NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
We are a pure play U.S. natural gas contract operations services business and 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
primary business segments: contract operations and aftermarket services. In our contract operations business, we use our owned fleet of natural gas compression equipment to provide operations services to our customers. In our aftermarket services business, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.
The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with U.S. GAAP for interim financial information and the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP are not required in these interim financial statements and have been condensed or omitted. Management believes that the information furnished includes all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods indicated. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements presented in our
2017
Form 10-K, which contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year. Certain prior year amounts have been reclassified to conform to the current year presentation.
2. Recent Accounting Developments
Accounting Standards Updates Implemented
ASU 2018-05 was issued in March 2018 to clarify the income taxes disclosure requirements as they pertain to SAB 118, including the requirement to disclose a reasonable estimate, if determinable, of the tax effects of the TCJA in the reporting period in which the TCJA was enacted, as well as additional disclosures required in the following interim reporting periods if the measurement period approach is used. In accordance with ASU 2018-05, we disclosed a reasonable estimate of the income tax effects of the TCJA on our consolidated financial statements in our 2017 Form 10-K. We completed our analysis of the tax effects of the TCJA in the third quarter of 2018 with no material change to the amounts disclosed at December 31, 2017. See
Note 14
(“Income Taxes”)
for further details.
On January 1, 2018, we adopted ASU 2018-02 which allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJA. As a result of the TCJA’s corporate rate reduction, we had
$0.3 million
of stranded tax effects in accumulated other comprehensive income related to our derivative instruments and terminated interest rate swaps, which we elected to reclassify to accumulated deficit.
On January 1, 2018, we adopted ASU 2017-12 using the modified retrospective approach to existing cash flow hedge relationships as of January 1, 2018. ASU 2017-12 expands and refines hedge accounting for both financial and nonfinancial risk components, aligns the recognition and presentation of the effects of the hedging instrument and hedged item in the financial statements and eliminates the requirement to separately measure and report hedge ineffectiveness. As a result of the adoption of ASU 2017-12, we recognized a net gain of
$0.4 million
as a cumulative-effect adjustment to opening retained earnings and a corresponding adjustment to other comprehensive income (loss) to reverse the cumulative ineffectiveness previously recognized in interest expense.
On January 1, 2018, we adopted ASU 2016-15 on a retrospective basis. ASU 2016-15 addresses diversity in practice and simplifies several elements of cash flow classification including how certain cash receipts and cash payments are classified in the statement of cash flows. ASU 2016-15 did not have an impact on our condensed consolidated statement of cash flow for the
nine
months ended
September 30, 2017
.
Revenue Recognition Update
On January 1, 2018, we adopted the Revenue Recognition Update using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. We recognized the cumulative effect of initially applying the Revenue Recognition Update as an adjustment to the opening balance of retained earnings. For contracts that were modified before the effective date, we identified performance obligations on the basis of the current version of the contract, which included any contract modifications since inception. The application of the practical expedient for contract modifications did not have a material effect on the adjustment to retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
Under previous guidance, contract operations revenue was recognized when earned, which generally occurs monthly when the service is provided under our customer contracts. Under the Revenue Recognition Update the timing of revenue recognition is impacted by contractual provisions for service availability guarantees of our compressor assets and re-billable costs associated with moving our compressor assets to a customer site. These changes are further discussed below and did not result in a material difference from previous practice for contract operations.
The Revenue Recognition Update resulted in a significant change related to our aftermarket services operations, maintenance, overhaul and reconfiguration services. Under previous guidance, revenue was recognized on a completed contract basis as products were delivered and title was transferred or services were performed for the customer. Under the Revenue Recognition Update, these services are recognized as revenue over time, using output or input methods to measure the progress toward complete satisfaction of the performance obligation based on the nature of the goods or services being provided. The adoption did not result in a material difference in the amount or timing of revenues for aftermarket services parts and components sales.
The Revenue Recognition Update provides guidance on contract costs that should be recognized as assets and amortized over the period that the related goods or services transfer to the customer. Certain costs that were previously expensed as incurred, such as sales commissions and freight charges to transport compressor assets, are deferred and amortized.
The following table summarizes the cumulative impact of the adoption of the Revenue Recognition Update on the opening balance sheet (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
Adjustments Due to the Revenue Recognition Update
|
|
January 1, 2018
|
Assets
|
|
|
|
|
|
Accounts receivable, trade
|
$
|
113,416
|
|
|
$
|
7,883
|
|
|
$
|
121,299
|
|
Inventory
|
90,691
|
|
|
(6,917
|
)
|
|
83,774
|
|
Contract costs
|
—
|
|
|
21,524
|
|
|
21,524
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Accrued liabilities
|
$
|
71,116
|
|
|
$
|
209
|
|
|
$
|
71,325
|
|
Deferred revenue
|
4,858
|
|
|
3,188
|
|
|
8,046
|
|
Deferred income taxes
|
97,943
|
|
|
4,427
|
|
|
102,370
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
Accumulated deficit
|
$
|
(2,241,243
|
)
|
|
$
|
14,666
|
|
|
$
|
(2,226,577
|
)
|
The following tables summarize the impact of the application of the Revenue Recognition Update on our condensed consolidated balance sheet and condensed consolidated statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
Balance Sheet
|
As Reported
|
|
Balance Excluding the Impact of the Revenue Recognition Update
|
|
Effect of Change
|
Assets
|
|
|
|
|
|
Accounts receivable, trade
|
$
|
141,781
|
|
|
$
|
123,079
|
|
|
$
|
18,702
|
|
Inventory
|
77,497
|
|
|
94,528
|
|
|
(17,031
|
)
|
Contract costs
|
36,482
|
|
|
—
|
|
|
36,482
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Accounts payable, trade
|
$
|
70,950
|
|
|
$
|
70,875
|
|
|
$
|
75
|
|
Accrued liabilities
|
74,879
|
|
|
74,619
|
|
|
260
|
|
Deferred revenue
|
12,909
|
|
|
8,865
|
|
|
4,044
|
|
Deferred income taxes
|
2,845
|
|
|
2,570
|
|
|
275
|
|
Other long-term liabilities
|
19,612
|
|
|
19,595
|
|
|
17
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
Additional paid-in capital
(1)
|
$
|
3,154,058
|
|
|
$
|
3,144,217
|
|
|
$
|
9,841
|
|
Accumulated deficit
|
(2,259,489
|
)
|
|
(2,283,130
|
)
|
|
23,641
|
|
——————
|
|
(1)
|
Represents the impact of the Revenue Recognition Update on net income attributable to noncontrolling interest which was reclassed to additional paid-in capital pursuant to the Merger.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
|
Statement of Operations
|
As Reported
|
|
Balance Excluding the Impact of the Revenue Recognition Update
|
|
Effect of Change
|
Revenue:
|
|
|
|
|
|
Contract operations
|
$
|
169,509
|
|
|
$
|
170,981
|
|
|
$
|
(1,472
|
)
|
Aftermarket services
|
62,863
|
|
|
59,623
|
|
|
3,240
|
|
Total revenue
|
232,372
|
|
|
230,604
|
|
|
1,768
|
|
Cost of sales (excluding depreciation and amortization):
|
|
|
|
|
|
Contract operations
|
69,056
|
|
|
73,673
|
|
|
(4,617
|
)
|
Aftermarket services
|
50,043
|
|
|
47,973
|
|
|
2,070
|
|
Total cost of sales (excluding depreciation and amortization)
|
119,099
|
|
|
121,646
|
|
|
(2,547
|
)
|
Selling, general and administrative
|
26,298
|
|
|
26,924
|
|
|
(626
|
)
|
Provision for income taxes
|
3,126
|
|
|
2,617
|
|
|
509
|
|
Net income attributable to Archrock stockholders
|
9,974
|
|
|
5,542
|
|
|
4,432
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
|
Statement of Operations
|
As Reported
|
|
Balance Excluding the Impact of the Revenue Recognition Update
|
|
Effect of Change
|
Revenue:
|
|
|
|
|
|
Contract operations
|
$
|
496,156
|
|
|
$
|
500,306
|
|
|
$
|
(4,150
|
)
|
Aftermarket services
|
175,126
|
|
|
161,065
|
|
|
14,061
|
|
Total revenue
|
671,282
|
|
|
661,371
|
|
|
9,911
|
|
Cost of sales (excluding depreciation and amortization):
|
|
|
|
|
|
Contract operations
|
201,460
|
|
|
214,823
|
|
|
(13,363
|
)
|
Aftermarket services
|
143,173
|
|
|
132,984
|
|
|
10,189
|
|
Total cost of sales (excluding depreciation and amortization)
|
344,633
|
|
|
347,807
|
|
|
(3,174
|
)
|
Selling, general and administrative
|
80,455
|
|
|
82,051
|
|
|
(1,596
|
)
|
Provision for income taxes
|
1,913
|
|
|
(1,837
|
)
|
|
3,750
|
|
Less: Net income attributable to the noncontrolling interest
|
(8,097
|
)
|
|
(6,141
|
)
|
|
(1,956
|
)
|
Net income (loss) attributable to Archrock stockholders
|
8,095
|
|
|
(880
|
)
|
|
8,975
|
|
Accounting Standards Updates Not Yet Implemented
In August 2018, the FASB issued ASU 2018-15 which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). For public entities, ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-15 on our consolidated financial statements and footnote disclosures and anticipate adopting this guidance on a prospective basis in the fourth quarter of 2018.
