NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
We are an energy infrastructure company with a pure-play focus on midstream natural gas compression. We believe we are the leading provider of natural gas compression services to customers in the oil and natural gas industry throughout the U.S. and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. We operate in
two
business segments: contract operations and aftermarket services. Our contract operations services primarily include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining our owned fleet of natural gas compression equipment to provide natural gas compression services to our customers. In our aftermarket services business, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.
The accompanying unaudited condensed consolidated financial statements included herein have been prepared in accordance with GAAP and the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP are not required in these interim financial statements and have been condensed or omitted. Management believes that the information furnished includes all adjustments, consisting 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
2018
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
Leases
ASC 842 Leases establishes a ROU model that requires a lessee to record a ROU asset and a lease liability on the balance sheet. Leases are 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. We adopted ASC 842 Leases on January 1, 2019 using the modified retrospective transition method and elected the practical expedient package to not reassess (i) whether any expired or existing contracts are or contain leases, (ii) lease classification of any expired or existing leases and (iii) initial direct costs for any existing leases. We did not elect the practical expedient to use hindsight in determining the lease term. Adoption of ASC 842 Leases resulted in recognition of an operating lease ROU asset of
$18.6 million
and an operating lease liability of
$20.0 million
in our condensed consolidated balance sheet at January 1, 2019. The difference of
$1.4 million
related to accrued rent and prepaid lease payments recorded to our consolidated balance sheet as of December 31, 2018. We did not recognize any finance lease ROU assets or liabilities upon adoption of ASC 842 Leases. There was no impact to our condensed consolidated statements of operations, equity or cash flows upon adoption. Comparative information has not been recast and continues to be reported under the accounting standards in effect for those periods.
ASC 842 Leases also provides a practical expedient, elected by class of underlying asset, to not separate lease and nonlease components and instead account for those components as a single component if certain conditions are met. ASC 842 Leases also provides clarification for lessors on whether ASC 842 Leases or the Revenue Recognition Update is applicable to the combined component based on determination of the predominant component. We have concluded that for our contract operations services agreements in which we are a lessor, the services nonlease component is predominant over the compression unit lease component and therefore ongoing recognition of these agreements will continue to follow the Revenue Recognition Update guidance. We have also elected, as a lessee, to not separate lease and nonlease components as it relates to our facility leases.
In addition, we have made an accounting policy election, as permitted by ASC 842 Leases, to not apply the recognition requirements of ASC 842 Leases to leases with an initial term of 12 months or less.
Accounting Standards Updates Not Yet Implemented
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 which 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 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.
3. 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 tax matters agreement.
The tax matters agreement governs the respective rights, responsibilities and obligations of Exterran Corporation and us with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and certain other matters regarding taxes. Subject to the provisions of this agreement 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
March 31, 2019
, we classified
$8.5 million
of unrecognized tax benefits (including interest and penalties) as noncurrent liabilities associated with discontinued operations related to operations of Exterran Corporation prior to the Spin-off. We have also recorded an offsetting
$8.5 million
indemnification asset related to this reserve to noncurrent assets associated with discontinued operations.
