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Item 7. Management’s Discussion and Analysis

2021-02-23 compared with 2020-02-21 · 244 added, 228 removed, 296 unchanged (61% of the section changed)

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Our aftermarket services business provides a full range of services to support the compression needs of our customers that own compression equipment including operations, maintenance, overhaul and reconfiguration services and sales of parts and components.

Recent Business Developments

2028 Notes Offering

Significant 2020 Transactions

December 2020 Notes Offering

On December 17, 2020, we completed a private offering of $300.0 million aggregate principal amount of 6.25% senior notes due April 2028.

We received net proceeds of $491.8 million after issuance costs, which were used to repay borrowings outstanding under our Credit Facility.

The notes were issued at 104.875% of their face value and we received net proceeds of $309.9 million after deducting issuance costs, which were used to repay borrowings outstanding under our Credit Facility.

See Note 14 (“Long-Term Debt”) to our Financial Statements for further details of this transaction.

Amendment to the Credit Facility

On November 8, 2019, we entered into Amendment No.

2, which extended the maturity date of, and changed the applicable margins for borrowings under, our Credit Facility.

See Part II Item 7 “Liquidity and Capital Resources — Financial Resources” and Note 13 (“Long-Term Debt”) to our Financial Statements for further details of this amendment.

Elite Acquisition

On August 1, 2019, we completed the Elite Acquisition whereby we acquired from Elite Compression substantially all of its assets, including a fleet of predominantly large compressors comprising approximately 430,000 horsepower, vehicles, real property and inventory, and certain liabilities for aggregate consideration consisting of $214.0 million in cash and 21.7 million shares of common stock with an acquisition date fair value of $225.9 million .

The cash portion of the acquisition was funded with borrowings on the Credit Facility.

On August 1, 2019, we completed an asset sale in which Harvest acquired from us approximately 80,000 active and idle compression horsepower, vehicles and parts inventory for cash consideration of $30.0 million .

We recorded a $6.6 million gain on the sale of these assets during 2019.

See Note 4 (“Business Transactions”) to our Financial Statements for further details of the Elite Acquisition and the Harvest Sale.

2027 Notes Offering and 2021 Notes Extinguishment

On March 21, 2019, we completed a private offering of $500.0 million aggregate principal amount of 6.875% senior notes due April 2027.

We received net proceeds of $491.2 million after issuance costs, which were used to repay borrowings outstanding under our Credit Facility.

On April 5, 2019, we repaid the 2021 Notes with borrowings from our Credit Facility.

See Note 13 (“Long-Term Debt”) to our Financial Statements for further details of these transactions.

July 2020 Disposition

On July 9, 2020, we completed the sale of the turbocharger business included within our aftermarket services segment.

We recognized a gain on the sale of $9.3 million during the year ended December 31, 2020.

See Note 4 (“Business Transactions”) to our Financial Statements for further details of this transaction.

2022 Notes Redemption

On April 1, 2020, we repaid the 2022 Notes with borrowings under our Credit Facility.

See Note 14 (“Long-Term Debt”) to our Financial Statements for further details of this transaction.

March 2020 Disposition

On March 1, 2020, we completed the sale of certain contract operations customer service agreements and approximately 200 compressors, comprising approximately 35,000 horsepower, used to provide compression services under those agreements as well as other assets used to support the operations.

We recognized a gain on the sale of $3.2 million during the year ended December 31, 2020.

See Note 4 (“Business Transactions”) to our Financial Statements for further details of this transaction.

Trends and Outlook

The key driver of our business is the production of U.S.

crude oil and natural gas.

Approximately 70% of our operating fleet is deployed for midstream applications with the remaining fleet being used in wellhead and gas lift applications to enhance oil production.

Changes in oil and natural gas production spending therefore typically result in changes in demand for our services.

Spending on oil and natural gas exploration and production typically declines when there is a significant and prolonged reduction in oil and natural gas prices or significant instability in energy markets and increases during periods of rising prices and market stability.

natural gas and crude oil.

Approximately 75% of our operating fleet is deployed for midstream natural gas gathering and wellhead applications, with the remaining fleet being used in gas lift applications to enhance crude oil production.

Changes in natural gas and crude oil production spending therefore typically result in changes in demand for our services.

Spending on natural gas and crude oil exploration and production typically declines when there is a significant and prolonged reduction in natural gas and crude oil prices or significant instability in energy markets and increases during periods of rising prices and market stability.

As our business is so closely aligned with production and is typically less directly impacted by commodity prices, we are not exposed to the volatility often faced in shorter-cycle oil field service businesses.

Increased global demand for U.S.

oil and natural gas production in recent years has contributed to increased production for both resources and record U.S.

COVID-19 Pandemic

In the first quarter of 2020, the COVID-19 pandemic caused a deterioration in global macroeconomic conditions, including a collapse in the demand for natural gas and crude oil coupled with an oversupply of crude oil, which led to substantial spending cuts by our customers and a decline in natural gas and crude oil production.

This global response to the pandemic has adversely impacted our market capitalization, revenue and cash flows.

Though demand has shown modest improvement since the lows reached in the second quarter as economies started to reopen, additional surges of the disease are currently underway globally and much uncertainty still exists surrounding the magnitude and duration of the pandemic and resulting economic downturn.

Similarly, the duration of the decreased spending and activity levels of our customers and the timing of their full impact on production remain difficult to predict.

The impact of the COVID-19 pandemic on our 2020 results is primarily visible in the $99.8 million non-cash impairment of our goodwill and the impairment’s resulting $22.6 million tax benefit.

Horsepower, utilization and revenue experienced declines beginning in the second quarter as compared to 2019 and are expected to remain at lower levels into 2021 in both our contract operations and aftermarket services businesses.

Long-lived and other asset impairment and restructuring charges have also been significantly impacted.

See “Financial Results of Operations” below and Note 9 (“Goodwill”), Note 18 (“Long-Lived and Other Asset Impairment”), Note 19 (“Restructuring Charges”) and Note 20 (“Income Taxes”) to our Financial Statements for further discussion.

In recent years, prior to the COVID-19 pandemic, increased global demand for U.S.

natural gas and crude oil production had contributed to increased production for both resources and record U.S.

natural gas production in 2018 and 2019.

Production fell sharply in the second quarter of 2020, however, as a result of the global response to the COVID-19 pandemic.

According to the EIA, average U.S.

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Average crude oil production (MMb/d)

These increases in production resulted in strong demand for our compression services in 2019 and 2018 .

Additionally, we increased our investment in new fleet units in each of 2019 , 2018 and 2017 to take advantage of improved market conditions.

As a result of this increased demand and investment, our contract operations revenue and average operating horsepower increased 15% and 10%, respectively, in 2019 compared to 2018 and 10% and 7%, respectively, in 2018 compared to 2017.

The EIA forecasts the following year-over-year changes in its January 2020 Short-Term Energy Outlook report:

The increases in production in 2018 and 2019 resulted in strong demand for our compression services in those years and into the first quarter of 2020.

Additionally, we increased our investment in new fleet units in 2019 and 2018 to take advantage of improved market conditions.

As a result of this increased demand and investment, our contract operations revenue and average operating horsepower increased 15% and 10%, respectively, in 2019 compared to 2018.

In 2020, however, the decrease in demand and production brought on by the COVID-19 pandemic drove revenue and average operating horsepower back down to below 2019 levels.