In August 2018, the FASB issued ASU 2018-13 which amends the required fair value measurements disclosures related to valuation techniques and inputs used, uncertainty in measurement, and changes in measurements applied. These amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-13 on our consolidated financial statements and footnote disclosures.
In June 2016, the FASB issued ASU 2016-13 that changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans, and requires entities to use a new forward-looking expected loss model that will result in the earlier recognition of allowance for losses. For public entities that meet the definition of an SEC filer, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted. Entities will apply ASU 2016-13 provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We are currently evaluating the impact of ASU 2016-13 on our consolidated financial statements and footnote disclosures.
Leases
ASC Topic 842 Leases establishes a ROU model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Under the new guidance, lessor accounting is largely unchanged. ASC Topic 842 Leases is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach that involves recasting the comparative periods in the year of initial application is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain transition practical expedients available. In July 2018 the FASB provided an optional transition method that would allow adoption of the standard as of the effective date without restating prior periods. We intend to adopt ASC Topic 842 Leases on January 1, 2019 using the optional transition method and are currently assessing the transition practical expedients. Upon adoption, we will recognize the cumulative effect of adoption as an adjustment to the opening balance of our retained earnings. Comparative information will continue to be reported under the accounting standards in effect for those periods.
Additionally, the July 2018 amendment provided lessors with a practical expedient to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the Revenue Recognition Update and certain conditions are met. The amendment also provided clarification on whether ASC Topic 842 or the Revenue Recognition Update is applicable to the combined component based on determination of the predominant component. An entity that elects the lessor practical expedient also should provide certain disclosures. We are evaluating the impact of the July 2018 amendment on our contract operations services agreements and have tentatively concluded that the services nonlease component is predominant, which would result in the ongoing recognition following the Revenue Recognition Update guidance.
Our evaluation of the impact of adopting ASC Topic 842 Leases is ongoing. We have established a cross-functional implementation team to identify our lease population and are assessing changes to our internal control structure, business processes, systems and accounting policies that are necessary to implement the standard. We do not believe the standard will materially affect our consolidated statements of operations or cash flows. At September 30, 2018, adoption of ASC Topic 842 Leases would have resulted in recognition of a ROU asset of less than
$25 million
and a lease liability of a similar amount in our consolidated balance sheet. The amount of the ROU asset and the lease liability we ultimately recognize will depend on our lease portfolio as of the adoption date.
3. Revenue from Contracts with Customers
Revenue Recognition
Revenue is recognized 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.
The following table presents our revenue from contracts with customers disaggregated by revenue source (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
Nine Months Ended September 30, 2018
|
Contract Operations
(1)
:
|
|
|
|
|
0 - 1000 horsepower per unit
|
$
|
60,725
|
|
|
$
|
179,917
|
|
1,001 - 1,500 horsepower per unit
|
69,663
|
|
|
204,841
|
|
Over 1,500 horsepower per unit
|
38,053
|
|
|
108,367
|
|
Other
(2)
|
1,068
|
|
|
3,031
|
|
Total contract operations
(3)
|
169,509
|
|
|
496,156
|
|
|
|
|
|
Aftermarket Services
(1)
:
|
|
|
|
Services
|
38,863
|
|
|
107,776
|
|
OTC parts and components sales
|
24,000
|
|
|
67,350
|
|
Total aftermarket services
(4)
|
62,863
|
|
|
175,126
|
|
|
|
|
|
Total revenue
(5)
|
$
|
232,372
|
|
|
$
|
671,282
|
|
——————
|
|
(1)
|
We operate in
two
segments: contract operations and aftermarket services. See
Note 20
(“Segments”)
for further details regarding our segments.
|
|
|
(2)
|
Primarily relates to fees associated with Archrock-owned non-compressor equipment.
|
|
|
(3)
|
Includes
$1.6 million
and
$4.3 million
for the
three and nine
months ended
September 30, 2018
, respectively, related to billable maintenance on Archrock-owned units that was recognized at a point in time. All other revenue within contract operations is recognized over time.
|
|
|
(4)
|
All service revenue within aftermarket services is recognized over time. All OTC parts and components sales revenue is recognized at a point in time.
|
Contract Operations
We provide comprehensive contract operations services including the personnel, equipment, tools, materials and supplies to meet our customers’ natural gas compression needs. Based on the operating specifications at the customer location and each customer's unique needs, these services include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining equipment to provide natural gas compression services to our customers.
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 compressor assets to a customer site are also included in the transaction price and are amortized over the initial contract term.
Variable consideration exists if customers are billed at a lesser standby rate when a unit is not running. We have elected to apply the invoicing practical expedient to recognize revenue for such variable consideration, 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.
We also 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.
As of
September 30, 2018
, we had
$267.3 million
of remaining performance obligations related to our contract operations segment. We have elected to apply the practical expedient to not consider the effects of the time value of money, as the expected time between the transfer of services and payment for such services is less than one year. The remaining performance obligations will be recognized through 2022 as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2019
|
|
2020
|
|
2021
|
|
2022
|
|
Total
|
Contract operations remaining performance obligations
|
$
|
93,227
|
|
|
$
|
118,368
|
|
|
$
|
46,404
|
|
|
$
|
8,276
|
|
|
$
|
1,073
|
|
|
$
|
267,348
|
|
Aftermarket Services
We provide a full range of services to support the compression needs of customers. We sell OTC parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.
We sell OTC parts and components needed for the maintenance or repair of customer-owned compression equipment. 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.
Our aftermarket service activities include operations, maintenance, overhaul and reconfiguration services on customer-owned compression equipment on an as-needed basis or as part of a monthly maintenance schedule. The service activities 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 will be 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 are generally short-term in nature and labor rates and parts pricing is agreed upon prior to commencing the service. We have elected to use the right-to-invoice practical expedient using an estimated gross margin percentage applied to actual costs incurred. The estimated gross margin percentage is fixed based on historical time and materials-based service. We evaluate the estimated gross margin percentage at the end of each reporting period and adjust the transaction price as appropriate.
We believe these fee- and cost-based inputs fairly depict our efforts to provide aftermarket services and the amount of revenue recognized is representative of the transfer of service and value that the customer will have received as of the reporting date. As of
September 30, 2018
we have elected to apply the practical expedient to not disclose the aggregate transaction price for the remaining performance obligations for aftermarket services, as there are no contracts with customers with an original contract term that is greater than one year.
Contract Balances
Contract operations services are generally billed monthly at the beginning of the month in which service is being provided. For aftermarket services, billings will typically occur when parts are delivered or when service is complete; however, milestone billings may be used in longer-term projects. 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. Freight billings to transport compressor assets and milestone billings on aftermarket services often result in a contract liability.
As of
September 30,
and
January 1, 2018
, our receivables from contracts with customers, net of allowance for doubtful accounts were
$136.8 million
and
$115.6 million
, respectively. As of
September 30,
and
January 1, 2018
, our contract liabilities were
$13.3 million
and
$9.0 million
, respectively, which are included in deferred revenue and other long-term liabilities in our condensed consolidated balance sheets. The increase in the contract liability balance during the nine months ended September 30, 2018 was due to the deferral of
$21.8 million
primarily related to freight billings and aftermarket services, partially offset by
$17.4 million
recognized as revenue during the period primarily related to freight billings and aftermarket services.
