
We must maintain certain consolidated financial ratios as defined in our Credit
Facility agreement (see below). As of
Amendment No. 3. On
? reduce the aggregate revolving commitment from
and
? adjust the maximum Senior Secured Debt to EBITDA and Total Debt to EBITDA
ratios, as defined in the Credit Facility agreement, to the following:
Senior Secured Debt to EBITDA 3.00 to 1.0 Total Debt to EBITDA Through fiscal year 2022 5.75 to 1.0
5.25 to 1.0
(1) Subject to a temporary increase to 5.50 to 1.0 for any quarter during which
an acquisition satisfying certain thresholds is completed and for the two
quarters immediately following such quarter.
See Note 9 ("Long-Term Debt") to our Financial Statements for further details on Amendment No. 3.
At-the-Market Continuous Equity Offering Program
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:
Three Months Ended
March 31,
(in thousands) 2021 2020
Net cash provided by (used in):
Operating activities $ 77,555 $ 99,129
Investing activities 16,518 (44,141)
Financing activities (93,237) (55,452)
Net increase (decrease) in cash and cash equivalents
32
Table of Contents
Operating Activities
The decrease in net cash provided by operating activities was primarily due to reduced cash inflows from revenue, deferred revenue and accounts receivable as well as increased cash outflow for inventory, partially offset by decreased cash outflows for cost of sales, SG&A expenses, contract costs and interest paid on long-term debt.
Investing Activities
The change in net cash provided by (used in) investing activities was primarily
due to a
Financing Activities
The increase in net cash used in financing activities was primarily due to a
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.
© Edgar Online, source