The EIA forecasts the following year-over-year changes in its February 2021 Short-Term Energy Outlook report:

Increase (Decrease)

dry natural gas production

Liquefied natural gas exports

crude oil production

Long term, the EIA expects dry natural gas production to increase 10% through 2024.

We believe that the abundance and economics of U.S.

shale and relative price stability of natural gas in the U.S.

will continue to drive demand for U.S.

natural gas for liquefied natural gas exports, natural gas exports via pipeline to Mexico and natural gas use in power generation and as a petrochemical feedstock.

natural gas domestic consumption

Liquefied natural gas exports

Overall, U.S.

natural gas and crude oil production is expected to show a modest decline in 2021 as producers limit drilling and completion activity to achieve maintenance levels of production and cash flows in the course of the COVID-19 pandemic.

Accordingly, we anticipate demand for our compression services to also decrease, though with a potential for improved conditions later in 2021 and into 2022.

Long term, the EIA expects dry natural gas production to increase 7% and 12% through 2025 and 2030, respectively.

Natural gas provides an affordable and reliable solution that we believe will play a prominent role in a cleaner energy mix, even as energy generation from renewables increases.

We believe that the U.S.

natural gas compression services industry continues to have growth potential over time due to, among other things, increased natural gas production in the U.S.

from unconventional sources, aging producing natural gas fields that will require more compression to continue producing the same volume of natural gas and expected increased demand for natural gas in the U.S.

for power generation, industrial uses and exports, including liquefied natural gas exports and exports of natural gas via pipeline to Mexico.

We expect that such an increase in demand for U.S.

natural gas will in turn lead to continued strong demand for compression services.

We anticipate that the horsepower acquired in the Elite Acquisition, together with continued strong demand for compression services, will help to maintain our high utilization and result in an increase in revenue in 2020 as compared to 2019 and 2018 in our contract operations business.

In our aftermarket services business, though activity levels decreased in 2019, the base of owned compression in the U.S.

In our aftermarket services business, though activity levels decreased in 2020 and 2019 as customers deferred maintenance activities, the base of owned compression in the U.S.

has increased over the past several years, which we believe will help sustain our aftermarket services business over the long term.

Certain Key Challenges and Uncertainties

In addition to general market conditions in the oil and natural gas industry and competition in the natural gas compression industry, we believe the following represent some of the key challenges and uncertainties we will face in the future.

Key Challenges and Uncertainties

In addition to general market conditions in the oil and gas industry and competition in the natural gas compression industry, we believe the following represent the key challenges and uncertainties we will face in the future.

Capital Requirements and the Availability of External Sources of Capital.

We funded a significant portion of our capital expenditures and the cash portion of the Elite Acquisition through borrowings under the Credit Facility and issued additional debt such that we now have a substantial amount of debt, which could limit our ability to fund future planned capital expenditures.

We have funded a significant portion of our capital expenditures and acquisitions through borrowings under the Credit Facility and have issued additional debt such that we now have a substantial amount of debt, which could limit our ability to fund future planned capital expenditures.

Current conditions could limit our ability to access the debt and equity markets to raise capital on affordable terms in 2021 and beyond.

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Cost Management .

In 2020, we will likely face rising costs due to manufacturer price increases and higher labor costs due to low unemployment rates in many of our operating areas.

To address rising costs, we are actively working to retain employees, negotiating sourcing agreements with vendors and passing cost increases through to customers where appropriate.

In addition, in order to improve our operations, in the fourth quarter of 2018 we began a process and technology transformation project that will, among other things, upgrade or replace our existing ERP, supply chain and inventory management systems and expand the remote monitoring capabilities of our compression fleet.

We believe these improvements will reduce our operating costs and increase our uptime.

We expensed $6.3 million in 2019 related to this project, and we anticipate that the project will continue to require significant resources and result in increased SG&A expense and capital expenditures for the implementation of new technologies in 2020.

In anticipation of lower customer activity levels in response to the COVID-19 pandemic, we implemented a plan in the second quarter of 2020 to reduce our annual operating, corporate and capital costs by between $75 million and $85 million.

In addition, in order to improve our operations, in late 2018 we began a process and technology transformation project that will, among other things, upgrade or replace our existing ERP, supply chain and inventory management systems and expand the remote monitoring capabilities of our compression fleet.

We believe these improvements will reduce our operating costs and increase our uptime, and we anticipate that the project will continue to require significant resources and result in increased SG&A expense and capital expenditures for the implementation of new technologies in 2021.

Cost management continues to be challenging and there is no guarantee that our efforts will result in a reduction in our operating expenses.

Continued natural gas production growth and resulting demand for our services could also cause us to experience increased operating expenses as we hire employees and incur additional expenses needed to support the market demand.

Natural gas production growth and resulting demand for our services, once resumed, could also cause us to experience increased operating expenses as we hire employees and incur additional expenses needed to support the rebound in market demand.

We believe that our ability to hire, train and retain qualified personnel will continue to be important.

Although we have been able to satisfy our personnel needs thus far, retaining employees in our industry continues to be a challenge.

Our ability to grow and to continue our current level of service to our customers will depend in part on our success in hiring, training and retaining our employees.

Although we have been able to historically satisfy our personnel needs, retaining employees in our industry continues to be a challenge.

Our ability to grow and to continue our current level of service to our customers will depend in part on our success in hiring, training and retaining our employees, including those employees impacted by our headcount reduction and furloughs through the course of the COVID-19 pandemic.

Later-Cycle Market Participant.

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As such, we anticipate that any significant change in the demand for our contract operations services will generally lag a change in drilling activity.

Increased oil and natural gas production in 2017, 2018 and 2019 contributed to increased new orders for our compression services in 2017 and 2018.

Despite these new orders, revenue gains were not realized until 2018 and 2019 as the operating horsepower declines and pricing pressure experienced prior to 2017 resulted in a decline in our revenue in 2017.

Dry natural gas production, one of the key drivers of our business, increased 12% in 2018 and 10% in 2019 and is expected to increase 10% in 2020 through 2024.

We believe this production growth will continue to increase demand for compression services, which we expect will result in continued increases in revenue and gross margin, though on a lag of several quarters or more.

Increased natural gas and crude oil production in 2018 and 2019 contributed to increased new orders for our compression services during those years and into the first quarter of 2020, the revenue gains from which were realized in 2019 and the first quarter of 2020.

In the second quarter of 2020, however, customer demand dropped sharply in response to the COVID-19 pandemic, and the associated decrease in our revenue occurred almost immediately.

Dry natural gas production, one of the key drivers of our business, increased 12% in 2018 and 10% in 2019 before falling 1% in 2020, and is expected to increase 7% in 2021 through 2025.

We believe that, similar to the rapid drops in customer demand and associated revenue experienced this year, our revenue will increase concurrently with a pickup in customer demand as the COVID-19 pandemic runs its course.

Long term, we expect to return to the more traditional cycle in which production growth increases demand for compression services, which results in increases in revenue and gross margin, though on a lag of several quarters or more.

Customer deferrals.

Our aftermarket services revenue decreased in 2019 as customers deferred near-term maintenance activities.

Our aftermarket services revenue decreased in 2020 and 2019 as customers deferred near-term maintenance activities.

We believe the large installed base of owned compression supports the long-term fundamentals of the aftermarket services business:

however, the timing of a recovery is difficult to predict.

We remain focused on cost management and the higher margin business within our aftermarket services operations.

however, the timing of a recovery is difficult to predict, particularly in light of the economic downturn caused by the COVID-19 pandemic.