4. Discontinued Operations
Spin-off of Exterran Corporation
In 2015 we completed the Spin-off. In order to effect the Spin-off and govern our relationship with Exterran Corporation after the Spin-off, we entered into several agreements with Exterran Corporation, which include but are not limited to the separation and distribution agreement, the tax matters agreement and the supply agreement. Certain terms of these agreements are described as follows:
|
|
•
|
The separation and distribution agreement specifies our right to promptly receive payments from a subsidiary of Exterran Corporation based on a notional amount corresponding to payments received by Exterran Corporation’s subsidiaries from PDVSA Gas, in respect of the sale of Exterran Corporation’s subsidiaries’ and joint ventures’ previously nationalized assets after such amounts are collected by Exterran Corporation’s subsidiaries. During the
nine
months ended
September 30, 2017
, we rece
ived
$19.7 million
from Exterran Corporation pursuant to this term of the separation and distribution agreement. Exterran Corporation was due to receive the remaining principal amount as of
September 30, 2018
of approximately
$20.9 million
. The separation and distribution agreement also specifies our right to receive a
$25.0 million
cash payment from a subsidiary of Exterran Corporation promptly following the occurrence of a qualified capital raise as defined in the Exterran Corporation credit agreement. Such a qualified capital raise occurred on April 4, 2017 and we received a cash payment of
$25.0 million
on April 11, 2017.
|
Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Exterran Corporation’s business with Exterran Corporation. Pursuant to the separation and distribution agreement, we and Exterran Corporation generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business.
|
|
•
|
The tax matters agreement governs the respective rights, responsibilities and obligations of Exterran Corporation and us with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and certain other matters regarding taxes. Subject to the provisions of this agreement Exterran Corporation and we agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. As of
September 30, 2018
, we classified
$6.4 million
of unrecognized tax benefits (including interest and penalties) as long-term liability associated with discontinued operations since it relates to operations of Exterran Corporation prior to the Spin-off. We have also recorded an offsetting
$6.4 million
indemnification asset related to this reserve as long-term assets associated with discontinued operations.
|
|
|
•
|
The supply agreement, which expired November 2017, set forth the terms under which Exterran Corporation provided manufactured equipment, including the design, engineering, manufacturing and sale of natural gas compression equipment, on an exclusive basis to us and the Partnership, subject to certain exceptions. For the
nine
months ended
September 30, 2017
, we purchased
$115.3 million
of newly-manufactured compression equipment from Exterran Corporation.
|
Other Discontinued Operations Activity
In December 2013, we abandoned our contract water treatment business as part of our continued emphasis on simplification and focus on our core businesses. The abandonment of this business meets the criteria established for recognition as discontinued operations under GAAP. Therefore certain deferred tax assets related to our contract water treatment business have been reported as discontinued operations in our condensed consolidated balance sheets. This business was previously included in our contract operations segment.
The following table summarizes the balance sheet data for discontinued operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
|
Exterran Corporation
|
|
Exterran Corporation
|
|
Contract Water Treatment Business
|
|
Total
|
Other current assets
|
$
|
300
|
|
|
$
|
300
|
|
|
$
|
—
|
|
|
$
|
300
|
|
Total current assets associated with discontinued operations
|
300
|
|
|
300
|
|
|
—
|
|
|
300
|
|
Other assets, net
|
6,421
|
|
|
6,421
|
|
|
—
|
|
|
6,421
|
|
Deferred income taxes
(1)
|
—
|
|
|
—
|
|
|
6,842
|
|
|
6,842
|
|
Total assets associated with discontinued operations
|
$
|
6,721
|
|
|
$
|
6,721
|
|
|
$
|
6,842
|
|
|
$
|
13,563
|
|
Other current liabilities
|
$
|
297
|
|
|
$
|
297
|
|
|
$
|
—
|
|
|
$
|
297
|
|
Total current liabilities associated with discontinued operations
|
297
|
|
|
297
|
|
|
—
|
|
|
297
|
|
Deferred income taxes
|
6,421
|
|
|
6,421
|
|
|
—
|
|
|
6,421
|
|
Total liabilities associated with discontinued operations
|
$
|
6,718
|
|
|
$
|
6,718
|
|
|
$
|
—
|
|
|
$
|
6,718
|
|
——————
|
|
(1)
|
Reduced by
$0.9 million
for current period tax amortization and
$5.9 million
for a valuation allowance recorded as a result of the Merger, whereby we assessed the available positive and negative evidence and concluded, based on the weight of the evidence, that a valuation allowance was required on our resulting net deferred tax asset position, with an offsetting increase to additional paid-in capital in our condensed consolidated balance sheet as of
September 30, 2018
. See
Note 17
(“Equity”)
for further details of the Merger.
|
5. Inventory
Inventory consisted of the following amounts (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Parts and supplies
|
$
|
65,393
|
|
|
$
|
72,528
|
|
Work in progress
|
12,104
|
|
|
18,163
|
|
Inventory
|
$
|
77,497
|
|
|
$
|
90,691
|
|
6. Property, Plant and Equipment, Net
Property, plant and equipment, net, consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Compression equipment, facilities and other fleet assets
|
$
|
3,314,995
|
|
|
$
|
3,192,363
|
|
Land and buildings
|
46,993
|
|
|
45,754
|
|
Transportation and shop equipment
|
101,868
|
|
|
100,133
|
|
Computer hardware and software
|
92,301
|
|
|
90,296
|
|
Other
|
12,867
|
|
|
12,419
|
|
Property, plant and equipment
|
3,569,024
|
|
|
3,440,965
|
|
Accumulated depreciation
|
(1,403,179
|
)
|
|
(1,364,038
|
)
|
Property, plant and equipment, net
|
$
|
2,165,845
|
|
|
$
|
2,076,927
|
|
7. Contract Costs
We capitalize incremental costs to obtain a contract with a customer if we expect to recover those costs.
Capitalized costs include commissions paid to our sales force to obtain contract operations contracts. We have applied the practical expedient to expense commissions paid for sales of service contracts and OTC parts and components within our aftermarket services segment as the amortization period is less than one year. As of
September 30
, and
January 1, 2018
, we recorded contract costs of
$3.9 million
and
$2.3 million
, respectively, associated with sales commissions.
We capitalize costs incurred to fulfill a contract if those costs relate directly to a contract, enhance resources that we will use in satisfying performance obligations and if we expect to recover those costs. Capitalized costs incurred to fulfill our customer contracts include freight charges to transport compressor assets before transferring services to the customer and mobilization activities associated with our contract operations services. As of
September 30
, and
January 1, 2018
, we recorded contract costs of
$32.6 million
and
$19.2 million
, respectively, associated with freight and mobilization.
Contract operations costs are amortized based on the transfer of service to which the assets relate, which is estimated to be
36 months
based on average contract term, including anticipated renewals. We assess periodically whether the
36
-month estimate fairly represents the average contract term and adjust as appropriate. Aftermarket services fulfillment costs are recognized based on the percentage-of-completion method applicable to the customer contract. Contract costs associated with commissions are amortized to SG&A. Contract costs associated with freight and mobilization are amortized to cost of sales (excluding depreciation and amortization). During the
three and nine
months ended
September 30, 2018
, we amortized
$0.4 million
and
$1.1 million
, respectively, related to commissions and
$3.6 million
and
$9.2 million
, respectively, related to freight and mobilization. During the three and
nine
months ended
September 30, 2018
, there was
no
impairment loss recorded in relation to the costs capitalized.
8. Long-Term Debt
Long-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Credit Facility
|
$
|
—
|
|
|
$
|
56,000
|
|
Partnership Credit Facility
|
826,500
|
|
|
674,306
|
|
|
|
|
|
Partnership’s 6% senior notes due April 2021
|
350,000
|
|
|
350,000
|
|
Less: Debt discount, net of amortization
|
(1,977
|
)
|
|
(2,523
|
)
|
Less: Deferred financing costs, net of amortization
|
(2,568
|
)
|
|
(3,338
|
)
|
|
345,455
|
|
|
344,139
|
|
|
|
|
|
Partnership’s 6% senior notes due October 2022
|
350,000
|
|
|
350,000
|
|
Less: Debt discount, net of amortization
|
(2,938
|
)
|
|
(3,441
|
)
|
Less: Deferred financing costs, net of amortization
|
(3,338
|
)
|
|
(3,951
|
)
|
|
343,724
|
|
|
342,608
|
|
Long-term debt
|
$
|
1,515,679
|
|
|
$
|
1,417,053
|
|
Credit Facility
On April 26, 2018, in connection with the Merger and Amendment No. 1, the Archrock Credit Facility was terminated. Upon termination, we repaid
$63.2 million
in borrowings and accrued and unpaid interest and fees outstanding. All commitments under the Archrock Credit Facility were terminated and the
$15.4 million
of letters of credit outstanding under the Archrock Credit Facility as of the Merger were converted to letters of credit under the Partnership Credit Facility. As a result of the termination, we recorded a debt extinguishment loss of
$2.5 million
.