The following table summarizes the statements of operations data for discontinued operations (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Other income, net
|
$
|
(1,432
|
)
|
|
$
|
—
|
|
Income from discontinued operations before income taxes
|
1,432
|
|
|
—
|
|
Provision for income taxes
|
1,705
|
|
|
—
|
|
Loss from discontinued operations, net of tax
|
$
|
(273
|
)
|
|
$
|
—
|
|
The following table summarizes the balance sheet data for discontinued operations (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
Other current assets
|
$
|
—
|
|
|
$
|
300
|
|
Other assets
|
8,467
|
|
|
7,063
|
|
Total assets associated with discontinued operations
|
$
|
8,467
|
|
|
$
|
7,363
|
|
|
|
|
|
Accrued liabilities
|
$
|
269
|
|
|
$
|
297
|
|
Deferred income taxes
|
8,467
|
|
|
7,063
|
|
Total liabilities associated with discontinued operations
|
$
|
8,736
|
|
|
$
|
7,360
|
|
4. Inventory
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
Parts and supplies
|
$
|
62,216
|
|
|
$
|
65,645
|
|
Work in progress
|
10,247
|
|
|
10,688
|
|
Inventory
|
$
|
72,463
|
|
|
$
|
76,333
|
|
5. Property, Plant and Equipment, Net
Property, plant and equipment, net, consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
Compression equipment, facilities and other fleet assets
|
$
|
3,438,832
|
|
|
$
|
3,323,465
|
|
Land and buildings
|
46,476
|
|
|
47,067
|
|
Transportation and shop equipment
|
107,408
|
|
|
103,766
|
|
Computer hardware and software
|
92,409
|
|
|
92,174
|
|
Other
|
11,789
|
|
|
11,880
|
|
Property, plant and equipment
|
3,696,914
|
|
|
3,578,352
|
|
Accumulated depreciation
|
(1,431,031
|
)
|
|
(1,407,314
|
)
|
Property, plant and equipment, net
|
$
|
2,265,883
|
|
|
$
|
2,171,038
|
|
6. Long-Term Debt
Long-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
Partnership Credit Facility
|
$
|
400,500
|
|
|
$
|
839,500
|
|
|
|
|
|
Partnership’s 6.875% senior notes due April 2027
|
500,000
|
|
|
—
|
|
Less: Deferred financing costs, net of amortization
|
(9,111
|
)
|
|
—
|
|
|
490,889
|
|
|
—
|
|
|
|
|
|
Partnership’s 6% senior notes due April 2021
|
350,000
|
|
|
350,000
|
|
Less: Debt discount, net of amortization
|
(1,598
|
)
|
|
(1,789
|
)
|
Less: Deferred financing costs, net of amortization
|
(2,055
|
)
|
|
(2,311
|
)
|
|
346,347
|
|
|
345,900
|
|
|
|
|
|
Partnership’s 6% senior notes due October 2022
|
350,000
|
|
|
350,000
|
|
Less: Debt discount, net of amortization
|
(2,590
|
)
|
|
(2,766
|
)
|
Less: Deferred financing costs, net of amortization
|
(2,929
|
)
|
|
(3,133
|
)
|
|
344,481
|
|
|
344,101
|
|
Long-term debt
|
$
|
1,582,217
|
|
|
$
|
1,529,501
|
|
Archrock Credit Facility
In April 2018, in connection with the Merger and Amendment No. 1, the Archrock Credit Facility was terminated. Prior to its termination, we incurred
$0.2 million
in commitment fees during the three months ended
March 31, 2018
and were in compliance with all of its covenants as of March 31, 2018.
Partnership Credit Facility
As of
March 31, 2019
, the Partnership had
$15.2 million
letters of credit outstanding under the Partnership Credit Facility and the applicable margin on borrowings outstanding was
2.7%
. The weighted average annual interest rate on the outstanding balance under the Partnership Credit Facility, excluding the effect of interest rate swaps, was
5.3%
and
5.4%
at
March 31, 2019
and
December 31, 2018
, respectively. The Partnership incurred
$0.5 million
in commitment fees on the daily unused amount of the Partnership Credit Facility during each of the
three
months ended
March 31, 2019
and
2018
.
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 a result of the ratio requirements above,
$485.8 million
of the
$834.3 million
of undrawn capacity was available for additional borrowings as of
March 31, 2019
. As of
March 31, 2019
, the Partnership was in compliance with all covenants under the Partnership Credit Facility agreement.
2027 Notes
On March 21, 2019, the Partnership completed a private offering of
$500.0 million
aggregate principal amount of
6.875%
senior notes due April 2027. The Partnership received net proceeds of
$490.9 million
after deducting issuance costs. The
$9.1 million
of issuance costs were recorded as deferred financing costs within long-term debt in our condensed consolidated balance sheets and are being amortized to interest expense in our condensed consolidated statement of operations over the term of the notes. The net proceeds were used to repay borrowings outstanding under the Partnership Credit Facility as of March 31, 2019. In April 2019, the Partnership borrowed on the Partnership Credit Facility to repay the
$350.0 million
of the Partnership’s
6%
senior notes due April 2021. See
Note 20
(“Subsequent Events”)
for further details of this redemption.