In the meantime, we remain focused on cost management and the higher margin business within our aftermarket services operations.

Increasing customer focus on free cash flow .

Many of our customers are transitioning their business model to focus on sustainable free cash flow generation rather than growth.

Prior to the COVID-19 pandemic, many of our customers had begun transitioning their business model to focus on sustainable free cash flow generation rather than growth, and the COVID-19 pandemic has further fueled this change in focus.

We expect this transition to have a positive impact on the industry in the long term, as we anticipate the change will reduce volatility through cycles and improve the financial strength of our customers.

In the near term, however, we can expect this transition to result in a deceleration in the natural gas production growth rate, to which demand for our products and services is closely aligned.

In the near term, however, we can expect this transition, combined with the impact of the COVID-19 pandemic, to result in a deceleration in the natural gas production growth rate, to which demand for our products and services is closely aligned.

Operating Highlights

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Gross margin has certain material limitations associated with its use as compared to net income (loss).

These limitations are primarily due to the exclusion of SG&A, depreciation and amortization, impairments, restatement and other charges, restructuring and other charges, interest expense, debt extinguishment loss, transaction-related costs, gain (loss) on sale of assets, net, other income (loss), net, provision for (benefit from) income taxes and loss from discontinued operations, net of tax.

These limitations are primarily due to the exclusion of SG&A, depreciation and amortization, impairments, restatement and other charges, restructuring charges, interest expense, debt extinguishment loss, transaction-related costs, (gain) loss on sale of assets, net, other (income) loss, net, provision for (benefit from) income taxes and loss from discontinued operations, net of tax.

Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue.

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To compensate for these limitations, management uses this non-GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.

The following table reconciles net income to gross margin (in thousands):

The following table reconciles net income (loss) to gross margin (in thousands):

Year Ended December 31,

Net income (loss)

Selling, general and administrative

Depreciation and amortization

Long-lived asset impairment

Long-lived and other asset impairment

Goodwill impairment

Restatement and other charges

Restructuring and other charges

Restructuring charges

Interest expense

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Revenue was $875.0 million, $965.5 million and $904.4 million during the years ended December 31, 2020, 2019 and 2018, respectively.

The decrease in revenue during the year ended December 31, 2020 compared to the year ended December 31, 2019 was due to decreases in revenue from our contract operations and aftermarket services businesses.

The increase in revenue during the year ended December 31, 2019 compared to the year ended December 31, 2018 was due to an increase in revenue from our contract operations business, partially offset by a decrease in revenue from our aftermarket services business.

The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was due to increases in revenue from our contract operations and aftermarket services businesses.

See “Contract Operations” and “Aftermarket Services” below for further details.

Net income attributable to Archrock stockholders.

We generated net income attributable to Archrock stockholders of $97.3 million , $21.1 million and $19.0 million during the years ended December 31, 2019 , 2018 and 2017 , respectively.

The increase in net income attributable to Archrock stockholders during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily driven by an increase in gross margin from our contract operations business, the change in provision for (benefit from) income taxes, an increase in gain on sale of assets, net and the decrease in net income attributable to the noncontrolling interest, partially offset by increases in long-lived asset impairment, SG&A, depreciation and amortization and interest expense.

The increase in net income attributable to Archrock stockholders during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily driven by the increase in gross margin from our contract operations and aftermarket services businesses and decreases in depreciation and amortization, SG&A and restatement and other charges, partially offset by the change in provision for (benefit from) income taxes, transaction-related costs, the change in net income (loss) attributable to the noncontrolling interest and an increase in interest expense.

Net income (loss) attributable to Archrock stockholders.

We had a net loss attributable to Archrock stockholders of $68.4 million and net income attributable to Archrock stockholders of $97.3 million and $21.1 million during the years ended December 31, 2020, 2019 and 2018, respectively.

The change from net income to net loss attributable to Archrock stockholders during the year ended December 31, 2020 compared to the year ended December 31, 2019 was primarily driven by goodwill impairment of $99.8 million, increases in long-lived and other asset impairment, restructuring charges and depreciation and amortization and decreases in benefit from income taxes, gain on sale of assets, net and gross margin from our aftermarket services business, partially offset by decreases in SG&A and transaction-related costs and an increase in gross margin from our contract operations business.

The increase in net income attributable to Archrock stockholders during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily driven by an increase in gross margin from our contract operations business, the change in provision for (benefit from) income taxes, an increase in gain on sale of assets, net and the decrease in net income attributable to noncontrolling interest, partially offset by increases in long-lived and other asset impairment, SG&A, depreciation and amortization and interest expense.

Financial Results of Operations:

Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

Contract Operations

(dollars in thousands)

Year Ended December 31,

(in thousands)

Cost of sales (excluding depreciation and amortization)

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(1) Defined as gross margin divided by revenue.

The increase in revenue during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to an increase in contract operations rates driven by an increase in customer demand, an increase in average operating horsepower (excluding the horsepower acquired in the Elite Acquisition) and $33.2 million of revenue associated with the compression assets acquired in the Elite Acquisition.

Gross margin increased during the year ended December 31, 2019 compared to the year ended December 31, 2018 primarily due to the increase in revenue mentioned above partially offset by the increase in cost of sales.

The increase in cost of sales was primarily driven by increases in maintenance, freight and lube oil expense associated with the increase in average operating horsepower and the horsepower acquired in the Elite Acquisition.

These increases in cost of sales were partially offset by a decrease in cost associated with the start-up of compression packages, as the majority of the increase in average operating horsepower was comprised of newly-built compressors.

Gross margin percentage increased during the year ended December 31, 2019 compared to the year ended December 31, 2018 primarily due to the increase in contract operations rates mentioned above.

Revenue decreased primarily due to returns of horsepower amidst the market downturn, the strategic disposition of horsepower in 2019 and 2020 and a decrease in revenues associated with reduced mobilization activity.

These decreases in revenue were partially offset by a $43.5 million increase in revenue attributable to the horsepower acquired in the Elite Acquisition in August 2019.

Gross margin increased due to the decrease in cost of sales, which was partially offset by the decrease in revenue discussed above.

The decrease in cost of sales was primarily driven by decreases in costs to mobilize compression packages, maintenance expense and lube oil expense, all of which were chiefly driven by the decreases in operating horsepower mentioned above.

In addition, there was a decrease in sales and use tax as the result of audit settlements in 2020.

These decreases were partially offset by increases in maintenance expense and lube oil expense associated with the horsepower acquired in the Elite Acquisition.

Aftermarket Services

(dollars in thousands)

Year Ended December 31,

(in thousands)

Cost of sales (excluding depreciation and amortization)

Gross margin percentage

The decrease in revenue during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to decreases in parts sales and service activities as customers deferred maintenance activities.

Gross margin decreased during the year ended December 31, 2019 compared to the year ended December 31, 2018 due to the decrease in revenue mentioned above, partially offset by a smaller decrease in cost of sales.

The decrease in cost of sales was primarily driven by the decrease in parts sales and service activities.

The decrease in revenue was due to decreases in service activities and parts sales, which were primarily driven by reduced customer demand and customer deferral of maintenance activities.

Gross margin decreased due to this decrease in revenue, but benefited from a decrease in cost of sales, which was driven by the same decrease in service activities and parts sales.