At
December 31, 2017
, the weighted average annual interest rate, excluding the effect of interest rate swaps, on the outstanding balance under the Archrock Credit Facility was
3.3%
. During the
three and nine
months ended
September 30, 2017
, we incurred
$0.2 million
and
$0.5 million
, respectively, in commitment fees on the daily unused amount of the Archrock Credit Facility. We incurred
$0.2 million
in commitment fees in 2018 prior to the facility’s termination and were in compliance with all covenants under the Archrock Credit Facility through its closing.
Partnership Credit Facility
The Partnership Credit Facility is a
five
-year,
$1.25 billion
asset-based revolving credit facility that will mature on
March 30, 2022
except that if any portion of the Partnership’s
6%
senior notes due April 2021 are outstanding as of December 2, 2020, then maturity will instead be on
December 2, 2020
. In March 2017, the Partnership incurred
$14.9 million
in transaction costs related to the formation of the Partnership Credit Facility. Concurrent with entering into the Partnership Credit Facility, the Partnership expensed
$0.6 million
of unamortized deferred financing costs and recorded a debt extinguishment loss of
$0.3 million
related to the termination of its Former Credit Facility.
On February 23, 2018, the Partnership amended the Partnership Credit Facility to, among other things:
|
|
•
|
increase the maximum Total Debt to EBITDA ratios, as defined in the Partnership Credit Facility agreement (see below for the revised ratios), effective as of the execution of Amendment No. 1 on February 23, 2018; and
|
|
|
•
|
effective upon completion of the Merger on April 26, 2018:
|
|
|
–
|
increase the aggregate revolving commitment from
$1.1 billion
to
$1.25 billion
;
|
|
|
–
|
increase the amount available for the issuance of letters of credit from
$25.0 million
to
$50.0 million
;
|
|
|
–
|
increase the basket sizes under certain covenants including covenants limiting our ability to make investments, incur debt, make restricted payments, incur liens and make asset dispositions;
|
|
|
–
|
name Archrock Services, L.P., one of our subsidiaries, as a borrower under the Partnership Credit Facility and certain of our other subsidiaries as loan guarantors; and
|
|
|
–
|
amend the definition of “Borrowing Base” to include certain assets of ours and our subsidiaries.
|
The Partnership incurred
$3.3 million
in transaction costs related to Amendment No. 1 which were included in other long-term assets in our condensed consolidated balance sheet and are being amortized over the term of the Partnership Credit Facility.
As of
September 30, 2018
, the Partnership had
$15.4 million
outstanding letters of credit under the Partnership Credit Facility and the applicable margin on amounts outstanding under the Credit Facility was
3.2%
. The weighted average annual interest rate on the outstanding balance under the Partnership Credit Facility, excluding the effect of interest rate swaps, was
5.5%
and
4.8%
at
September 30, 2018
and
December 31, 2017
, respectively. The Partnership incurred
$0.6 million
in commitment fees on the daily unused amount of the Partnership Credit Facility and the Former Credit Facility during each of the three months ended
September 30, 2018
and
2017
, and
$1.7 million
and
$1.5 million
during the
nine
months ended
September 30, 2018
and
2017
, respectively.
The Partnership must maintain the following consolidated financial ratios, as defined in the Partnership Credit Facility agreement:
|
|
|
EBITDA to Interest Expense
|
2.5 to 1.0
|
Senior Secured Debt to EBITDA
|
3.5 to 1.0
|
Total Debt to EBITDA
|
|
Through fiscal year 2018
|
5.95 to 1.0
|
Through fiscal year 2019
|
5.75 to 1.0
|
Through second quarter of 2020
|
5.50 to 1.0
|
Thereafter
(1)
|
5.25 to 1.0
|
——————
|
|
(1)
|
Subject to a temporary increase to
5.5
to 1.0 for any quarter during which an acquisition satisfying certain thresholds is completed and for the two quarters immediately following such quarter.
|
As of
September 30, 2018
, the Partnership had undrawn capacity of
$408.1 million
under the Partnership Credit Facility. As a result of the ratio requirements above,
$324.0 million
of the
$408.1 million
of undrawn capacity was available for additional borrowings as of
September 30, 2018
. As of
September 30, 2018
, the Partnership was in compliance with all covenants under the Partnership Credit Facility agreement.
9. Derivatives
We are exposed to market risks associated with changes in the variable interest rate of the Partnership Credit Facility. We use derivative instruments to manage our exposure to fluctuations in this variable interest rate and thereby minimize the risks and costs associated with financial activities. We do not use derivative instruments for trading or other speculative purposes.
At
September 30, 2018
, the Partnership was a party to the following interest rate swaps, which were entered into to offset changes in expected cash flows due to fluctuations in the associated variable interest rates (in millions):
|
|
|
|
|
|
Expiration Date
|
|
Notional Value
|
May 2019
|
|
$
|
100.0
|
|
May 2020
|
|
100.0
|
|
March 2022
|
|
300.0
|
|
|
|
$
|
500.0
|
|
The counterparties to the derivative agreements are major financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us. The Partnership has no specific collateral posted for its derivative instruments.
We have designated these interest rate swaps as cash flow hedging instruments and so any change in their fair value is recognized as a component of other comprehensive income (loss) until the hedged transaction affects earnings. At that time, amounts are reclassified into earnings to interest expense, the same statement of operations line item to which the earnings effect of the hedged item is recorded. Cash flows from derivatives designated as hedges are classified in our condensed consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions, unless the derivative contract contains a significant financing element; in this case, the cash settlements for these derivatives are classified as cash flows from financing activities.
We expect the hedging relationship to be highly effective as the swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate. Prior to adoption of ASU 2017-12, we performed quarterly calculations to determine whether the swap agreements continued to be highly effective at achieving offsetting changes in cash flows attributable to the hedged risk. Upon adoption of ASU 2017-12, we perform quarterly qualitative prospective and retrospective hedge effectiveness assessments unless facts and circumstances related to the hedging relationships change such that we can no longer assert qualitatively that the cash flow hedge relationships were and continue to be highly effective. We estimate that
$3.6 million
of the deferred pre-tax gain attributable to interest rate swaps included in accumulated other comprehensive income (loss) at
September 30, 2018
will be reclassified into earnings as interest income at then-current values during the next twelve months as the underlying hedged transactions occur.
In August 2017, the Partnership amended the terms of
$300.0 million
of its interest rate swap agreements to adjust the fixed interest rate and extend the maturity dates to March 2022. These amendments effectively created new derivative contracts and terminated the old derivative contracts. As a result, as of the amendment date, we discontinued the original cash flow hedge relationships on a prospective basis and designated the amended interest rate swaps under new cash flow hedge relationships based on the amended terms. The fair value of the interest rate swaps immediately prior to the execution of the amendments was a liability of
$0.7 million
. The associated amount in accumulated other comprehensive income (loss) was amortized into interest expense over the original terms of the interest rate swaps through May 2018.
As of
September 30, 2018
, the weighted average effective fixed interest rate on the interest rate swaps was
1.8%
.
The following tables present the effect of the derivative instruments designated as cash flow hedging instruments on our condensed consolidated balance sheets (in thousands):
|
|
|
|
|
|
|
|
|
|
Fair Value Asset (Liability)
|
|
September 30, 2018
|
|
December 31, 2017
|
Other current assets
|
$
|
3,592
|
|
|
$
|
186
|
|
Other long-term assets
|
9,487
|
|
|
4,490
|
|
Accrued liabilities
|
—
|
|
|
(134
|
)
|
|
$
|
13,079
|
|
|
$
|
4,542
|
|
The following tables present the effect of the derivative instruments designated as cash flow hedging instruments on our condensed consolidated statements of operations (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Pre-tax gain recognized in other comprehensive income (loss)
|
$
|
1,642
|
|
|
$
|
1,919
|
|
|
$
|
8,583
|
|
|
$
|
2,282
|
|
Pre-tax gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense
|
429
|
|
|
(678
|
)
|
|
(83
|
)
|
|
(2,521
|
)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30, 2018
|
|
Nine Months Ended
September 30, 2018
|
Total amount of interest expense in which the effects of cash flow hedges are recorded
|
$
|
23,518
|
|
|
$
|
69,402
|
|
Amount of gain reclassified from accumulated other comprehensive income (loss) into interest expense
|
429
|
|
|
582
|
|
See
Note 18
(“Accumulated Other Comprehensive Income”)
for further details on the derivative instruments.