The 2027 Notes have not been and will not be registered under the Securities Act or the securities laws of any other jurisdiction and may not be offered or sold in the U.S. except pursuant to a registration exemption under the Securities Act and applicable state securities laws. The Partnership offered and issued the 2027 Notes only to qualified institutional buyers in accordance with Rule 144A under the Securities Act and to certain non-U.S. persons outside the U.S. in accordance with Regulation S under the Securities Act.
The 2027 Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by us and all of our existing subsidiaries, other than Archrock Partners, L.P. and APLP Finance Corp., which are co-issuers of the 2027 Notes, and certain of our future subsidiaries. The 2027 Notes and the guarantees rank equally in right of payment with all of our and the guarantors’ existing and future senior indebtedness.
Prior to April 1, 2022, the Partnership may redeem all or part of the 2027 Notes at a redemption price equal to
100%
of the principal amount of the 2027 Notes plus a make-whole premium plus accrued and unpaid interest, if any. The Partnership may also redeem up to
35%
of the aggregate principal amount of the 2027 Notes prior to April 1, 2022 with the net proceeds of one or more equity offerings at a redemption price of
106.875%
of the principal amount of the 2027 Notes plus any accrued and unpaid interest as long as at least
65%
of the aggregate principal amount of the 2027 Notes remains outstanding after such redemption and the redemption occurs within 180 days of the closing of such equity offering. On or after April 1, 2022, the Partnership may redeem all or part of the 2027 Notes at redemption prices equal to
105.156%
,
103.438%
and
101.719%
for the 12-month periods beginning on April 1, 2022, 2023 and 2024, respectively, and
100.000%
beginning on April 1, 2025 and at any time thereafter, plus any accrued and unpaid interest.
7. Revenue from Contracts with Customers
Disaggregation of Revenue
The following table presents our revenue from contracts with customers disaggregated by revenue source (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Contract operations
(1)
:
|
|
|
|
0 - 1,000 horsepower per unit
|
$
|
63,739
|
|
|
$
|
59,592
|
|
1,001 - 1,500 horsepower per unit
|
74,340
|
|
|
66,230
|
|
Over 1,500 horsepower per unit
|
43,425
|
|
|
34,410
|
|
Other
(2)
|
1,003
|
|
|
965
|
|
Total contract operations
(3)
|
182,507
|
|
|
161,197
|
|
|
|
|
|
Aftermarket services
(1)
:
|
|
|
|
Services
|
33,521
|
|
|
32,207
|
|
OTC parts and components sales
|
20,131
|
|
|
18,636
|
|
Total aftermarket services
(4)
|
53,652
|
|
|
50,843
|
|
|
|
|
|
Total revenue
|
$
|
236,159
|
|
|
$
|
212,040
|
|
——————
|
|
(1)
|
We operate in
two
segments: contract operations and aftermarket services. See
Note 19
(“Segments”)
for further details regarding our segments.
|
|
|
(2)
|
Primarily relates to fees associated with Archrock-owned non-compressor equipment.
|
|
|
(3)
|
Includes
$2.1 million
and
$1.3 million
for the
three
months ended
March 31, 2019
and 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.
|
Performance Obligations
As of
March 31, 2019
, we had
$285.4 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2020
|
|
2021
|
|
2022
|
|
2023
|
|
Total
|
Remaining performance obligations
|
$
|
179,663
|
|
|
$
|
82,926
|
|
|
$
|
20,634
|
|
|
$
|
2,170
|
|
|
$
|
20
|
|
|
$
|
285,413
|
|
As of
March 31, 2019
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
As of
March 31, 2019
and
December 31, 2018
, our receivables from contracts with customers, net of allowance for doubtful accounts were
$138.6 million
and
$142.1 million
, respectively. As of
March 31, 2019
and
December 31, 2018
, our contract liabilities were
$13.8 million
and
$17.1 million
, respectively, which are included in deferred revenue and other liabilities in our condensed consolidated balance sheets. Freight billings to customers for the transport of compressor assets and milestone billings on aftermarket services often result in a contract liability. During the
three
months ended
March 31, 2019
and 2018 we recognized
$12.7 million
and
$5.2 million
, respectively, as revenue during the period primarily related to freight billings and aftermarket services.