Costs and Expenses

(dollars in thousands)

Year Ended December 31,

(in thousands)

Selling, general and administrative

Depreciation and amortization

Long-lived asset impairment

Long-lived and other asset impairment

Goodwill impairment

Restatement and other charges

Restructuring charges

Interest expense

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Selling, general and administrative.

The increase in SG&A expense during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to a $9.2 million increase in sales and use tax expense primarily resulting from the settlement of audits in 2018, a $4.1 million increase in costs related to our process and technology transformation project and a $2.7 million increase in compensation and benefits.

The decrease in SG&A was primarily due to a $6.2 million decrease in sales and use tax that was mainly driven by audit settlements, a $2.1 million decrease in professional expenses, a $2.1 million decrease in compensation and benefits and a $1.9 million decrease in employee travel and meeting expenses.

These decreases were partially offset by a $1.0 million increase in bad debt expense.

Depreciation and amortization.

The increase in depreciation and amortization expense during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to an increase in depreciation expense associated with fixed asset additions, which was partially offset by a decrease in expense from assets reaching the end of their useful lives, asset retirements and the impact of asset impairments during 2018 and 2019.

The increase in depreciation expense was partially offset by a decrease in amortization expense that primarily resulted from certain intangible assets reaching the end of their useful lives, partially offset by amortization expense related to the intangible assets acquired in the Elite Acquisition.

Long-lived asset impairment.

During the years ended December 31, 2019 and 2018 , we reviewed the future deployment of our idle compressors for units that were not of the type, configuration, condition, make or model that are cost efficient to maintain and operate.

In addition, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale.

See Note 17 (“Long-Lived Asset Impairment”) to our Financial Statements for further details.

The following table presents the results of our impairment review, as recorded to our contract operations segment (dollars in thousands):

The increase in depreciation and amortization was primarily due to an increase in depreciation expense associated with fixed asset additions during 2019, including the fixed assets acquired in the Elite Acquisition, and the first half of 2020, partially offset by a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives as well as the impact of asset impairments in 2019 and the first half of 2020 and compression asset sales during 2019.

Long-lived and other asset impairment.

Each quarter, we review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate.

In addition, we evaluate for impairment idle units that have been culled from our compression fleet in prior years and are available for sale.

See Note 18 (“Long-Lived and Other Asset Impairment”) to our Financial Statements for further details.

The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment (dollars in thousands):

Year Ended December 31,

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Impairment recorded on idle compressors retired from the active fleet

Restatement and other charges.

During the years ended December 31, 2019 and 2018 , we recorded expense of $0.4 million and $1.3 million, respectively, for our share of professional and legal fees related to the restatement of prior period financial statements and disclosures and related matters.

We recorded $1.3 million for the expected recovery of shared fees incurred during the year ended December 31, 2018 .

Also during the year ended December 31, 2020, $1.7 million of capitalized implementation and unamortized prepaid costs related to the mobile workforce component of our multi-year process and technology transformation project was impaired.

See Note 12 (“Hosting Arrangements”) to our Financial Statements for further details.

Goodwill impairment.

During the year ended December 31, 2020, we recorded $99.8 million of goodwill impairment due to the decline in the fair value of our contract operations reporting unit.

See Note 9 (“Goodwill”) to our Financial Statements for further details.

Restructuring charges .

We recorded $8.5 million of severance and property disposal costs related to restructuring activities during the year ended December 31, 2020.

See Note 19 (“Restructuring Charges”) to our Financial Statements for further details .

Interest expense.

The increase in interest expense during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to an increase in the average outstanding balance of long-term debt, partially offset by a decrease in the weighted average effective interest rate.

The increase in interest expense was primarily due to an increase in the average outstanding balance of long-term debt, partially offset by a decrease in the weighted average effective interest rate.

Debt extinguishment loss.

We recorded a debt extinguishment loss of $4.0 million during the year ended December 31, 2020 as a result of the redemption of the 2022 Notes.

We recorded a debt extinguishment loss of $2.5 million during the year ended December 31, 2018 as a result of the termination of the Archrock Credit Facility.

We recorded a debt extinguishment loss of $3.7 million during the year ended December 31, 2019 as a result of the redemption of the 2021 Notes.

See Note 14 (“Long-Term Debt”) to our Financial Statements for further details.

Transaction-related costs.

We incurred $8.2 million and $10.2 million of financial advisory, legal and other professional fees during the years ended December 31, 2019 and 2018, respectively.

The $8.2 million of fees incurred during the year ended December 31, 2019 related primarily to the Elite Acquisition.

The $10.2 million of fees incurred during the year ended December 31, 2018 related to the Merger.

See Note 4 (“Business Transactions”) and Note 15 (“Equity”) to our Financial Statements for further details of these transactions.

We incurred $8.2 million of financial advisory, legal and other professional fees during the year ended December 31, 2019 related primarily to the Elite Acquisition.

Gain on sale of assets, net.

The increase in gain on sale of assets, net was primarily due to a $6.6 million gain related to the Harvest Sale during the year ended December 31, 2019 and a $3.2 million increase in gains recognized on other compression equipment sales during the year ended December 31, 2019 compared to the year ended December 31, 2018 .

See Note 4 (“Business Transactions”) for further details of the Harvest Sale.

Our net gain on the sale of assets during the year ended December 31, 2020 was primarily due to a $9.3 million gain on the July 2020 Disposition, a $3.2 million gain on the March 2020 Disposition, which included a $4.8 million gain on the compression assets sold, and gains of $3.7 million on sales of transportation and shop equipment.

These gains were offset by a $5.1 million loss on other compression assets sold during 2020.

Our net gain on the sale of assets during the year ended December 31, 2019 was primarily due to a $6.6 million gain on the Harvest Sale, gains of $7.9 million on other 2019 compression asset sales and gains of $1.6 million on sales of transportation and shop equipment.

Other income, net.

The increase in other income, net during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to a $0.9 million decrease in indemnification expense incurred pursuant to our tax matters agreement with Exterran Corporation and income of $0.3 million related to equipment damaged at a customer site during 2019, partially offset by $0.5 million in indemnification income earned pursuant to that same tax matters agreement during 2018 and a $0.3 million decrease in interest income earned related to tax refunds and settlements.

Provision for (Benefit from) Income Taxes

(dollars in thousands)

The increase in other income, net was primarily due to a $0.7 million decrease in indemnification expense incurred pursuant to our tax matters agreement with Exterran Corporation.

Benefit from Income Taxes

Year Ended December 31,

Provision for (benefit from) income taxes

(in thousands)

Benefit from income taxes

Effective tax rate

The change in provision for (benefit from) income taxes was primarily due to the release of a valuation allowance in the year ended December 31, 2019 , as well as a higher release of an unrecognized tax benefit due to the settlement of a tax audit in the year ended December 31, 2019 compared to the year ended December 31, 2018 .

The decrease in benefit from income taxes was primarily due to the release of a valuation allowance and the release of an unrecognized tax benefit due to the settlement of a tax audit during the year ended December 31, 2019, partially offset by the tax effect of the decrease in book income during the year ended December 31, 2020 compared to the year ended December 31, 2019.

See Note 20 (“Income Taxes”) to our Financial Statements for further details.

Net Income Attributable to the Noncontrolling Interest

(dollars in thousands)

Year Ended December 31,

Net income attributable to the noncontrolling interest

Net income attributable to the noncontrolling interest was the portion of the Partnership’s earnings that were applicable to the Partnership’s publicly-held common unitholder interest through the completion of the Merger.