10. Fair Value Measurements
The accounting standard for fair value measurements and disclosures establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value into the following three categories:
|
|
•
|
Level 1 — Quoted unadjusted prices for identical instruments in active markets to which we have access at the date of measurement.
|
|
|
•
|
Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 inputs are those in markets for which there are few transactions, the prices are not current, little public information exists or prices vary substantially over time or among brokered market makers.
|
|
|
•
|
Level 3 — Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are those inputs that reflect our own assumptions regarding how market participants would price the asset or liability based on the best available information.
|
Assets and Liabilities Measured at Fair Value on a Recurring Basis
On a quarterly basis, our interest rate swaps are valued based on the income approach (discounted cash flow) using market observable inputs, including London Interbank Offered Rate forward curves. These fair value measurements are classified as Level 2.
The following table presents our interest rate swaps asset and liability measured at fair value on a recurring basis with pricing levels as of the date of valuation (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Interest rate swaps asset
|
$
|
13,079
|
|
|
$
|
4,676
|
|
Interest rate swaps liability
|
—
|
|
|
(134
|
)
|
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the
nine
months ended
September 30, 2018
, we recorded non-recurring fair value measurements related to our idle and previously-culled compressor units. Our estimate of the compressor units’ fair value was primarily based on the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. We discounted the expected proceeds, net of selling and other carrying costs, using a weighted average disposal period of
four years
. These fair value measurements are classified as Level 3. The fair value of our impaired compressor units was
$1.5 million
and
$2.6 million
at
September 30, 2018
and
December 31, 2017
, respectively. See
Note 11
(“Long-Lived Asset Impairment”)
for further details.
Other Financial Instruments
The carrying amounts of our cash, receivables and payables approximate fair value due to the short-term nature of those instruments.
The carrying amount of borrowings outstanding under the Partnership Credit Facility approximates fair value due to its variable interest rate. The fair value of these outstanding borrowings was estimated using a discounted cash flow analysis based on interest rates offered on loans with similar terms to borrowers of similar credit quality, which are Level 3 inputs.
The fair value of our fixed rate debt was estimated based on quoted prices in inactive markets and is considered a Level 2 measurement. The following table summarizes the carrying amount and fair value of our fixed rate debt (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Carrying amount of fixed rate debt
(1)
|
$
|
689,179
|
|
|
$
|
686,747
|
|
Fair value of fixed rate debt
|
706,000
|
|
|
702,000
|
|
——————
|
|
(1)
|
Carrying amounts are shown net of unamortized debt discounts and unamortized deferred financing costs. See
Note 8
(“Long-Term Debt”)
for further details.
|
11. Long-Lived Asset Impairment
We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressor units from our active fleet, indicate that the carrying amount of an asset may not be recoverable.
We periodically review the future deployment of our idle compression assets for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. Based on these reviews, we determine that certain idle compressor units should be retired from the active fleet. The retirement of these units from the active fleet triggers a review of these assets for impairment and as a result of our review, we may record an asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit is estimated based on the expected net sale proceeds compared to other fleet units we recently sold, a review of other units recently offered for sale by third parties or the estimated component value of the equipment we plan to use.
In connection with our review of our idle compression assets, we evaluate for impairment idle units that were culled from our fleet in prior years and are available for sale. Based on that review, we may reduce the expected proceeds from disposition and record additional impairment to reduce the book value of each unit to its estimated fair value.
The following table presents the results of our impairment review as recorded in our contract operations segment (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Idle compressor units retired from the active fleet
|
60
|
|
|
50
|
|
|
225
|
|
|
190
|
|
Horsepower of idle compressor units retired from the active fleet
|
23,000
|
|
|
20,000
|
|
|
73,000
|
|
|
71,000
|
|
Impairment recorded on idle compressor units retired from the active fleet
|
$
|
6,660
|
|
|
$
|
5,934
|
|
|
$
|
18,323
|
|
|
$
|
19,686
|
|
In addition to the impairment discussed above, during the
three and nine
months ended
September 30, 2017
,
$0.8 million
of leasehold improvements and furniture and fixtures were impaired in conjunction with the relocation of our corporate office during the third quarter of 2017. See
Note 13
(“Corporate Office Relocation”)
for further details.
12. Restructuring and Other Charges
As discussed in
Note 4
(“Discontinued Operations”)
, we completed the Spin-off in 2015. During the
three and nine
months ended
September 30, 2017
, we incurred
$0.4 million
and
$1.2 million
, respectively, of costs for retention benefits associated with the Spin-off that were directly attributable to Archrock. The restructuring charges associated with the Spin-off are not directly attributable to our reportable segments because they primarily represent costs incurred within the corporate function. No such costs were incurred subsequent to December 31, 2017.
13. Corporate Office Relocation
During the
three and nine
months ended
September 30, 2017
, we recorded
$2.1 million
in charges associated with the relocation of our corporate headquarters during the third quarter 2017. These charges were reflected in SG&A and included accelerated expense associated with the contractual lease payments of our former corporate office, which were made through the end of the lease term in the first quarter of 2018, and relocation costs to move our corporate office. Additionally, leasehold improvements and furniture and fixtures were impaired in the third quarter of 2017 and are reflected in long-lived asset impairment in our condensed consolidated income statements (see
Note 11
(“
Long-Lived Asset Impairment
”)). We did not incur additional costs as a result of the relocation subsequent to September 30, 2017.
The following table summarizes the changes to our accrued liability balance related to our corporate office relocation for the
nine
months ended
September 30, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
Beginning balance
|
$
|
583
|
|
|
$
|
—
|
|
Additions for costs expensed
|
—
|
|
|
2,113
|
|
Less non-cash expense
(1)
|
—
|
|
|
(613
|
)
|
Reductions for payments
|
(583
|
)
|
|
(72
|
)
|
Ending balance
|
$
|
—
|
|
|
$
|
1,428
|
|
——————
|
|
(1)
|
Represents non-cash write-off of leasehold improvements, furniture and fixtures and the net liability associated with the straight-line expense associated with the lease of our former corporate office.
|
The following table summarizes our corporate office relocation costs by category during the
three and nine
months ended
September 30, 2017
(in thousands):
|
|
|
|
|
Remaining lease costs
|
$
|
1,258
|
|
Impairment of leasehold improvements and furniture and fixtures
|
795
|
|
Relocation costs
|
60
|
|
Total corporate relocation costs
|
$
|
2,113
|
|
14. Income Taxes
Unrecognized Tax Benefits
As of
September 30, 2018
, we believe
$0.9 million
of our unrecognized tax benefits will be reduced prior to September 30, 2019 due to the settlement of audits or the expiration of statutes of limitations or both. However, due to the uncertain and complex application of the tax regulations, it is possible that the ultimate resolution of these matters may result in liabilities which could materially differ from this estimate.
Impact of the TCJA
At December 31, 2017, a provisional amount for the effects of the TCJA was recorded and resulted in a
$53.4 million
tax benefit to our provision for income taxes in our consolidated statement of operations. This amount consisted of a
$57.7 million
tax benefit due to reducing our continuing operations net deferred tax liability, a
$4.6 million
tax detriment due to reducing our discontinued operations deferred tax asset and a
$0.3 million
tax benefit due to reducing our other comprehensive income net deferred tax liability. As of
September 30, 2018
, our analysis of the impact of the TCJA was complete and there were no material changes to the provisional amount recorded at December 31, 2017.
15. Stock-Based Compensation
Stock Incentive Plan
In April 2013, we adopted the 2013 Plan to provide for the granting of stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, other stock-based awards and dividend equivalent rights to employees, directors and consultants of Archrock. The 2013 Plan is administered by the compensation committee of our board of directors. Under the 2013 Plan, the maximum number of shares of common stock available for issuance pursuant to awards is
10,100,000
. Each option and stock appreciation right granted counts as
one
share against the aggregate share limit, and any share subject to a stock settled award other than a stock option, stock appreciation right or other award for which the recipient pays intrinsic value counts as
1.75
shares against the aggregate share limit. Shares subject to awards granted under the 2013 Plan that are subsequently canceled, terminated, settled in cash or forfeited (excluding shares withheld to satisfy tax withholding obligations or to pay the exercise price of an option) are, to the extent of such cancellation, termination, settlement or forfeiture, available for future grant under the 2013 Plan. Cash-settled awards are not counted against the aggregate share limit. No additional grants have been or may be made under the 2007 Plan following the adoption of the 2013 Plan. Previous grants made under the 2007 Plan will continue to be governed by that plan and the applicable award agreements.
