Item 3. Quantitative and Qualitative Disclosures About Market Risk
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Commodity Price Risk
Market risk is the risk of loss arising from adverse changes in market rates and prices. We do not take title to any natural gas or crude oil in connection with our rendered services, and accordingly, we do not bear direct exposure to fluctuating commodity prices. However, the demand for our compression services depends on the continued demand for, and production of, natural gas and crude oil. Sustained low natural gas or crude oil prices over the long term could result in a decline in the production of natural gas or crude oil, which could result in reduced demand for our compression services. We do not intend to hedge our indirect exposure to fluctuating commodity prices. A one percent decrease in average revenue-generating horsepower during the six months ended June 30, 2024 would result in an annual decrease of approximately $8.4 million and $5.7 million in our revenue and Adjusted gross margin, respectively. Adjusted gross margin is a non-GAAP financial measure. For a reconciliation of Adjusted gross margin to gross margin, its most directly comparable financial measure, calculated and presented in accordance with GAAP, please read Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” of this report.
Interest Rate Risk
We are exposed to market risk due to variable interest rates under the Credit Agreement.
As of June 30, 2024, we had $756.2 million of variable-rate indebtedness outstanding at a weighted-average interest rate of 8.10%. Based on our June 30, 2024 variable-rate indebtedness outstanding, a one percent increase or decrease, respectively, in the effective interest rate would result in an annual increase or decrease, respectively, in our interest expense of approximately $7.6 million.
For further information regarding our exposure to interest rate fluctuations on our debt obligations, see Note 8 to our unaudited condensed consolidated financial statements under Part I, Item 1 “Financial Statements” of this report.
As of June 30, 2024, we have an interest-rate swap outstanding to manage interest-rate risk associated with the floating-rate Credit Agreement with a notional principal amount of $700 million and a termination date of December 31, 2025. Under the interest-rate swap, we pay a fixed interest rate of 3.9725% and receive floating interest rate payments that are indexed to the one-month SOFR. Based on the fixed interest rate as of June 30, 2024, a one percent increase or decrease in the SOFR interest-rate forward curve would result in an increase or decrease, respectively, in the fair value of this interest-rate swap of $11.2 million, prior to any discount factors or credit valuation adjustments.
For further information regarding our interest-rate swap, see Note 7 to our unaudited condensed consolidated financial statements under Part I, Item 1 “Financial Statements” of this report.
Credit Risk
Our credit exposure generally relates to receivables for services provided. If any significant customer of ours should have credit or financial problems resulting in a delay or failure to pay the amount it owes us, it could have a material adverse effect on our business, financial condition, results of operations, and cash flows.
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