Immediately prior to the Merger, public unitholders held a 57% ownership interest in the Partnership.

Subsequent to the Merger, the Partnership is a wholly-owned subsidiary.

See Note 15 (“Equity”) to our Financial Statements for further details of the Merger.

Financial Results of Operations:

Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

Contract Operations

(dollars in thousands)

Year Ended December 31,

(in thousands)

Cost of sales (excluding depreciation and amortization)

Gross margin percentage

The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to a 7% increase in average operating horsepower and an increase in contract operations rates driven by an increase in customer demand.

The increase in revenue was partially offset by the deferral of rebillable freight revenue as a result of the adoption of the Revenue Recognition Update.

The increase in cost of sales was primarily driven by increases in maintenance expense and lube oil expense associated with the increase in average operating horsepower.

These increases were partially offset by decreases in freight expense and expense associated with the mobilization of compression packages as a result of the capitalization and amortization of the portion of these costs that were incurred prior to the transfer of service in accordance with the adoption of the Revenue Recognition Update.

Gross margin percentage increased during the year ended December 31, 2018 compared to the year ended December 31, 2017 primarily due to the increase in rates and the capitalization of costs incurred to fulfill contracts prior to the transfer of service as a result of the adoption of the Revenue Recognition Update.

Gross margin percentage increased during the year ended December 31, 2019 compared to the year ended December 31, 2018 primarily due to the increase in contract operations rates mentioned above.

Aftermarket Services

(dollars in thousands)

Year Ended December 31,

(in thousands)

Cost of sales (excluding depreciation and amortization)

Gross margin percentage

The increase in revenue during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to increases in service activities and part sales driven by increased customer demand as well as the change to recognize revenue for service activities over time as a result of the adoption of the Revenue Recognition Update.

Gross margin increased during the year ended December 31, 2018 compared to the year ended December 31, 2017 due to the increase in revenue mentioned above partially offset by the increase in cost of sales.

The increase in cost of sales was primarily driven by the increase in service activities and part sales as well as the change to recognize costs associated with service activities over time as a result of the adoption of the Revenue Recognition Update.

Gross margin percentage increased during the year ended December 31, 2018 compared to the year ended December 31, 2017 primarily due to higher billable labor utilization as a result of the increase in activity mentioned above.

The decrease in cost of sales was primarily driven by the decrease in parts sales and service activities.

Costs and Expenses

(dollars in thousands)

Year Ended December 31,

(in thousands)

Selling, general and administrative

Depreciation and amortization

Long-lived asset impairment

Long-lived and other asset impairment

Restatement and other charges

Restructuring and other charges

Interest expense

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Selling, general and administrative.

The decrease in SG&A expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to a $6.9 million decrease in sales and use tax primarily resulting from the settlement of audits in the fourth quarter of 2018, a $3.5 million decrease in bad debt expense, a $1.4 million decrease in facility rent expense and a $1.3 million decrease in corporate office relocation costs (see Note 19 (“Corporate Office Relocation”) to our Financial Statements), partially offset by a $2.9 million increase in professional expenses.

Depreciation and amortization.

The decrease in depreciation and amortization expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to a decrease in depreciation expense resulting from certain assets reaching the end of their depreciable lives as well as the impact of asset impairments during 2017 and 2018, partially offset by an increase in depreciation expense associated with fixed asset additions.

Long-lived asset impairment.

During the years ended December 31, 2018 and 2017, we reviewed the future deployment of our idle compression assets for units that were not of the type, configuration, condition, make or model that are cost efficient to maintain and operate.

In addition, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale.

See Note 17 (“Long-Lived Asset Impairment”) to our Financial Statements for further details.

The following table presents the results of our impairment review, as recorded in our contract operations segment (dollars in thousands):

Long-lived and other asset impairment.

Each quarter, we review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate.

In addition, we evaluate for impairment idle units that have been culled from our compression fleet in prior years and are available for sale.

See Note 18 (“Long-Lived and Other Asset Impairment”) to our Financial Statements for further details.

The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment (dollars in thousands):

Year Ended December 31,

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Impairment recorded on idle compressors retired from the active fleet

In addition to the impairment discussed above, $2.9 million of property, plant and equipment was impaired during the year ended December 31, 2017 as the result of physical asset observations and other events that indicated the carrying values of the assets, which were comprised of approximately 7,000 horsepower of idle compressors, were not recoverable and $0.8 million of leasehold improvements and furniture and fixtures that were impaired in connection with the relocation of our corporate office.

See Note 19 (“Corporate Office Relocation”) to our Financial Statements for further details.

Restatement and other charges.

During the year ended December 31, 2018 we recorded $1.3 million for the expected recovery of shared professional and legal fees incurred related to the restatement of prior period financial statements and disclosures and related matters.

We were billed $1.3 million and $4.4 million for our share of these fees during 2018 and 2017, respectively.

Restructuring and other charges.

During the year ended December 31, 2017, we incurred $1.4 million, of costs associated with the Spin-off, which were directly attributable to Archrock.

No such costs were incurred subsequent to December 31, 2017.

During the years ended December 31, 2019 and 2018, we recorded expense of $0.4 million and $1.3 million, respectively, for our share of professional and legal fees related to the restatement of prior period financial statements and disclosures and related matters.

We recorded $1.3 million for the expected recovery of shared fees incurred during the year ended December 31, 2018.

Interest expense.

The increase in interest expense during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to increases in the average outstanding balance of long-term debt and the weighted average effective interest rate partially offset by a $0.6 million write-off of deferred financing costs associated with the termination of the Former Credit Facility in 2017.

Debt extinguishment loss.

We recorded a debt extinguishment loss of $2.5 million during the year ended December 31, 2018 as a result of the termination of the Archrock Credit Facility.

We recorded a debt extinguishment loss of $3.7 million during the year ended December 31, 2019 as a result of the redemption of the 2021 Notes.

We recorded a debt extinguishment loss of $2.5 million during the year ended December 31, 2018 as a result of the termination of the Former Credit Facility.

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Transaction-related costs.

We incurred $10.2 million and $0.3 million of costs related to the Merger consisting of financial advisory, legal and other professional fees during the years ended December 31, 2018 and 2017, respectively.

See Note 15 (“Equity”) to our Financial Statements for further details of this transaction.

We incurred $8.2 million and $10.2 million of financial advisory, legal and other professional fees during the years ended December 31, 2019 and 2018, respectively.

The $8.2 million of fees incurred during the year ended December 31, 2019 related primarily to the Elite Acquisition.

The $10.2 million of fees incurred during the year ended December 31, 2018 related to the Merger.

See Note 4 (“Business Transactions”) and Note 16 (“Equity”) to our Financial Statements for further details of these transactions.

Gain on sale of assets, net.

Included in gain on sale, net of assets during the year ended December 31, 2018 compared to the year ended December 31, 2017 was a $1.9 million decrease in gains recognized on land and building sales, offset by a $1.3 million increase in gains recognized on the sale of compression equipment and a $0.5 million decrease in losses recognized on the sale of other assets.

See Note 4 (“Business Transactions”) for further details of the Harvest Sale.

Other income, net.

The decrease in other income, net during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to a $0.6 million increase in indemnification expense incurred pursuant to our tax matters agreement with Exterran Corporation partially offset by a $0.5 million increase in indemnification income earned pursuant to the same agreement and $0.3 million in interest income earned related to a tax refund.