The compensation committee of our board of directors generally establishes its schedule for making annual long-term incentive awards, consisting of a combination of restricted shares and performance units vesting over multiple years, to our named executive officers several months in advance and does not make such awards based on knowledge of material nonpublic information. Although the compensation committee of our board of directors has historically granted awards on a regular, predictable cycle — after earnings information has been disseminated to the marketplace — such awards may be granted at other times during the year, as determined in the sole discretion of the compensation committee.
Stock Options
Stock options are granted at fair market value at the grant date, are exercisable according to the vesting schedule established by the compensation committee of our board of directors in its sole discretion and expire no later than
seven
years after the grant date. Stock options generally vest one-third per year on each of the first three anniversaries of the grant date, subject to continued service through the applicable vesting date.
The following table presents stock option activity during the
nine
months ended
September 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options
(in thousands)
|
|
Weighted
Average
Exercise Price
Per Share
|
|
Weighted
Average
Remaining
Life
(in years)
|
|
Aggregate
Intrinsic
Value
(in thousands)
|
Options outstanding, January 1, 2018
|
489
|
|
|
$
|
12.28
|
|
|
|
|
|
Exercised
|
(30
|
)
|
|
8.79
|
|
|
|
|
|
|
Canceled
|
(53
|
)
|
|
13.96
|
|
|
|
|
|
Options outstanding and exercisable, September 30, 2018
|
406
|
|
|
12.31
|
|
|
0.8
|
|
$
|
1,305
|
|
Intrinsic value is the difference between the market value of our stock and the exercise price of each stock option multiplied by the number of stock options outstanding for those stock options where the market value exceeds their exercise price. The total intrinsic value of stock options exercised during
nine
months ended
September 30, 2018
was
$0.1 million
.
Restricted Stock, Stock-Settled Restricted Stock Units, Performance Units, Cash-Settled Restricted Stock Units and Cash Settled Performance Units
For grants of restricted stock, restricted stock units and performance units, we recognize compensation expense over the vesting period equal to the fair value of our common stock at the grant date. Our restricted stock, restricted stock units, and performance units include rights to receive dividends or dividend equivalents. We remeasure the fair value of cash-settled restricted stock units and cash-settled performance units and record a cumulative adjustment of the expense previously recognized. Our obligation related to the cash-settled restricted stock units and cash settled performance units is reflected as a liability in our condensed consolidated balance sheets. Restricted stock, stock-settled restricted stock units, cash-settled restricted stock units and cash-settled performance units generally vest one-third per year on dates as specified in the applicable award agreement, subject to continued service through the applicable vesting date. Stock-settled performance units cliff vest at the end of the performance period as specified in the terms of the applicable award agreement, subject to continued service through the applicable vesting date.
The following table presents restricted stock, restricted stock unit, performance unit, cash-settled restricted stock unit and cash- settled performance unit activity during the
nine
months ended
September 30, 2018
:
|
|
|
|
|
|
|
|
|
Shares
(in thousands)
|
|
Weighted
Average
Grant Date
Fair Value
Per Share
|
Non-vested awards, January 1, 2018
|
1,440
|
|
|
$
|
10.39
|
|
Granted
|
1,148
|
|
|
9.66
|
|
Converted
(1)
|
140
|
|
|
7.03
|
|
Vested
|
(747
|
)
|
|
10.46
|
|
Canceled
|
(219
|
)
|
|
9.79
|
|
Non-vested awards, September 30, 2018
(2)
|
1,762
|
|
|
9.69
|
|
——————
|
|
(1)
|
Reflects conversion of Partnership phantom units into Archrock restricted stock units pursuant to the Merger See “Partnership Long-Term Incentive Plan” section below for detail regarding the conversion of awards.
|
|
|
(2)
|
Non-vested awards as of
September 30, 2018
are comprised of
216,000
cash-settled restricted stock units and cash-settled performance units and
1,546,000
restricted shares and stock-settled performance units.
|
As of
September 30, 2018
, we expect
$13.2 million
of unrecognized compensation cost related to unvested restricted stock, stock-settled restricted stock units, performance units, cash-settled restricted stock units and cash-settled performance units to be recognized over the weighted-average period of
2.3
years.
Partnership Long-Term Incentive Plan
In April 2017, the Partnership adopted the 2017 Partnership LTIP to provide for the benefit of employees, directors and consultants of the Partnership, us and our respective affiliates. The 2017 Partnership LTIP provided for the issuance of unit options, unit appreciation rights, restricted units, phantom units, performance awards, bonus awards, distribution equivalent rights, cash awards and other unit based awards. Previous grants made under the 2006 Partnership LTIP continued to be governed by the 2006 Partnership LTIP and the applicable award agreements. We recognized compensation expense over the vesting period equal to the fair value of the Partnership’s common units at the grant date. Phantom units granted under the 2017 and 2006 LTIP may include nonforfeitable tandem distribution equivalent rights to receive cash distributions on unvested phantom units in the quarter in which distributions are paid on common units. Phantom units generally vested
one-third
per year on dates as specified in the applicable award agreements subject to continued service through the applicable vesting date. During the nine months ended September 30, 2018,
53,091
phantom units vested with a weighted average grant date fair value per unit of
$11.24
.
Pursuant to the Merger, all outstanding phantom units previously granted under the 2017 and 2006 Partnership LTIP were converted into comparable awards based on Archrock’s common shares. As such, all outstanding phantom units were converted, effective as of the closing of the Merger, into Archrock restricted stock units. See
Note 17
(“Equity”)
for further details regarding the Merger. Each Archrock restricted stock unit will be subject to the same vesting, forfeiture and other terms and conditions applicable to the converted Partnership phantom units. Under Accounting Standards Codification Topic 718, Compensation - Stock Compensation, we determined that there was no additional compensation cost to record as the conversion of awards did not result in incremental fair value.
16. Earnings per Share
Basic income (loss) attributable to Archrock common stockholders per common share is computed using the two-class method, which is an earnings allocation formula that determines net income (loss) per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Under the two-class method, basic income (loss) attributable to Archrock common stockholders per common share is determined by dividing income (loss) attributable to Archrock common stockholders after deducting amounts allocated to participating securities, by the weighted average number of common shares outstanding for the period. Participating securities include unvested restricted stock and stock settled restricted stock units that have nonforfeitable rights to receive dividends or dividend equivalents, whether paid or unpaid. During periods of net loss, no effect is given to participating securities because they do not have a contractual obligation to participate in our losses.
Diluted income (loss) attributable to Archrock common stockholders per common share is computed using the weighted average number of shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options and stock to be issued pursuant to our employee stock purchase plan unless their effect would be anti-dilutive.
The following table summarizes net income (loss) attributable to Archrock common stockholders used in the calculation of basic and diluted loss per common share (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Income (loss) from continuing operations attributable to Archrock stockholders
|
$
|
9,974
|
|
|
$
|
(10,181
|
)
|
|
$
|
8,095
|
|
|
$
|
(28,553
|
)
|
Loss from discontinued operations, net of tax
|
—
|
|
|
(54
|
)
|
|
—
|
|
|
(54
|
)
|
Net income (loss) attributable to Archrock stockholders
|
9,974
|
|
|
(10,235
|
)
|
|
8,095
|
|
|
(28,607
|
)
|
Less: Net income attributable to participating securities
|
(241
|
)
|
|
(179
|
)
|
|
(554
|
)
|
|
(513
|
)
|
Net income (loss) attributable to Archrock common stockholders
|
$
|
9,733
|
|
|
$
|
(10,414
|
)
|
|
$
|
7,541
|
|
|
$
|
(29,120
|
)
|
The following table shows the potential shares of common stock that were included in computing diluted income (loss) attributable to Archrock common stockholders per common share (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Weighted average common shares outstanding including participating securities
|
129,486
|
|
|
70,952
|
|
|
104,489
|
|
|
70,847
|
|
Less: Weighted average participating securities outstanding
|
(1,644
|
)
|
|
(1,308
|
)
|
|
(1,576
|
)
|
|
(1,327
|
)
|
Weighted average common shares outstanding — used in basic income (loss) per common share
|
127,842
|
|
|
69,644
|
|
|
102,913
|
|
|
69,520
|
|
Net dilutive potential common shares issuable:
|
|
|
|
|
|
|
|
On exercise of options
|
111
|
|
|
*
|
|
|
96
|
|
|
*
|
|
On the settlement of employee stock purchase plan shares
|
2
|
|
|
*
|
|
|
4
|
|
|
*
|
|
Weighted average common shares outstanding — used in diluted income (loss) per common share
|
127,955
|
|
|
69,644
|
|
|
103,013
|
|
|
69,520
|
|
——————
|
|
*
|
Excluded from diluted income (loss) per common share as their inclusion would have been anti-dilutive.