8. Leases
We determine if an arrangement is a lease at inception. We determine lease classification and recognize ROU assets and liabilities on the lease commencement date based on the present value of lease payments over the lease term. As the discount rate implicit in the lease is rarely readily determinable, we estimate our incremental borrowing rate using information available at commencement date in determining the present value of the lease payments. The lease term includes options to extend when we are reasonably certain to exercise the option. Short-term leases, those with an initial term of 12 months or less, are not recorded on the balance sheet. Variable costs such as our proportionate share of actual costs for utilities, common area maintenance, property taxes and insurance are not included in the lease liability and are recognized in the period in which they are incurred. Operating lease expense for lease payments is recognized on a straight-line basis over the term of the lease. As of March 31, 2019, all of our leases were operating.
The facility leases discussed below, of which we are the lessee, contain lease and nonlease components for which we have elected the practical expedient to account for as a single lease component, as the nonlease components are not significant to the total consideration in the contract and separating the nonlease component would have no effect on lease classification. As it relates to our contract operations services agreements in which we are the lessor, the services nonlease component is predominant over the compression unit lease component and therefore ongoing recognition of these agreements will continue to follow the Revenue Recognition Update guidance.
We have operating leases and subleases for office space, temporary housing, storage and shops. Our leases have remaining lease terms of
one
to
12 years
and most include options to extend the lease term, at our discretion, for an additional three to five years. We are not, however, reasonably certain that we will exercise any of the options to extend and as such, they have not been included in the remaining lease terms.
Balance sheet information related to our operating leases was as follows (in thousands):
|
|
|
|
|
|
|
|
Classification
|
|
March 31, 2019
|
ROU assets
|
Operating lease ROU assets
|
|
$
|
18,490
|
|
|
|
|
|
Lease liabilities
|
|
|
|
Current
|
Accrued liabilities
|
|
$
|
2,700
|
|
Noncurrent
|
Operating lease liabilities
|
|
17,201
|
|
Total lease liabilities
|
|
|
$
|
19,901
|
|
The components of lease cost were as follows (in thousands):
|
|
|
|
|
|
Three Months Ended
March 31, 2019
|
Operating lease cost
|
$
|
974
|
|
Short-term lease cost
|
173
|
|
Variable lease cost
|
382
|
|
Total lease cost
|
$
|
1,529
|
|
Cash flow and noncash information related to our operating leases were as follows (in thousands):
|
|
|
|
|
|
Three Months Ended
March 31, 2019
|
Operating cash flows - cash paid for amounts included in the measurement of operating lease liabilities
|
$
|
1,311
|
|
Operating lease ROU assets obtained in exchange for new lease liabilities
|
617
|
|
Other supplemental information related to our operating leases was as follows:
|
|
|
|
|
March 31, 2019
|
Weighted average remaining lease term (in years)
|
9
|
|
Weighted average discount rate
|
5.3
|
%
|
Remaining maturities of lease liabilities governed under ASC 842 Leases as of March 31, 2019 were as follows (in thousands):
|
|
|
|
|
2019
|
$
|
2,453
|
|
2020
|
3,679
|
|
2021
|
3,454
|
|
2022
|
2,397
|
|
2023
|
2,131
|
|
2024
|
1,740
|
|
Thereafter
|
9,310
|
|
Total lease payments
|
25,164
|
|
Less: Interest
|
(5,263
|
)
|
Total lease liabilities under ASC 842 Leases
|
$
|
19,901
|
|
Maturities of lease liabilities governed under ASC 840 Leases as of December 31, 2018 were as follows (in thousands):
|
|
|
|
|
2019
|
$
|
4,317
|
|
2020
|
3,980
|
|
2021
|
3,562
|
|
2022
|
2,433
|
|
2023
|
2,170
|
|
Thereafter
|
11,935
|
|
Total lease liabilities under ASC 840 Leases
|
$
|
28,397
|
|
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
March 31, 2019
, 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
|
|
May 2020
|
100
|
|
March 2022
|
300
|
|
|
$
|
500
|
|
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. 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. During the three months ended March 31, 2019, we performed a quantitative assessment of hedge effectiveness which confirmed that the interest rate swap cash flow hedge relationship was and continues to be highly effective. We estimate that
$2.4 million
of the deferred pre-tax gain attributable to interest rate swaps included in accumulated other comprehensive income at
March 31, 2019
will be reclassified into earnings as interest income at then-current values during the next 12 months as the underlying hedged transactions occur.
As of
March 31, 2019
, the weighted average effective fixed interest rate on the interest rate swaps was
1.8%
.
The following table presents the effect of the derivative instruments designated as cash flow hedging instruments on our condensed consolidated balance sheets (in thousands):
|
|
|
|
|
|
|
|
|
|
Fair Value Asset (Liability)
|
|
March 31, 2019
|
|
December 31, 2018
|
Other current assets
|
$
|
2,428
|
|
|
$
|
3,185
|
|
Other assets
|
1,654
|
|
|
4,122
|
|
|
$
|
4,082
|
|
|
$
|
7,307
|
|
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
March 31,
|
|
2019
|
|
2018
|
Pre-tax gain (loss) recognized in other comprehensive income (loss)
|
$
|
(2,299
|
)
|
|
$
|
4,696
|
|
Pre-tax gain (loss) reclassified from accumulated other comprehensive income into interest expense
|
926
|
|
|
(474
|
)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Total amount of interest expense in which the effects of cash flow hedges are recorded
|
$
|
23,617
|
|
|
$
|
22,547
|
|
Amount of gain (loss) reclassified from accumulated other comprehensive income into interest expense
|
926
|
|
|
(54
|
)
|
See
Note 10
(“Fair Value Measurements”)
and
Note 17
(“Accumulated Other Comprehensive Income”)
for further details on our 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. Our interest rate swap assets measured at fair value on a recurring basis with pricing levels as of
March 31, 2019
and
December 31, 2018
were
$4.1 million
and
$7.3 million
, respectively.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
During the
three
months ended
March 31, 2019
, 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
$0.3 million
and
$2.3 million
at
March 31, 2019
and
December 31, 2018
, 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):
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
December 31, 2018
|
Carrying amount of fixed rate debt
(1)
|
$
|
1,181,717
|
|
|
$
|
690,001
|
|
Fair value of fixed rate debt
|
1,216,000
|
|
|
674,000
|
|
——————
|
|
(1)
|
Carrying amounts are shown net of unamortized debt discounts and unamortized deferred financing costs. See
Note 6
(“Long-Term Debt”)
.
|
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
March 31,
|
|
2019
|
|
2018
|
Idle compressor units retired from the active fleet
|
20
|
|
|
45
|
|
Horsepower of idle compressor units retired from the active fleet
|
15,000
|
|
|
22,000
|
|
Impairment recorded on idle compressor units retired from the active fleet
|
$
|
3,092
|
|
|
$
|
4,710
|
|
12. Hosting Arrangements
In the fourth quarter of 2018 we began a process and technology transformation project that will, among other things, upgrade our existing ERP system, improve our supply chain and inventory management and expand the remote monitoring capabilities of our compression fleet. Included in this project is the implementation of hosting arrangements that are service contracts related to the cloud migration of our ERP system and hosted cloud services for our new mobile workforce telematics tool.
Certain costs incurred for the implementation of our hosting arrangements that are service contracts are being capitalized and will be amortized on a straight-line basis over the term of the respective contract. As of March 31, 2019 and December 31, 2018, we had
$1.1 million
and
$0.4 million
, respectively, of implementation costs related to our hosting arrangements that are service contracts capitalized to other assets in our condensed consolidated balance sheets. Amortization of the capitalized implementation costs will be recorded to SG&A in our consolidated statements of income and is expected to begin in future periods as the individual contract components become ready for their intended use.
13. Income Taxes
The year-to-date effective tax rate for the three months ended March 31, 2019 differed significantly from our statutory rate primarily due to the reduction of a valuation allowance, which was recorded to offset the tax effect of the increase in book income in the three months ended March 31, 2019, as well as the release of an unrecognized tax benefit due to the settlement of a tax audit.
Unrecognized Tax Benefits
As of
March 31, 2019
, we believe it is reasonably possible that
$1.8 million
of our unrecognized tax benefits, including penalties, interest and discontinued operations, will be reduced prior to March 31, 2020 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.
14. Earnings Per Share
Net Income (Loss) Attributable to Archrock Common Stockholders Per Common Share
Basic net 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 net income (loss) attributable to Archrock common stockholders per common share is determined by dividing net 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 net 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, performance-based restricted stock units 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 net income (loss) per common share (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Net income (loss) from continuing operations attributable to Archrock stockholders
|
$
|
19,729
|
|
|
$
|
(3,816
|
)
|
Loss from discontinued operations, net of tax
|
(273
|
)
|
|
—
|
|
Net income (loss) attributable to Archrock stockholders
|
19,456
|
|
|
(3,816
|
)
|
Less: Net income attributable to participating securities
|
(356
|
)
|
|
(157
|
)
|
Net income (loss) attributable to Archrock common stockholders
|
$
|
19,100
|
|
|
$
|
(3,973
|
)
|
The following table shows the potential shares of common stock that were included in computing diluted net income (loss) attributable to Archrock common stockholders per common share (in thousands):
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Weighted average common shares outstanding including participating securities
|
130,238
|
|
|
71,299
|
|
Less: Weighted average participating securities outstanding
|
(2,029
|
)
|
|
(1,383
|
)
|
Weighted average common shares outstanding — used in basic net income (loss) per common share
|
128,209
|
|
|
69,916
|
|
Net dilutive potential common shares issuable:
|
|
|
|
On exercise of options and vesting of performance-based restricted stock units
|
40
|
|
|
*
|
|
On the settlement of employee stock purchase plan shares
|
6
|
|
|
*
|
|
Weighted average common shares outstanding — used in diluted net income (loss) per common share
|
128,255
|
|
|
69,916
|
|
——————
|
|
*
|
Excluded from diluted net 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 net income (loss) attributable to Archrock common stockholders per common share as their inclusion would have been anti-dilutive (in thousands):
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Net dilutive potential common shares issuable:
|
|
|
|
On exercise of options where exercise price is greater than average market value for the period
|
154
|
|
|
223
|
|
On exercise of options and vesting of performance-based restricted stock units
|
—
|
|
|
78
|
|
On the settlement of employee stock purchase plan shares
|
—
|
|
|
3
|
|
Net dilutive potential common shares issuable
|
154
|
|
|
304
|
|
15. Equity
Merger Transaction
In April 2018, we completed the Merger and acquired all of the common units of the Partnership not owned by us prior to the Merger. 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.
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 in the second quarter of 2018 and no gain or loss was recognized in our condensed consolidated statements of operations as a result of the Merger. The tax effects of the Merger were reported as adjustments to other assets, noncurrent assets associated with discontinued operations, deferred income taxes, additional paid-in capital and other comprehensive income.
We incurred
$0.2 million
and
$4.1 million
of transaction costs directly attributable to the Merger during the
three
months ended
March 31, 2019
and 2018, respectively, including financial advisory, legal service and other professional fees, which were recorded to Merger-related costs in our condensed consolidated statements of operations.
Prior to the Merger, at March 31, 2018, public unitholders held a
57%
ownership interest in the Partnership and we owned the remaining
43%
equity interest. The earnings of the Partnership that were attributed to its common units held by the public prior to the Merger are reflected in net income attributable to the noncontrolling interest in our condensed consolidated statements of operations. There were no changes in our ownership interest in the Partnership during the three months ended
March 31, 2018
.
Cash Dividends
The following table summarizes our dividends declared and paid:
|
|
|
|
|
|
|
|
|
|
Dividends per
Common Share
|
|
Total Dividends
(in thousands)
|
2018
|
|
|
|
Q1
|
$
|
0.120
|
|
|
$
|
8,532
|
|
Q2
|
0.120
|
|
|
15,486
|
|
Q3
|
0.132
|
|
|
17,114
|
|
Q4
|
0.132
|
|
|
17,156
|
|
|
|
|
|
2019
|
|
|
|
Q1
|
$
|
0.132
|
|
|
$
|
17,231
|
|
On
April 24, 2019
, our board of directors declared a quarterly dividend of
$0.132
per share of common stock to be paid on
May 15, 2019
to stockholders of record at the close of business on
May 8, 2019
.
16. Stock-Based Compensation
We have granted restricted stock, restricted stock units, and performance based restricted stock units to employees and non-employee directors under the Archrock, Inc. 2013 Stock Incentive Plan.
The following table presents restricted stock, restricted stock unit, performance-based restricted stock unit and cash- settled performance unit activity during the
three
months ended
March 31, 2019
:
|
|
|
|
|
|
|
|
|
Shares
(in thousands)
|
|
Weighted
Average
Grant Date
Fair Value
Per Share
|
Non-vested awards, January 1, 2019
|
1,728
|
|
|
$
|
9.68
|
|
Granted
|
1,380
|
|
|
10.01
|
|
Vested
|
(379
|
)
|
|
6.13
|
|
Canceled
|
(15
|
)
|
|
9.99
|
|
Non-vested awards, March 31, 2019
(1)
|
2,714
|
|
|
10.34
|
|
——————
|
|
(1)
|
Non-vested awards as of
March 31, 2019
are comprised of
376,000
cash-settled restricted stock units and cash-settled performance units and
2,338,000
restricted shares and stock-settled performance units.
|
As of
March 31, 2019
, we expect
$21.5 million
of unrecognized compensation cost related to unvested restricted stock, stock-settled restricted stock units, performance units, cash-settled restricted stock units and cash-settled performance units to be recognized over the weighted-average period of
2.4
years.
Total stock-based compensation expense consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Equity awards
|
$
|
2,357
|
|
|
$
|
1,794
|
|
Liability awards
|
966
|
|
|
301
|
|
Total stock-based compensation
|
$
|
3,323
|
|
|
$
|
2,095
|
|
17. 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 consists of changes in the fair value of our interest rate swap derivative instruments, net of tax, which 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 of our derivative cash flow hedges, net of tax and excluding noncontrolling interest, during the
three
months ended
March 31, 2019
and
2018
(in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Beginning accumulated other comprehensive income
|
$
|
5,773
|
|
|
$
|
1,197
|
|
Gain (loss) recognized in other comprehensive income (loss), net of tax provision of $0 and $416, respectively
(1)
|
(2,299
|
)
|
|
1,572
|
|
(Gain) loss reclassified from accumulated other comprehensive income (loss) to interest expense, net of tax benefit of $0 and $(45), respectively
(1)(2)
|
(926
|
)
|
|
425
|
|
Other comprehensive income (loss) attributable to Archrock stockholders
|
(3,225
|
)
|
|
1,997
|
|
Ending accumulated other comprehensive income
|
$
|
2,548
|
|
|
$
|
3,194
|
|
——————
|
|
(1)
|
Included adjustment of
$0.7 million
related to an increase in the valuation allowance recorded to offset the tax effect of other comprehensive loss recorded during the three months ended March 31, 2019.
|
|
|
(2)
|
Included stranded tax effects resulting from the Tax Cuts and Jobs Act, which was implemented in December 2017, of
$0.3 million
reclassified to accumulated deficit during the
three
months ended March 31, 2018.
|
See
Note 9
(“Derivatives”)
for further details on our interest rate swap derivative instruments.
18. 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 2019 through the first quarter of 2020 and maximum potential future payments of
$2.3 million
. As of
March 31, 2019
, 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 each of
March 31, 2019
and
December 31, 2018
, we accrued
$4.5 million
for the outcomes of non-income based tax audits. We do not expect that the ultimate resolutions of these audits will result in a material variance from the amounts accrued. We do not accrue for unasserted claims for tax audits unless we believe the assertion of a claim is probable, it is probable that it will be determined that the claim is owed and we can reasonably estimate the claim or range of the claim. We believe the likelihood is remote that the impact of potential unasserted claims from non-income based tax audits could be material to our consolidated financial position, but it is possible that the resolution of future audits could be material to our consolidated results of operations or cash flows.
Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. The tax contingencies mentioned above relate to tax matters for which we are responsible in managing the audit. As of
March 31, 2019
and
December 31, 2018
, we recorded an indemnification liability (including penalties and interest), in addition to the tax contingency above, of
$2.7 million
and
$2.6 million
, respectively, for our share of non-income based tax contingencies related to audits being managed by Exterran Corporation.
Insurance Matters
Our business can be hazardous, involving unforeseen circumstances such as uncontrollable flows of natural gas or well fluids and fires or explosions. As is customary in our industry, we review our safety equipment and procedures and carry insurance against some, but not all, risks of our business. Our insurance coverage includes property damage, general liability and commercial automobile liability and other coverage we believe is appropriate. We believe that our insurance coverage is customary for the industry and adequate for our business; however, losses and liabilities not covered by insurance would increase our costs.
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.
The SEC has been conducting an investigation in connection with certain previously disclosed errors and irregularities at one of our former international operations. The SEC’s investigation related to the circumstances giving rise to the restatement of prior period consolidated and combined financial statements. On April 8, 2019, we received notice that the investigation had concluded with no enforcement action.
19. Segments
We manage our business segments primarily based on the type of product or service provided. We have
two
segments which we operate within the U.S.: contract operations and aftermarket services. The contract operations segment primarily provides natural gas compression services to meet specific customer requirements. The aftermarket services segment provides a full range of services to support the compression needs of customers, from 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
months ended
March 31, 2019
and
2018
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
Operations
|
|
Aftermarket
Services
|
|
Total
|
Three months ended March 31, 2019
|
|
|
|
|
|
Revenue
|
$
|
182,507
|
|
|
$
|
53,652
|
|
|
$
|
236,159
|
|
Gross margin
|
107,772
|
|
|
9,750
|
|
|
117,522
|
|
Three months ended March 31, 2018
|
|
|
|
|
|
Revenue
|
$
|
161,197
|
|
|
$
|
50,843
|
|
|
$
|
212,040
|
|
Gross margin
|
96,602
|
|
|
8,506
|
|
|
105,108
|
|
The following table reconciles total gross margin to income before income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2019
|
|
2018
|
Total gross margin
|
$
|
117,522
|
|
|
$
|
105,108
|
|
Less:
|
|
|
|
Selling, general and administrative
|
28,989
|
|
|
27,508
|
|
Depreciation and amortization
|
44,106
|
|
|
44,455
|
|
Long-lived asset impairment
|
3,092
|
|
|
4,710
|
|
Restatement and other charges
|
421
|
|
|
485
|
|
Interest expense
|
23,617
|
|
|
22,547
|
|
Merger-related costs
|
180
|
|
|
4,125
|
|
Other income, net
|
(205
|
)
|
|
(1,145
|
)
|
Income before income taxes
|
$
|
17,322
|
|
|
$
|
2,423
|
|
20. Subsequent Events
On April 5, 2019, the Partnership borrowed on the Partnership Credit Facility to repay the Partnership's
6%
senior notes due April 2021. The notes were redeemed at
100%
of their
$350.0 million
aggregate principal amount plus accrued and unpaid interest of
$0.2 million
. The Partnership will record a debt extinguishment loss of approximately
$3.7 million
in the second quarter related to the redemption.