(dollars in thousands)

Provision for (Benefit from) Income Taxes

Year Ended December 31,

(in thousands)

Provision for (benefit from) income taxes

Effective tax rate

The change in provision for (benefit from) income taxes during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to the tax benefit from remeasuring our deferred tax liabilities and assets due to the corporate income tax rate reduction from the TCJA (see Note 20 (“Income Taxes”) to our Financial Statements) recorded in 2017 compared to 2018 and an increase in book income tax effected at the lower corporate income tax rate in 2018 as the result of the TCJA, partially offset by a lower unrecognized tax benefit recorded in 2018 compared to 2017 and benefits recorded in 2018 for the settlement of a tax audit and the release of an unrecognized tax benefit due to the expiration of a statute of limitations.

Net (Income) Loss Attributable to the Noncontrolling Interest

(dollars in thousands)

The change in provision for (benefit from) income taxes was primarily due to the release of a valuation allowance in the year ended December 31, 2019, as well as a higher release of an unrecognized tax benefit due to the settlement of a tax audit in the year ended December 31, 2019 compared to the year ended December 31, 2018.

See Note 20 (“Income Taxes”) to our Financial Statements for further details.

Net Income Attributable to Noncontrolling Interest

Year Ended December 31,

Net (income) loss attributable to the noncontrolling interest

The noncontrolling interest comprises the portion of the Partnership’s earnings that are applicable to the Partnership’s publicly-held common unitholder interest through the completion of the Merger.

Immediately prior to the Merger and as of December 31, 2017 , public unitholders held an ownership interest in the Partnership of 57%.

The change in net (income) loss attributable to the noncontrolling interest was primarily due to the change in net income (loss) of the Partnership partially offset by Archrock’s acquisition of all of the outstanding common units of the Partnership in conjunction with the Merger.

The change in net income (loss) of the Partnership was primarily due to the increase in revenue and decreases in SG&A, depreciation and amortization, long-lived asset impairment and provision for income taxes, partially offset by increases in cost of sales (excluding depreciation and amortization), interest expense, net and transaction-related costs.

(in thousands)

Net income attributable to noncontrolling interest

Net income attributable to noncontrolling interest was the portion of the Partnership’s earnings that were applicable to the Partnership’s publicly-held common unitholder interest through the completion of the Merger.

Immediately prior to the Merger, public unitholders held a 57% ownership interest in the Partnership.

Subsequent to the Merger, the Partnership is a wholly-owned subsidiary.

See Note 16 (“Equity”) to our Financial Statements for further details of the Merger.

Liquidity and Capital Resources

Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets.

Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under the Credit Facility.

Our cash flow is affected by numerous factors including prices and demand for our services, oil and natural gas exploration and production spending, conditions in the financial markets and other factors.

We believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our liquidity needs through at least December 31, 2020 .

We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities in open market purchases, privately negotiated transactions or otherwise.

Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

Capital Requirements

Our contract operations business is capital intensive, requiring significant investment to maintain and upgrade existing operations.

Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of compression equipment required for us to render those contract operations services to our customers.

Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of compression equipment required for us to provide those contract operations services to our customers.

Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:

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● maintenance capital expenditures, which are made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets.

The majority of our growth capital expenditures are related to the acquisition cost of new compressors that we add to our fleet.

In addition to the cost of newly acquired compressors, growth capital expenditures can also include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures.

These latter expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.

Maintenance capital expenditures are related to major overhauls of significant components of a compression package, such as the engine, compressor and cooler, which return the components to a like-new condition, but do not modify the applications for which the compression package was designed.

Growth Capital Expenditures

The majority of our growth capital expenditures are related to the acquisition cost of new compressors when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new compressor is expected to generate economic returns over its expected useful life that exceed our cost of capital.

In addition to newly-acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures.

These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.

Growth capital expenditures were $79.1 million, $300.5 million and $251.6 million during the years ended December 31, 2020, 2019 and 2018, respectively.

The increase in growth capital expenditures in 2019 compared to 2018 and also in 2018 compared to 2017 was primarily due to increased investment in new compression equipment as a result of increased customer demand to support higher U.S natural gas production levels.

We anticipate decreased 2020 growth capital expenditures due to an expected deceleration in the growth rate of natural gas production in 2020 as compared to 2019.

The decrease in growth capital expenditures in 2020 compared to 2019 was the result of a previously-planned decrease in spending in 2020, which was based on an expected deceleration in the growth rate of natural gas production, and a further reduction in spend in response to the decreased customer demand that resulted from the COVID-19 pandemic.

The increase in growth capital expenditures in 2019 compared to 2018 was primarily due to increased investment in new compression equipment as a result of increased customer demand to support higher U.S.

natural gas production levels.

Maintenance Capital Expenditures

Maintenance capital expenditures were $32.0 million, $58.6 million and $49.7 million during the years ended December 31, 2020, 2019 and 2018, respectively.

The decrease in maintenance capital expenditures in 2020 compared to 2019 was the result of decreased customer demand amidst the COVID-19 pandemic and optimized engine overhaul practices.

The increase in maintenance capital expenditures in 2019 compared to 2018 was due to an increase in scheduled maintenance activities in 2019 due to maintenance cycle requirements as well as the increase in horsepower as the result of the Elite Acquisition.

The increase in 2018 compared to 2017 was primarily due to the increase in idle horsepower returning to operation and the increase in scheduled maintenance activities in 2018 due to maintenance cycle requirements.

We intend to grow our business both organically and through third-party acquisitions.

If we are successful in growing our business in the future, we would expect our maintenance capital expenditures to increase over the long term.

We generally invest funds necessary to purchase fleet additions when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new equipment expenditure is expected to generate economic returns over its expected useful life that exceed our cost of capital.

Projected Capital Spend

We currently plan to spend approximately $80 million to $106 million in capital expenditures during 2021, primarily consisting of approximately $30 million to $50 million for growth capital expenditures and approximately $40 million to $45 million for maintenance capital expenditures.

We anticipate decreased 2021 capital expenditures, particularly growth capital expenditures, as compared to 2020 due to the impact that we expect the COVID-19 pandemic will continue to have on customer demand.

Financial Resources

Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets.

Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under the Credit Facility.

Beginning in the first quarter of 2020, the COVID-19 pandemic has caused a deterioration in global macroeconomic conditions, which has significantly impacted our estimates of future revenues and cash flows.

However, we have no near-term maturities and believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our future liquidity needs.

Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

Revolving Credit Facilities

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The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 2.7% and 4.3% at December 31, 2020 and 2019, respectively.

On November 8, 2019, we amended the Credit Facility to, among other things, extend the maturity date of the Credit Facility from March 30, 2022 to November 8, 2024 (or June 3, 2022, if any portion of the 2022 notes remains outstanding at such date) and change the applicable margin for borrowings under the Credit Facility such that (i) the applicable margin for Eurodollar loans, as defined in the Credit Facility agreement, ranges from 2.00% to 2.75% and (ii) the applicable margin for Alternative Base Rate loans ranges from 1.00% to 1.75%, in each case determined based on a total leverage ratio pricing grid.

On February 23, 2018, we amended the Credit Facility to, among other things:

increase the maximum Total Debt to EBITDA ratios, as defined in the Credit Facility agreement (see below for the revised ratios), effective as of the execution of Amendment No.

1 in February 2018;

effective upon completion of the Merger in April 2018:

As of December 31, 2020, there were $12.4 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%.