|
The following table shows the potential shares of common stock issuable that were excluded from computing diluted income (loss) attributable to Archrock common stockholders per common share as their inclusion would have been anti-dilutive (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net dilutive potential common shares issuable:
|
|
|
|
|
|
|
|
On exercise of options where exercise price is greater than average market value for the period
|
187
|
|
|
240
|
|
|
199
|
|
|
278
|
|
On exercise of options
|
—
|
|
|
100
|
|
|
—
|
|
|
116
|
|
Net dilutive potential common shares issuable
|
187
|
|
|
340
|
|
|
199
|
|
|
394
|
|
17. Equity
Merger Transaction
On January 1, 2018, we entered into the Merger Agreement pursuant to which we agreed to merge the Partnership with and into our indirect wholly-owned subsidiary. On April 26, 2018, the Merger was completed and we issued
57.6 million
shares of our common stock to acquire the
41.2 million
common units of the Partnership not owned by us prior to the Merger at a fixed exchange ratio of
1.40
shares of our common stock for each Partnership common unit for total implied consideration of
$625.3 million
. Additionally, the incentive distribution rights in the Partnership, all of which we owned indirectly prior to the Merger, were canceled and ceased to exist. As a result of the Merger, the Partnership’s common units are no longer publicly traded. The Partnership’s 6% senior notes due April 2021 and October 2022 were not impacted by the Merger and remain outstanding.
As we controlled the Partnership prior to the Merger and continue to control the Partnership after the Merger, we accounted for the change in our ownership interest in the Partnership as an equity transaction which was reflected as a reduction of the noncontrolling interest with corresponding increases to common stock, additional paid-in capital and accumulated other comprehensive income. No gain or loss was recognized in our condensed consolidated statements of operations as a result of the Merger.
The following table presents the effects of changes in our ownership interest in the Partnership on the equity attributable to Archrock stockholders:
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
Net income (loss) attributable to Archrock stockholders
|
$
|
8,095
|
|
|
$
|
(28,607
|
)
|
Increase in Archrock stockholders’ additional paid-in capital for purchase of Partnership common units
|
54,751
|
|
|
17,638
|
|
Change from net income (loss) attributable to Archrock stockholders and transfers from noncontrolling interest
|
$
|
62,846
|
|
|
$
|
(10,969
|
)
|
Prior to the Merger, public unitholders held an approximate
57%
ownership interest in the Partnership and we owned the remaining equity interest. The equity interests in the Partnership that were owned by the public prior to April 26, 2018 are reflected within noncontrolling interest in our condensed consolidated balance sheet as of December 31, 2017. The earnings of the Partnership that were attributed to its common units held by the public prior to April 26, 2018 are reflected in net income (loss) attributable to the noncontrolling interest in our condensed consolidated statement of operations.
The tax effects of the Merger were reported as adjustments to other long-term assets, long-term assets associated with discontinued operations, deferred income taxes, additional paid-in capital and other comprehensive income. Due to the change in ownership and tax step up from the consideration given in the Merger, we recorded a
$156.5 million
deferred tax asset which resulted in an overall
$55.0 million
net deferred tax asset. We evaluated the realizability of our resulting net deferred tax asset position by assessing the available positive and negative evidence and concluded, based on the weight of the evidence, that a
$53.4 million
valuation allowance was required. The
$103.1 million
net tax impact of the change in deferred tax asset and the valuation allowance was recorded as an offsetting increase to additional paid-in capital.
We incurred
$0.2 million
and
$10.0 million
of transaction costs directly attributable to the Merger during the
three and nine
months ended
September 30, 2018
, respectively, including financial advisory, legal service and other professional fees, which were recorded to merger-related costs on our condensed consolidated statements of operations.
Partnership Capital Offering
In August 2017, the Partnership sold, pursuant to a public underwritten offering,
4,600,000
common units, including
600,000
common units pursuant to an over-allotment option. The Partnership received net proceeds of
$60.3 million
after deducting underwriting discounts, commissions and offering expenses, which it used to repay borrowings outstanding under the Partnership Credit Facility. In connection with this sale and as permitted under its partnership agreement, the Partnership sold
93,163
general partner units to its General Partner for a contribution of
$1.3 million
to maintain the General Partner’s approximate
2%
general partner interest in the Partnership.
Cash Dividends
The following table summarizes our dividends per common share:
|
|
|
|
|
|
|
|
|
|
|
|
Declaration Date
|
|
Payment Date
|
|
Dividends per
Common Share
|
|
Total Dividends
(in thousands)
|
January 19, 2017
|
|
February 15, 2017
|
|
$
|
0.120
|
|
|
$
|
8,458
|
|
April 26, 2017
|
|
May 16, 2017
|
|
0.120
|
|
|
8,534
|
|
July 26, 2017
|
|
August 15, 2017
|
|
0.120
|
|
|
8,536
|
|
October 20, 2017
|
|
November 15, 2017
|
|
0.120
|
|
|
8,536
|
|
January 18, 2018
|
|
February 14, 2018
|
|
0.120
|
|
|
8,532
|
|
April 25, 2018
|
|
May 15, 2018
|
|
0.120
|
|
|
15,486
|
|
July 25, 2018
|
|
August 14, 2018
|
|
0.132
|
|
|
17,114
|
|
On
October 24, 2018
, our board of directors declared a quarterly dividend of
$0.132
per share of common stock to be paid on
November 14, 2018
to stockholders of record at the close of business on
November 7, 2018
.
18. Accumulated Other Comprehensive Income
Components of comprehensive income (loss) are net income (loss) and all changes in equity during a period except those resulting from transactions with owners. Our accumulated other comprehensive income (loss) consists of changes in the fair value of derivative instruments, net of tax, that are designated as cash flow hedges, amortization of terminated interest rate swaps and adjustments related to changes in our ownership of the Partnership.
The following table presents the changes in accumulated other comprehensive income (loss) of our derivative cash flow hedges, net of tax and excluding noncontrolling interest, during the
three and nine
months ended
September 30, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Beginning accumulated other comprehensive income (loss)
|
$
|
9,374
|
|
|
$
|
(936
|
)
|
|
$
|
1,197
|
|
|
$
|
(1,678
|
)
|
Gain recognized in other comprehensive income, net of tax provision of $345, $247, $1,234 and $290, respectively
|
1,298
|
|
|
931
|
|
|
3,349
|
|
|
1,104
|
|
(Gain) loss reclassified from accumulated other comprehensive loss to interest expense, net of tax provision (benefit) of $90, $(108), $37 and $(414), respectively
(1)
|
(339
|
)
|
|
200
|
|
|
117
|
|
|
769
|
|
Merger-related adjustments
(2)
|
—
|
|
|
—
|
|
|
5,670
|
|
|
—
|
|
Other comprehensive income attributable to Archrock stockholders
|
959
|
|
|
1,131
|
|
|
9,136
|
|
|
1,873
|
|
Ending accumulated other comprehensive income
|
$
|
10,333
|
|
|
$
|
195
|
|
|
$
|
10,333
|
|
|
$
|
195
|
|
——————
|
|
(1)
|
Included stranded tax effects resulting from the TCJA of
$0.3 million
reclassified to accumulated deficit during the
nine
months ended
September 30, 2018
. See
Note 2
(“Recent Accounting Developments”)
for further details.
|
|
|
(2)
|
Pursuant to the Merger, we reclassified a gain of
$5.7 million
from noncontrolling interest to accumulated other comprehensive income (loss) related to the fair value of our derivative instruments that was previously attributed to public ownership of the Partnership.
|
See
Note 9
(“Derivatives”)
for further details on the derivative instruments.
19. Commitments and Contingencies
Performance Bonds
In the normal course of business we have issued performance bonds to various state authorities that ensure payment of certain obligations. We have also issued a bond to protect our 401(k) retirement plan against losses caused by acts of fraud or dishonesty. The bonds have expiration dates in 2018 through the first quarter of 2020 and maximum potential future payments of
$2.3 million
. As of
September 30, 2018
, we were in compliance with all obligations to which the performance bonds pertain.