In November 2019, we amended the Credit Facility to, among other things, extend the maturity date of the Credit Facility from March 30, 2022 to November 8, 2024 and change the applicable margin for borrowings under the Credit Facility such that (i) the applicable margin for LIBOR loans ranges from 2.00% to 2.75% and (ii) the applicable margin for base rate loans ranges from 1.00% to 1.75%.

In February 2018, we amended the Credit Facility to, among other things:

● increase the maximum Total Debt to EBITDA ratios, as defined in the Credit Facility agreement (see below for the revised ratios);

● 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.

See Note 14 (“Long-Term Debt”) to the Financial Statements for further details of these amendments.

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The Credit Facility borrowing base consists of eligible accounts receivable, inventory and compressors.

We must maintain the following consolidated financial ratios, as defined in the Credit Facility agreement:

As of December 31, 2020, prior to Amendment No.

3, the following consolidated financial ratios, as defined in our Credit Facility agreement, were required:

EBITDA to Interest Expense

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Total Debt to EBITDA

Through fiscal year 2019

Through second quarter of 2020

January 1 through June 30, 2020

Thereafter (1)

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The Credit Facility agreement contains various additional covenants including, but not limited to, mandatory prepayments from the net cash proceeds of certain asset transfers, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay distributions.

In addition, if as of any date we have cash and cash equivalents (other than proceeds from a debt or equity issuance received in the 30 days prior to such date reasonably expected to be used to fund an acquisition permitted under the Credit Facility agreement) in excess of $50.0 million, then such excess amount will be used to pay down outstanding borrowings of a corresponding amount under the Credit Facility.

As of December 31, 2020, we were in compliance with all covenants under the Credit Facility.

Archrock Credit Facility.

In April 2018, in connection with the Merger, we terminated the Archrock Credit Facility and borrowed on the Credit Facility to repay $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 were converted to letters of credit under the Credit Facility.

Prior to its termination, the Archrock Credit Facility required us to maintain various financial ratios and other covenants, all of which we were in compliance with through its closing.

The average daily debt balance under the Archrock Credit Facility in 2018, through its closing in April 2018, was $51.7 million.

In February 2021, we further amended the Credit Facility to, among other things:

● reduce the aggregate revolving commitment from $1.25 billion to $750.0 million, and

● adjust the maximum Senior Secured Debt to EBITDA ratio and Total Debt to EBITDA ratios above to the following:

Senior Secured Debt to EBITDA

Total Debt to EBITDA

Through fiscal year 2022

January 1, 2023 through September 30, 2023

Thereafter (1)

(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.

Former Credit Facility.

In April 2018, in connection with the Merger, we terminated the Former Credit Facility and borrowed on the Credit Facility to repay $63.2 million in borrowings and accrued and unpaid interest and fees outstanding.

All commitments under the Former Credit Facility were terminated and the $15.4 million of letters of credit outstanding under the Former Credit Facility were converted to letters of credit under the Credit Facility.

Prior to its termination, the Former Credit Facility required us to maintain various financial ratios and other covenants, all of which we were in compliance with through its closing.

The average daily debt balance under the Former Credit Facility in 2018, through its closing in April 2018, was $51.7 million.

Senior Notes Transactions

On December 20, 2019, we completed a private offering of $500.0 million aggregate principal amount of 6.25% senior notes due April 2028 and received net proceeds of $491.8 million after deducting issuance costs.

The net proceeds were used to partially repay borrowings outstanding under the Credit Facility.

On March 21, 2019, we completed a private offering of $500.0 million aggregate principal amount of 6.875% senior notes due April 2027 and received net proceeds of $491.2 million after deducting issuance costs.

The net proceeds were used to repay borrowings outstanding under the Credit Facility.

On April 5, 2019, we repaid the 2021 Notes with borrowings from our Credit Facility.

In December 2020, we completed a private offering of $300.0 million aggregate principal amount of 6.25% senior notes due April 2028 and received net proceeds of $309.9 million after deducting issuance costs.

The net proceeds were used to repay borrowings outstanding under our Credit Facility.

In April 2020, we repaid the 2022 Notes with borrowings under our Credit Facility.

In December 2019, we completed a private offering of $500.0 million aggregate principal amount of 6.25% senior notes due April 2028 and received net proceeds of $491.8 million after deducting issuance costs.

The net proceeds were used to repay borrowings outstanding under our Credit Facility.

In April 2019, we repaid the 2021 Notes with borrowings under our Credit Facility.

In March 2019, we completed a private offering of $500.0 million aggregate principal amount of 6.875% senior notes due April 2027 and received net proceeds of $491.2 million after deducting issuance costs.

The net proceeds were used to repay borrowings outstanding under our Credit Facility.

See Note 14 (“Long-Term Debt”) to our Financial Statements for further details of these transactions.

The 2022 Notes are guaranteed on a senior unsecured basis by all of the Partnership’s existing subsidiaries (other than Archrock Partners Finance Corp., which is a co-issuer of the 2022 Notes) and certain of the Partnership’s future subsidiaries.

The 2022 Notes and the guarantees, respectively, are the Partnership’s and the guarantors’ general unsecured senior obligations, rank equally in right of payment with all of the Partnership’s and the guarantors’ other senior obligations and are effectively subordinated to all of the Partnership’s and the guarantors’ existing and future secured debt to the extent of the value of the collateral securing such indebtedness.

In addition, the 2022 Notes and guarantees are effectively subordinated to all existing and future indebtedness and other liabilities of any future non-guarantor subsidiaries.

Guarantees by the Partnership’s subsidiaries are full and unconditional, subject to customary release provisions, and constitute joint and several obligations.

The Partnership has no assets or operations independent of its subsidiaries and there are no significant restrictions upon its subsidiaries’ ability to distribute funds to the Partnership.

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 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.

Our cash flows from operating, investing and financing activities, as reflected in the consolidated statements of cash flows, are summarized in the table below (in thousands):

Our cash flows as reflected in our consolidated statements of cash flows, are summarized below (in thousands):

Year Ended December 31,

Net cash provided by (used in) operations:

Net cash provided by (used in):

Operating activities

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Financing activities

Net change in cash and cash equivalents

Net decrease in cash and cash equivalents

Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

Operating Activities.

The increase in net cash provided by operating activities was primarily due to decreased cash outflows for cost of sales, SG&A expenses, contract costs and transaction-related costs and increased cash inflows from accounts receivable, partially offset by reduced cash inflows from revenue and deferred revenue and cash outflows for restructuring charges in 2020.

Investing Activities.

The decrease in net cash used in investing activities was primarily due to a $244.9 million decrease in capital expenditures, $214.0 million cash paid in the Elite Acquisition in 2019 and proceeds of $33.7 million from the March 2020 and July 2020 dispositions, partially offset by a $62.1 million decrease in proceeds from other sales of property, plant and equipment, $30.0 million of which related to proceeds from the Harvest Sale in 2019.

Financing Activities.

The change in net cash provided by (used in) financing activities was primarily due to $155.4 million of net repayments of long-term debt in 2020 compared to $323.5 million of net borrowings in 2019 and a $10.3 million increase in dividends paid to Archrock stockholders, partially offset by a $17.2 million decrease in payments for debt issuance costs.

Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

Operating Activities.