Tax Matters
We are subject to a number of state and local taxes that are not income-based. As many of these taxes are subject to audit by the taxing authorities, it is possible that an audit could result in additional taxes due. We accrue for such additional taxes when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the liability. As of
September 30, 2018
and
December 31, 2017
, we accrued
$3.2 million
and
$1.7 million
, respectively, for the outcomes of non-income based tax audits. We do not expect that the ultimate resolutions of these audits will result in a material variance from the amounts accrued. We do not accrue for unasserted claims for tax audits unless we believe the assertion of a claim is probable, it is probable that it will be determined that the claim is owed and we can reasonably estimate the claim or range of the claim. We believe the likelihood is remote that the impact of potential unasserted claims from non-income based tax audits could be material to our consolidated financial position, but it is possible that the resolution of future audits could be material to our consolidated results of operations or cash flows.
Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. The tax contingencies mentioned above relate to tax matters for which we are responsible in managing the audit. As of both
September 30, 2018
and
December 31, 2017
, we recorded an indemnification liability (including penalties and interest), in addition to the tax contingency above, of
$1.6 million
for our share of non-income based tax contingencies related to audits being managed by Exterran Corporation.
Insurance Matters
Our business can be hazardous, involving unforeseen circumstances such as uncontrollable flows of natural gas or well fluids and fires or explosions. As is customary in our industry, we review our safety equipment and procedures and carry insurance against some, but not all, risks of our business. Our insurance coverage includes property damage, general liability and commercial automobile liability and other coverage we believe is appropriate. In addition, we have a minimal amount of insurance on our offshore assets. We believe that our insurance coverage is customary for the industry and adequate for our business; however, losses and liabilities not covered by insurance would increase our costs.
Additionally, we are substantially self-insured for workers’ compensation and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to the deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages.
Indemnification Obligations
In connection with the Spin-off, we entered into a separation and distribution agreement which provides for cross-indemnities between Exterran Corporation’s operating subsidiary and us and established procedures for handling claims subject to indemnification and related matters. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Exterran Corporation’s business with Exterran Corporation. Pursuant to the separation and distribution agreement, we and Exterran Corporation will generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business.
Litigation and Claims
In the ordinary course of business, we are involved in various pending or threatened legal actions. While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from any of these actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to pay dividends. However, because of the inherent uncertainty of litigation and arbitration proceedings, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to pay dividends.
Heavy Equipment
In 2011, the Texas Legislature enacted changes that affected the appraisal of natural gas compressors for ad valorem tax purposes by expanding the special valuation methodology for “Heavy Equipment Inventory” to include inventory held for lease effective from the beginning of 2012. Under the Heavy Equipment Statutes, we are a “Heavy Equipment Dealer” and our natural gas compressors are Heavy Equipment Inventory. As such, we began filing our ad valorem taxes under this methodology starting in the 2012 tax year. Our natural gas compressors are taxable under the Heavy Equipment Statutes in the counties where we maintain a business location and store our inventory of natural gas compressors as opposed to where the compressors may be located on January 1 of a tax year. Although a few appraisal review boards accepted our position, many denied it. As a result, our wholly-owned subsidiary, Archrock Services Leasing LLC, formerly known as EES Leasing, and the Partnership’s wholly-owned subsidiary, Archrock Partners Leasing LLC, formerly known as EXLP Leasing, filed numerous petitions for review in the appropriate district courts with respect to the 2012-2017 tax years.
To date,
three
cases have been decided by trial courts, with
two
of the decisions having been rendered by the same presiding judge. All
three
of those decisions were appealed, and all
three
of the appeals have been decided on by intermediate appellate courts. On March 2, 2018, the Texas Supreme Court ruled in
one
of the cases,
EXLP Leasing LLC & EES Leasing LLC v. Galveston Central Appraisal District
, on two of the three issues related to the Heavy Equipment Statutes: constitutionality and situs. The third issue — the district court’s ruling that the Heavy Equipment Statutes apply to the compressors — was not appealed in this case. The Texas Supreme Court ruled in our favor on all accounts, holding that the Heavy Equipment Statutes are constitutional and that our natural gas compressors are taxable only in the counties where we maintain a business location that manages our inventory of natural gas compressors. On September 28, 2018, the Texas Supreme Court denied Galveston Central Appraisal District’s motion for rehearing, thus concluding the litigation in this case.
Two
cases,
EXLP Leasing LLC & EES Leasing LLC v. Loving County Appraisal District
and
EES Leasing LLC & EXLP Leasing LLC v. Ward County Appraisal District
, remain pending for review by the Texas Supreme Court. We expect the pending cases to be disposed of in a manner consistent with the Galveston case.
As a result of the rulings on the Heavy Equipment litigation thus far, all counties in which we filed petitions for review have removed our compressors from their 2018 property rolls except for Galveston County, which has agreed to do so promptly. As of September 30, 2018, many of the petitions that we filed for tax years 2012-2017 have been closed and the remaining pending petitions are in the process of being closed. We believe that the likelihood of an unfavorable outcome or further litigation on this issue is remote.
Other
The SEC has been conducting an investigation in connection with certain previously disclosed errors and possible irregularities at one of our former international operations. We and Exterran Corporation are cooperating with the SEC in the investigation of this matter. The SEC’s investigation related to the circumstances giving rise to the restatement of prior period consolidated and combined financial statements is continuing, and we are presently unable to predict the duration, scope or results or whether the SEC will commence any legal action.
20. Segments
We manage our business segments primarily based upon the type of product or service provided. We have
two
segments which we operate within the U.S.: contract operations and aftermarket services. The contract operations segment primarily provides natural gas compression services to meet specific customer requirements. The aftermarket services segment provides a full range of services to support the compression needs of customers, from part sales and normal maintenance services to full operation of a customer’s owned assets.
We evaluate the performance of our segments based on gross margin for each segment. Revenue includes only sales to external customers.
The following table presents revenue and gross margin by segment during the
three and nine
months ended
September 30, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
Operations
|
|
Aftermarket
Services
|
|
Total
|
Three months ended September 30, 2018
|
|
|
|
|
|
Revenue
|
$
|
169,509
|
|
|
$
|
62,863
|
|
|
$
|
232,372
|
|
Gross margin
|
100,453
|
|
|
12,820
|
|
|
113,273
|
|
Three months ended September 30, 2017
|
|
|
|
|
|
Revenue
|
$
|
153,524
|
|
|
$
|
44,329
|
|
|
$
|
197,853
|
|
Gross margin
|
81,573
|
|
|
5,843
|
|
|
87,416
|
|
|
|
|
|
|
|
Nine months ended September 30, 2018
|
|
|
|
|
|
Revenue
|
$
|
496,156
|
|
|
$
|
175,126
|
|
|
$
|
671,282
|
|
Gross margin
|
294,696
|
|
|
31,953
|
|
|
326,649
|
|
Nine months ended September 30, 2017
|
|
|
|
|
|
Revenue
|
$
|
454,622
|
|
|
$
|
131,098
|
|
|
$
|
585,720
|
|
Gross margin
|
256,331
|
|
|
19,271
|
|
|
275,602
|
|
The following table reconciles total gross margin to income (loss) before income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Total gross margin
|
$
|
113,273
|
|
|
$
|
87,416
|
|
|
$
|
326,649
|
|
|
$
|
275,602
|
|
Less:
|
|
|
|
|
|
|
|
Selling, general and administrative
|
26,298
|
|
|
29,108
|
|
|
80,455
|
|
|
81,823
|
|
Depreciation and amortization
|
43,779
|
|
|
47,463
|
|
|
131,565
|
|
|
142,483
|
|
Long-lived asset impairment
|
6,660
|
|
|
7,105
|
|
|
18,323
|
|
|
20,858
|
|
Restatement and other charges
|
396
|
|
|
566
|
|
|
(195
|
)
|
|
3,287
|
|
Restructuring and other charges
|
—
|
|
|
422
|
|
|
—
|
|
|
1,245
|
|
Interest expense
|
23,518
|
|
|
22,892
|
|
|
69,402
|
|
|
66,817
|
|
Debt extinguishment loss
|
—
|
|
|
—
|
|
|
2,450
|
|
|
291
|
|
Merger-related costs
|
182
|
|
|
—
|
|
|
9,993
|
|
|
—
|
|
Other income, net
|
(660
|
)
|
|
(2,716
|
)
|
|
(3,449
|
)
|
|
(4,472
|
)
|
Income (loss) before income taxes
|
$
|
13,100
|
|
|
$
|
(17,424
|
)
|
|
$
|
18,105
|
|
|
$
|
(36,730
|
)
|