The increase in net cash provided by operating activities during the year ended December 31, 2019 compared to the year ended December 31, 2018 was primarily due to an increase in revenue from our contract operations business, the receipt of cash proceeds in 2019 pursuant to a settlement of certain sales and use tax audits and decreases in accounts receivable and cost of sales (excluding depreciation and amortization).

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These cash flows were partially offset by a $20.2 million increase in dividends paid to Archrock shareholders, a $19.1 million increase in payments for debt issuance costs and an $18.7 million decrease in contributions from Exterran Corporation.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Operating Activities.

The increase in net cash provided by operating activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to an increase in revenue in our contract operations and aftermarket services segments primarily driven by an increase in customer demand, partially offset by an increase in cost of sales, including freight and mobilization costs incurred to fulfill contracts prior to the transfer of service, an increase in accounts receivable, trade as a result of the timing of payments received from our customers, an increase in transaction-related costs and an increase in interest paid.

Investing Activities.

The increase in net cash used in investing activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to a $97.4 million increase in capital expenditures and a $13.0 million decrease in proceeds from sale of property, plant and equipment.

Financing Activities.

The change in net cash provided by (used in) financing activities during the year ended December 31, 2018 compared to the year ended December 31, 2017 was primarily due to $109.2 million of net borrowings of long-term debt during 2018 compared to $28.2 million in net repayments of long term-debt during 2017, a $32.7 million decrease in distributions to noncontrolling partners in the Partnership and a $11.5 million decrease in payments for debt issuance costs.

These changes were partially offset by $60.3 million of proceeds received from a public offering by the Partnership of its common units during 2017, a $26.0 million decrease in contributions from Exterran Corporation (see Note 5 (“Discontinued Operations”) ) and a $24.2 million increase in dividends to Archrock stockholders.

On January 27, 2021, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock, or approximately $22.2 million, that was paid on February 16, 2021 to stockholders of record at the close of business on February 8, 2021.

Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition and results of operations, credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.

Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.

Contractual Obligations

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Credit Facility

2022 Notes (3)

2027 Notes (3)

2028 Notes (3)

Senior notes (2)

Total long-term debt

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(1) See Note 14 (“Long-Term Debt”) to our Financial Statements for further details on our long-term debt.

The Credit Facility will mature on November 8, 2024 except that if any portion of the 2022 Notes are outstanding as of June 3, 2022 , it will instead mature on June 3, 2022 .

Represents the full face value of the senior notes, not reduced by unamortized discount and unamortized deferred financing costs.

Calculated using interest rates in effect as of December 31, 2019 , including the effect of interest rate swaps.

Includes commitments to purchase fleet and non-fleet assets and costs associated with the cloud migration of our ERP system and other information technology-related costs.

(2) Represents the full face value of our senior notes, not reduced by unamortized discount, premium and deferred financing costs.

(3) For 2021, calculated using interest rates in effect as of December 31, 2020, including the effect of interest rate swaps.

Beginning in Q2 2022 through 2024, calculated using the interest rates in effect as of December 31, 2020, excluding the effect of interest rate swaps due to the maturity of our interest rate swaps in March 2022.

See Note 22 (“Derivatives”) for further details.

(4) Primarily includes commitments to purchase fleet and non-fleet assets and costs associated with the cloud migration of our ERP system and other information technology-related costs.

At December 31, 2020, $18.9 million of unrecognized tax benefits (including discontinued operations) have been recorded as liabilities in accordance with the accounting standard for income taxes related to uncertain tax positions and we are uncertain as to if or when such amounts may be settled.

Related to these unrecognized tax benefits, we have also recorded a liability for potential penalties and interest of $2.1 million (including discontinued operations).

Related to these unrecognized tax benefits, we have also recorded a liability for potential penalties and interest (including discontinued operations) of $2.1 million.

Off-Balance Sheet Arrangements

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Critical Accounting Estimates

This discussion and analysis of our financial condition and results of operations is based upon the Financial Statements, which have been prepared in accordance with GAAP.

The preparation of the Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures of contingent assets and liabilities.

This discussion and analysis of our financial condition and results of operations is based upon our Financial Statements, which have been prepared in accordance with GAAP.

The preparation of our Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures of contingent assets and liabilities.

We evaluate our estimates and accounting policies on an ongoing basis and base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances.

The results of this process form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Actual results may differ from these estimates under different assumptions or conditions and these differences can be material to our financial condition, results of operations and liquidity.

Actual results may differ from these estimates under different assumptions or conditions and these differences can be material to our financial condition, results of operations and cash flows.

We describe our significant accounting policies more fully in Note 2 (“Basis of Presentation and Significant Accounting Policies”) to our Financial Statements.

Outstanding accounts receivable are reviewed regularly for non-payment indicators and allowances for doubtful accounts are recorded based on management’s estimate of collectibility at each balance sheet date.

Allowance for Credit Losses

Outstanding accounts receivable are reviewed regularly for non-payment indicators and allowances for credit losses are recorded based on management’s estimate of collectibility at each balance sheet date.

We measure expected credit losses on a collective (pool) basis when similar risk characteristics exist.

If a customer does not share similar risk characteristics with other customers, we evaluate the customer’s outstanding trade receivables for expected credit losses on an individual basis.

Each reporting period, we reassess our customers’ risk profiles and determine the appropriate asset pool classification, or perform individual assessments of expected credit losses, based on the customers’ risk characteristics at the reporting date.

Judgment is used to determine the expected credit loss for customers that do not share similar risk characteristics with other customers, based on customer specific items such as legal proceedings, past experience with the customer and/or ongoing customer negotiations.

During the years ended December 31, 2020, 2019 and 2018, we recorded bad debt expense of $3.5 million, $2.6 million and $1.7 million, respectively.

A five percent change in bad debt expense would have impacted income before income taxes by approximately $0.1 million during the year ended December 31, 2019 .

A five percent change in bad debt expense would have impacted loss before income taxes by $0.2 million during the year ended December 31, 2020.

Inventory is a significant component of current assets and is stated at the lower of cost and net realizable value using the average cost method.

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The fair value calculation would require us to make significant estimates to determine future cash flows, including future revenues, costs and capital requirements and the appropriate risk-adjusted discount rate by which to discount the estimated future cash flows.

Our goodwill is allocated to our contract operations reporting unit.

Our fourth quarter qualitative assessment determined that it was not more likely than not that the fair value of the contract operations reporting unit was less than its carrying amount as of December 31, 2019, and as such, no quantitative impairment test of our goodwill was warranted.

Our goodwill was allocated to our contract operations reporting unit.

In the first quarter of 2020, the global response to the COVID-19 pandemic significantly impacted our market capitalization and estimates of future revenues and cash flows, which triggered the need to perform a quantitative test of the fair value of our contract operations reporting unit as of March 31, 2020.

The quantitative test determined that the carrying amount of our contract operations reporting unit exceeded its fair value and we recorded a full impairment loss on goodwill in the first quarter as a result.

We account for business combinations using the acquisition method which requires assets acquired and liabilities assumed to be recorded at their fair value on the acquisition date.

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The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various state and local jurisdictions.

The TCJA included a provision which lowered the corporate income tax rate from 35% to 21%.

This reduced rate required us to remeasure our reported deferred tax assets and liabilities in 2017.

See Note 20 (“Income Taxes”) to our Financial Statements for more discussion on this topic.

The accounting standard for income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits.

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If our actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period in which the difference becomes known.

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.

Subject to the provisions of our tax matters agreement with Exterran Corporation, 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 tax audit.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis