Archrock, Inc. - Quarter Report: 2021 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 001-33666

Archrock, Inc.

(Exact name of registrant as specified in its charter)


Delaware	74-3204509
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

9807 Katy Freeway, Suite 100, Houston, Texas 77024

(Address of principal executive offices, zip code)

(281) 836-8000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol	Name of exchange on which registered
Common stock, $0.01 par value per share	AROC	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Number of shares of the common stock of the registrant outstanding as of October 26, 2021: 154,049,828 shares.

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TABLE OF CONTENTS


	Page
Glossary	3
Forward-Looking Statements	4

Part I. Financial Information
Item 1. Financial Statements (unaudited)	5
Condensed Consolidated Balance Sheets	5
Condensed Consolidated Statements of Operations	6
Condensed Consolidated Statements of Comprehensive Income (Loss)	7
Condensed Consolidated Statements of Equity	8
Condensed Consolidated Statements of Cash Flows	10
Notes to Condensed Consolidated Financial Statements	11
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
Item 4. Controls and Procedures	40

Part II. Other Information
Item 1. Legal Proceedings	41
Item 1A. Risk Factors	41
Item 2. Purchases of Equity Securities by Issuer and Affiliated Purchasers	41
Item 3. Defaults Upon Senior Securities	41
Item 4. Mine Safety Disclosures	41
Item 5. Other Information	41
Item 6. Exhibits	42

Signatures	43

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GLOSSARY

The following terms and abbreviations appearing in the text of this report have the meanings indicated below.

2020 Form 10-K	Annual Report on Form 10-K for the year ended December 31, 2020
2022 Notes	$350.0 million of 6.00% senior notes due October 2022, issued in April 2014
2027 Notes	$500.0 million of 6.875% senior notes due April 2027, issued in March 2019
2028 Notes	$800.0 million of 6.25% senior notes due April 2028, $500.0 million of which was issued in December 2019, $300.0 million of which was issued in December 2020
Amendment No. 3	Amendment No. 3 to Credit Agreement, dated February 22, 2021, which amended that Credit Agreement, dated as of March 30, 2017, which governs the Credit Facility
Archrock, our, we, us	Archrock, Inc., individually and together with its wholly-owned subsidiaries
ASU 2016-13	Accounting Standards Update No. 2016-13—Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
ASU 2020-04	Accounting Standards Update No. 2020-04—Reference Rate Reform (Topic 848)—Facilitation of the Effects of Reference Rate Reform on Financial Reporting
ATM Agreement	Equity Distribution Agreement, dated February 23, 2021, entered into with Wells Fargo Securities, LLC and BofA Securities, Inc., as sales agents, relating to the at-the-market offer and sale of shares of our common stock from time to time
COVID-19	Coronavirus disease 2019
Credit Facility	$750.0 million asset-based revolving credit facility due November 2024, as governed by Amendment No. 3 to Credit Agreement, dated February 22, 2021, which amended that Credit Agreement, dated as of March 30, 2017
EBITDA	Earnings before interest, taxes, depreciation and amortization
Elite Acquisition	Transaction completed on August 1, 2019 whereby we acquired from Elite Compression Services, LLC substantially all of its assets and certain liabilities
ERP	Enterprise Resource Planning
ESPP	Employee Stock Purchase Plan
Exchange Act	Securities Exchange Act of 1934, as amended
February 2021 Disposition	Sale completed in February 2021 of certain contract operations customer service agreements, compressors and other assets
Financial Statements	Condensed consolidated financial statements included in Part I Item 1 of this Quarterly Report on Form 10-Q
GAAP	U.S. generally accepted accounting principles
Hilcorp	Hilcorp Energy Company
JDH Capital	JDH Capital Holdings, L.P.
July 2021 Dispositions	Sales completed in July 2021 of certain contract operations customer service agreements, compressors and other assets
July 2020 Disposition	Sale completed in July 2020 of the turbocharger business included within our aftermarket services segment
LIBOR	London Interbank Offered Rate
March 2020 Disposition	Sale completed in March 2020 of certain contract operations customer service agreements, compressors and other assets
OTC	Over-the-counter, as related to aftermarket services parts and components
ROU	Right-of-use, as related to the lease model under Accounting Standards Codification Topic 842 Leases
SEC	U.S. Securities and Exchange Commission
SG&A	Selling, general and administrative
Spin-off	Spin-off completed in November 2015 of our international contract operations, international aftermarket services and global fabrication businesses into a standalone public company operating as Exterran Corporation
U.S.	United States of America

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements” intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of Section 21E of the Exchange Act, including, without limitation, statements regarding the effects of the COVID-19 pandemic on our business, operations, customers and financial condition; our business growth strategy and projected costs; future financial position; the sufficiency of available cash flows to fund continuing operations and pay dividends; the expected amount of our capital expenditures; anticipated cost savings; future revenue, gross margin and other financial or operational measures related to our business; the future value of our equipment; and plans and objectives of our management for our future operations. You can identify many of these statements by words such as “believe,” “expect,” “intend,” “project,” “anticipate,” “estimate,” “will continue” or similar words or the negative thereof.

Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this Quarterly Report on Form 10-Q. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, no assurance can be given that these expectations will prove to be correct. Known material factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include the risk factors described in our 2020 Form 10-K and those set forth from time to time in our filings with the SEC, which are available through our website at www.archrock.com and through the SEC’s website at www.sec.gov.

All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available to us on the date of this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this Quarterly Report on Form 10-Q.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ARCHROCK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share amounts)

(unaudited)


	September 30, 2021		December 31, 2020
Assets
Current assets:
Cash and cash equivalents	$	3,488	$	1,097
Accounts receivable, trade, net of allowance of $3,057 and $3,370, respectively		108,936		104,425
Inventory		66,630		63,670
Other current assets		7,652		12,819
Total current assets		186,706		182,011
Property, plant and equipment, net		2,252,226		2,389,674
Operating lease ROU assets		18,256		19,236
Intangible assets, net		50,815		61,531
Contract costs, net		24,375		29,216
Deferred tax assets		48,227		56,934
Other assets		27,502		30,084
Noncurrent assets associated with discontinued operations		10,117		11,036
Total assets	$	2,618,224	$	2,779,722

Liabilities and Equity
Current liabilities:
Accounts payable, trade	$	44,685	$	30,819
Accrued liabilities		104,753		76,993
Deferred revenue		3,985		3,880
Total current liabilities		153,423		111,692
Long-term debt		1,516,135		1,688,867
Operating lease liabilities		16,454		16,925
Deferred tax liabilities		801		725
Other liabilities		19,496		18,088
Noncurrent liabilities associated with discontinued operations		7,868		7,868
Total liabilities		1,714,177		1,844,165
Commitments and contingencies (Note 20)
Equity:
Preferred stock: $0.01 par value per share, 50,000,000 shares authorized, zero issued		—		—
Common stock: $0.01 par value per share, 250,000,000 shares authorized, 161,459,405 and 160,014,960 shares issued, respectively		1,614		1,600
Additional paid-in capital		3,437,298		3,424,624
Accumulated other comprehensive loss		(2,028)		(5,006)
Accumulated deficit		(2,446,755)		(2,401,988)
Treasury stock: 7,402,188 and 7,052,769 common shares, at cost, respectively		(86,082)		(83,673)
Total equity		904,047		935,557
Total liabilities and equity	$	2,618,224	$	2,779,722

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ARCHROCK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2021		2020		2021		2020
Revenue:
Contract operations	$	158,911	$	175,223	$	488,810	$	570,146
Aftermarket services		36,255		30,408		97,402		105,498
Total revenue		195,166		205,631		586,212		675,644
Cost of sales (excluding depreciation and amortization):
Contract operations		61,280		60,444		184,032		202,485
Aftermarket services		30,652		25,709		83,925		89,386
Total cost of sales (excluding depreciation and amortization)		91,932		86,153		267,957		291,871
Selling, general and administrative		28,839		18,681		80,000		78,052
Depreciation and amortization		45,280		47,279		135,185		145,950
Long-lived and other asset impairment		5,121		10,727		15,154		72,132
Goodwill impairment		—		—		—		99,830
Restructuring charges		313		2,900		1,953		7,036
Interest expense		25,508		25,221		82,711		80,664
Debt extinguishment loss		—		—		—		3,971
Gain on sale of assets, net		(15,393)		(9,146)		(29,549)		(11,073)
Other (income) expense, net		337		(324)		(1,634)		(1,317)
Income (loss) before income taxes		13,229		24,140		34,435		(91,472)
Provision for (benefit from) income taxes		3,925		5,808		12,210		(18,236)
Net income (loss)	$	9,304	$	18,332	$	22,225	$	(73,236)

Basic and diluted net income (loss) per common share	$	0.06	$	0.12	$	0.14	$	(0.49)

Weighted average common shares outstanding:
Basic		152,158		150,974		151,615		150,730
Diluted		152,297		151,038		151,769		150,730

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ARCHROCK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2021		2020		2021		2020
Net income (loss)	$	9,304	$	18,332	$	22,225	$	(73,236)
Other comprehensive income (loss), net of tax:
Interest rate swap gain (loss), net of reclassifications to earnings		585		935		2,547		(4,586)
Amortization of dedesignated interest rate swaps		431		—		431		—
Total other comprehensive income (loss), net of tax		1,016		935		2,978		(4,586)
Comprehensive income (loss)	$	10,320	$	19,267	$	25,203	$	(77,822)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ARCHROCK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(in thousands, except share and per share amounts)

(unaudited)



						Accumulated
	Common			Additional		Other				Treasury
	Stock			Paid-in		Comprehensive		Accumulated		Stock
	Amount		Shares	Capital		Loss		Deficit		Amount		Shares	Total
Balance at June 30, 2020	$	1,598	159,810,336	$	3,419,512	$	(6,908)	$	(2,380,626)	$	(82,703)	(6,860,984)	$	950,873
Treasury stock purchased											(960)	(138,922)		(960)
Cash dividends ($0.145 per common share)									(22,308)					(22,308)
Shares issued under ESPP			30,351		155									155
Stock-based compensation, net of forfeitures		1	130,669		2,657							(2,258)		2,658
Comprehensive income
Net income									18,332					18,332
Interest rate swap gain, net of reclassifications to earnings							935							935
Balance at September 30, 2020	$	1,599	159,971,356	$	3,422,324	$	(5,973)	$	(2,384,602)	$	(83,663)	(7,002,164)	$	949,685

Balance at June 30, 2021	$	1,613	161,339,554	$	3,434,224	$	(3,044)	$	(2,433,553)	$	(85,419)	(7,278,449)	$	913,821
Treasury stock purchased											(663)	(92,540)		(663)
Cash dividends ($0.145 per common share)									(22,506)					(22,506)
Shares issued under ESPP			22,425		175									175
Stock-based compensation, net of forfeitures		1	97,426		2,899							(31,199)		2,900
Comprehensive income
Net income									9,304					9,304
Interest rate swap gain, net of reclassifications to earnings							585							585
Amortization of dedesignated interest rate swaps							431							431
Balance at September 30, 2021	$	1,614	161,459,405	$	3,437,298	$	(2,028)	$	(2,446,755)	$	(86,082)	(7,402,188)	$	904,047

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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						Accumulated
	Common			Additional		Other				Treasury
	Stock			Paid-in		Comprehensive		Accumulated		Stock
	Amount		Shares	Capital		Loss		Deficit		Amount		Shares	Total
Balance at December 31, 2019	$	1,587	158,636,918	$	3,412,509	$	(1,387)	$	(2,244,877)	$	(81,869)	(6,702,602)	$	1,085,963
Treasury stock purchased											(1,794)	(235,079)		(1,794)
Cash dividends ($0.435 per common share)									(66,655)					(66,655)
Shares issued under ESPP		1	140,606		521									522
Stock-based compensation, net of forfeitures		11	1,193,832		8,616							(64,483)		8,627
Contribution from Exterran Corporation					678									678
Impact of ASU 2016-13 adoption									166					166
Comprehensive loss
Net loss									(73,236)					(73,236)
Interest rate swap loss, net of reclassifications to earnings							(4,586)							(4,586)
Balance at September 30, 2020	$	1,599	159,971,356	$	3,422,324	$	(5,973)	$	(2,384,602)	$	(83,663)	(7,002,164)	$	949,685

Balance at December 31, 2020	$	1,600	160,014,960	$	3,424,624	$	(5,006)	$	(2,401,988)	$	(83,673)	(7,052,769)	$	935,557
Treasury stock purchased											(2,409)	(277,316)		(2,409)
Cash dividends ($0.435 per common share)									(66,992)					(66,992)
Shares issued under ESPP			66,541		546									546
Stock-based compensation, net of forfeitures		10	1,020,756		8,731							(72,103)		8,741
Net proceeds from issuance of common stock		4	357,148		3,397									3,401
Comprehensive income
Net income									22,225					22,225
Interest rate swap gain, net of reclassifications to earnings							2,547							2,547
Amortization of dedesignated interest rate swaps							431							431
Balance at September 30, 2021	$	1,614	161,459,405	$	3,437,298	$	(2,028)	$	(2,446,755)	$	(86,082)	(7,402,188)	$	904,047

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ARCHROCK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)


	Nine Months Ended
	September 30,
	2021		2020
Cash flows from operating activities:
Net income (loss)	$	22,225	$	(73,236)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		135,185		145,950
Long-lived and other asset impairment		15,154		72,132
Goodwill impairment		—		99,830
Inventory write-downs		621		915
Amortization of operating lease ROU assets		2,922		2,555
Amortization of deferred financing costs		8,839		4,179
Amortization of debt discount		—		187
Amortization of debt premium		(1,504)		—
Amortization of dedesignated interest rate swaps		431		—
Debt extinguishment loss		—		3,971
Interest rate swaps		2,866		2,094
Stock-based compensation expense		8,741		8,423
Non-cash restructuring charges		—		1,660
Provision for credit losses		151		2,235
(Gain) loss on sale of assets, net		(10,604)		1,402
Gain on sale of business		(18,945)		(12,475)
Deferred income tax provision (benefit)		11,778		(18,288)
Amortization of contract costs		15,523		20,286
Deferred revenue recognized in earnings		(8,081)		(17,183)
Change in assets and liabilities:
Accounts receivable, trade		(2,133)		31,134
Inventory		(5,994)		3,244
Other assets		1,326		(23,539)
Contract costs, net		(11,481)		(10,390)
Accounts payable and other liabilities		33,626		10,679
Deferred revenue		8,167		10,696
Other		(88)		373
Net cash provided by operating activities		208,725		266,834
Cash flows from investing activities:
Capital expenditures		(70,881)		(130,343)
Proceeds from sale of business		83,075		32,914
Proceeds from sale of property, plant and equipment and other assets		24,683		14,043
Proceeds from insurance and other settlements		977		1,391
Net cash provided by (used in) investing activities		37,854		(81,995)
Cash flows from financing activities:
Borrowings of long-term debt		522,751		871,500
Repayments of long-term debt		(695,751)		(988,500)
Payments for debt issuance costs		(2,451)		(943)
Payments for settlement of interest rate swaps that include financing elements		(3,283)		(1,856)
Dividends paid to stockholders		(66,992)		(66,655)
Net proceeds from issuance of common stock		3,401		—
Proceeds from stock issued under ESPP		546		522
Purchases of treasury stock		(2,409)		(1,794)
Contribution from Exterran Corporation		—		678
Net cash used in financing activities		(244,188)		(187,048)
Net increase (decrease) in cash and cash equivalents		2,391		(2,209)
Cash and cash equivalents, beginning of period		1,097		3,685
Cash and cash equivalents, end of period	$	3,488	$	1,476

Supplemental disclosure of non-cash investing and financing transactions:
Non-cash consideration received in July 2020 Disposition	$	—	$	6,500

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ARCHROCK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of Business and Basis of Presentation

We are an energy infrastructure company with a pure-play focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the oil and natural gas industry throughout the 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 predominant segment, contract operations, primarily includes 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 reflects all normal recurring adjustments necessary to fairly present 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 2020 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

Reference Rate Reform

On June 10, 2021, we prospectively adopted ASU 2020-04, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued as a result of reference rate reform. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. Entities may elect to apply the amendments for contract modifications as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020. On June 10, 2021, we amended one of our interest rate swap agreements and determined that the modifications meet the criteria for the optional expedients and exceptions, which allow us to forego dedesignation of the hedging relationship and to subsequently assess effectiveness on a qualitative basis. The adoption of ASU 2020-04 did not have a material impact on our consolidated financial statements. In the first quarter, we evaluated Amendment No. 3 to our Credit Facility and determined that ASU 2020-04 was not applicable. We will continue to assess any modifications to our interest rate swap and Credit Facility agreements during the effective period of this update and will apply the amendments as applicable.

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3. Business Transactions

July 2021 Dispositions

In July 2021, we completed sales of certain contract operations customer service agreements and approximately 575 compressors, comprising approximately 100,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We allocated customer-related and contract-based intangible assets based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We received cash consideration of $60.3 million for the sales and recorded gains on the sales of $13.0 million in gain on sale of assets, net in our condensed consolidated statements of operations during the three and nine months ended September 30, 2021. Remaining cash consideration from the sales of $1.3 million is expected to be received in the fourth quarter of 2021.

February 2021 Disposition

In February 2021, we completed the sale of certain contract operations customer service agreements and approximately 300 compressors, comprising approximately 40,000 horsepower, used to provide compression services under those agreements as well as other assets used to support the operations. We allocated customer-related and contract-based intangible assets based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We recorded a gain on the sale of $6.0 million in gain on sale of assets, net in our condensed consolidated statements of operations during the nine months ended September 30, 2021.

July 2020 Disposition

In July 2020, we completed the sale of the turbocharger business included within our aftermarket services segment. In connection with the sale, we entered into a supply agreement to purchase a minimum amount of turbocharger goods and services over a two-year term. In addition to cash of $9.5 million received upon closing, an additional $3.0 million was received on the first anniversary of the closing date in July 2021, and $3.5 million is being received through the purchase of turbocharger goods and services under the supply agreement. We received $2.5 million during the nine months ended September 30, 2021 and a total of $3.2 million since sale completion under the supply agreement. We recognized a gain on the sale of $9.3 million in gain on sale of assets, net in our condensed consolidated statements of operations during the three and nine months ended September 30, 2020.

March 2020 Disposition

In March 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 allocated customer-related and contract-based intangible assets and goodwill based on a ratio of the horsepower sold relative to the total horsepower of the asset group. We recognized a gain on the sale of $3.2 million in gain on sale of assets, net in our condensed consolidated statements of operations during the nine months ended September 30, 2020.

4. Discontinued Operations

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, including a tax matters agreement, which governs the respective rights, responsibilities and obligations of Exterran Corporation and us with respect to certain tax matters.

As of both September 30, 2021 and December 31, 2020, we had $7.9 million of unrecognized tax benefits (including interest and penalties) related to Exterran Corporation operations prior to the Spin-off recorded to noncurrent liabilities associated with discontinued operations in our condensed consolidated balance sheets. We had an offsetting indemnification asset of $7.9 million related to these unrecognized tax benefits recorded to noncurrent assets associated with discontinued operations as of both September 30, 2021 and December 31, 2020.

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The following table presents the balance sheets for our discontinued operations:


(in thousands)	September 30, 2021		December 31, 2020
Other assets	$	7,868	$	7,868
Deferred tax assets		2,249		3,168
Total assets associated with discontinued operations	$	10,117	$	11,036

Deferred tax liabilities	$	7,868	$	7,868
Total liabilities associated with discontinued operations	$	7,868	$	7,868

5. Inventory


(in thousands)	September 30, 2021		December 31, 2020
Parts and supplies	$	59,478	$	57,433
Work in progress		7,152		6,237
Inventory	$	66,630	$	63,670

6. Property, Plant and Equipment, net


(in thousands)	September 30, 2021		December 31, 2020
Compression equipment, facilities and other fleet assets	$	3,269,801	$	3,439,432
Land and buildings		43,373		45,167
Transportation and shop equipment		95,210		106,868
Computer hardware and software		84,733		84,680
Other		24,496		14,457
Property, plant and equipment		3,517,613		3,690,604
Accumulated depreciation		(1,265,387)		(1,300,930)
Property, plant and equipment, net	$	2,252,226	$	2,389,674

7. Goodwill

Our goodwill was recognized in connection with the Elite Acquisition and represents the excess of consideration transferred over the fair value of the assets and liabilities acquired. All of the goodwill was allocated to our contract operations reporting unit. We review the carrying amount of our goodwill in the fourth quarter of every year, or whenever indicators of potential impairment exist, to determine if the carrying amount of our contract operations reporting unit exceeds its fair value, including the goodwill. Beginning in the first quarter of 2020, the COVID-19 pandemic caused a significant deterioration in global macroeconomic conditions, including a collapse in the demand for oil coupled with an oversupply of oil, which commenced substantial spending cuts by our customers and a decline in production. This global response to the 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 goodwill impairment loss of $99.8 million during the first quarter of 2020.

Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions, which have a significant impact on the fair value determined. We determined the fair value of our reporting unit using an equal weighting of both the expected present value of future cash flows and a market approach. The present value of future cash flows was estimated using our most recent forecast and the weighted average cost of capital. The market approach uses a market multiple on the earnings before interest expense, provision for income taxes and depreciation and amortization expense of comparable peer companies. Significant estimates for our reporting unit included in our impairment analysis were our cash flow forecasts, our estimate of the market’s weighted average cost of capital and market multiples.

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8. Hosting Arrangements

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. Included in this project are hosting arrangements that are service contracts related to the cloud migration of our ERP system and cloud services for our new mobile workforce, telematics and inventory management tools.

As of September 30, 2021 and December 31, 2020, we had $10.8 million and $7.7 million, respectively, of capitalized implementation costs related to our hosting arrangements that are service contracts included in other assets in our condensed consolidated balance sheets. Accumulated amortization was $0.6 million and $0.3 million at September 30, 2021 and December 31, 2020, respectively. We recorded $0.1 million of amortization expense to SG&A in our condensed consolidated statements of operations during each of the three months ended September 30, 2021 and 2020, and $0.3 million and $0.2 million during the nine months ended September 30, 2021 and 2020, respectively.

During the three and nine months ended September 30, 2020, we impaired $1.6 million of capitalized implementation costs related to the hosting arrangements of the mobile workforce component of our project due to the termination of the agreement, which was included in long-lived and other asset impairment in our condensed consolidated statements of operations.

9. Long-Term Debt


(in thousands)	September 30, 2021		December 31, 2020
Credit Facility	$	220,000	$	393,000

2028 Notes
Principal		800,000		800,000
Debt premium, net of amortization		13,037		14,541
Deferred financing costs, net of amortization		(10,821)		(11,766)
		802,216		802,775

2027 Notes
Principal		500,000		500,000
Deferred financing costs, net of amortization		(6,081)		(6,908)
		493,919		493,092

Long-term debt	$	1,516,135	$	1,688,867

Credit Facility

As of September 30, 2021, there were $12.5 million letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 2.6% and 2.7% at September 30, 2021 and December 31, 2020, respectively. We incurred $0.5 million and $0.4 million in commitment fees on the daily unused amount of the Credit Facility during the three months ended September 30, 2021 and 2020, respectively, and $1.5 million during each of the nine months ended September 30, 2021 and 2020.

We must maintain certain consolidated financial ratios, as defined in our Credit Facility agreement. As of September 30, 2021, the ratio requirements did not constrain our undrawn capacity and as such, $517.5 million was available for additional borrowings. As of September 30, 2021, we were in compliance with all covenants under the Credit Facility agreement.

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Amendment No. 3

On February 22, 2021, we amended our 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 and Total Debt to EBITDA ratios, as defined in the Credit Facility agreement, to the following:


Senior Secured Debt to EBITDA		3.00 to 1.0
Total Debt to EBITDA
Through fiscal year 2022		5.75 to 1.0
January 1, 2023 through September 30, 2023		5.50 to 1.0
Thereafter ⁽¹⁾		5.25 to 1.0

(1)	Subject to a temporary increase to 5.50 to 1.0 for any quarter during which an acquisition satisfying certain thresholds is completed and for the two quarters immediately following such quarter.

We incurred $1.8 million in transaction costs related to Amendment No. 3, which were included in other assets in our condensed consolidated balance sheets and are being amortized over the remaining term of the Credit Facility. In addition, we wrote off $4.9 million of unamortized deferred financing costs as a result of the amendment, which was recorded to interest expense in our condensed consolidated statements of operations during the nine months ended September 30, 2021.

2022 Notes Redemption

In April 2020, the 2022 Notes were redeemed at 100% of their $350.0 million aggregate principal amount plus accrued and unpaid interest of $10.5 million with borrowings under the Credit Facility. A debt extinguishment loss of $4.0 million related to the redemption was recognized during the nine months ended September 30, 2020.

10. Accumulated Other Comprehensive Loss

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 loss consists of changes in the fair value of our interest rate swap derivative instruments, net of tax.


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Beginning accumulated other comprehensive loss	$	(3,044)	$	(6,908)	$	(5,006)	$	(1,387)
Other comprehensive income (loss), net of tax:
Loss recognized in other comprehensive income (loss), net of tax benefit of $123, $18, $141 and $1,764, respectively		(458)		(69)		(529)		(6,635)
Loss reclassified from accumulated other comprehensive loss to interest expense, net of tax benefit of $393, $267, $933 and $545, respectively		1,474		1,004		3,507		2,049
Total other comprehensive income (loss)		1,016		935		2,978		(4,586)
Ending accumulated other comprehensive loss	$	(2,028)	$	(5,973)	$	(2,028)	$	(5,973)

See Note 17 (“Derivatives”) for further details on our interest rate swap derivative instruments.

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11. Equity

At-the-Market Continuous Equity Offering Program

On February 23, 2021, we entered into the ATM Agreement, pursuant to which we may offer and sell shares of our common stock from time to time for an aggregate offering price of up to $50.0 million. We intend to use the net proceeds of these offerings, after deducting sales agent fees and offering expenses, for general corporate purposes. Offerings of common stock pursuant to the ATM Agreement will terminate upon the earlier of (i) the sale of all shares of common stock subject to the ATM Agreement or (ii) the termination of the ATM Agreement by us or by each of the sales agents. Any sales agent may also terminate the ATM Agreement but only with respect to itself.

During the nine months ended September 30, 2021, we sold 357,148 shares of common stock for net proceeds of $3.4 million pursuant to the ATM Agreement.

Cash Dividends

The following table summarizes our dividends declared and paid in each of the quarterly periods of 2021 and 2020:


	Declared Dividends		Dividends Paid
	per Common Share		(in thousands)
2021
Q3	$	0.145	$	22,506
Q2		0.145		22,331
Q1		0.145		22,155

2020
Q4	$	0.145	$	22,177
Q3		0.145		22,308
Q2		0.145		22,176
Q1		0.145		22,171

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12. Revenue from Contracts with Customers

The following table presents our revenue from contracts with customers by segment (see Note 22 (“Segments”)) and disaggregated by revenue source:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Contract operations:
0 ― 1,000 horsepower per unit	$	41,576	$	51,409	$	134,413	$	175,877
1,001 ― 1,500 horsepower per unit		66,138		73,205		201,454		236,083
Over 1,500 horsepower per unit		51,018		50,142		152,360		156,351
Other ⁽¹⁾		179		467		583		1,835
Total contract operations revenue ⁽²⁾		158,911		175,223		488,810		570,146

Aftermarket services:
Services		19,249		17,961		53,149		62,492
OTC parts and components sales		17,006		12,447		44,253		43,006
Total aftermarket services revenue ⁽³⁾		36,255		30,408		97,402		105,498

Total revenue	$	195,166	$	205,631	$	586,212	$	675,644

(1)	Primarily relates to fees associated with owned non-compression equipment.

(2)

Includes $0.7 million and $1.4 million for the three months ended September 30, 2021 and 2020, respectively, and $3.1 million and $4.5 million for the nine months ended September 30, 2021 and 2020, respectively, related to billable maintenance on owned compressors that was recognized at a point in time. All other contract operations revenue is recognized over time.

(3)	All services 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 September 30, 2021, we had $268.2 million of remaining performance obligations related to our contract operations segment, which will be recognized through 2026 as follows:


(in thousands)	2021		2022		2023		2024		2025			2026	Total
Remaining performance obligations	$	1,093	$	95,890	$	128,521	$	32,787	$	9,148	$	759	$	268,198

We do 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 Assets and Liabilities

Contract Assets

As of September 30, 2021 and December 31, 2020, our receivables from contracts with customers, net of allowance for credit losses, were $95.3 million and $95.6 million, respectively.

Allowance for Credit Losses

Trade accounts receivable are due from companies of varying size engaged principally in oil and natural gas activities throughout the U.S. We review the financial condition of customers prior to extending credit and generally do not obtain collateral for trade receivables. Payment terms are on a short-term basis and in accordance with industry practice. We consider this credit risk to be limited due to these companies’ financial resources, the nature of the products and services we provide and the terms of our customer agreements.

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Due to the short-term nature of our trade receivables, we consider the amortized cost to be the same as the carrying amount of the receivable, excluding the allowance for credit losses. We recognize an allowance for credit losses when a receivable is recorded, even when the risk of loss is remote. We utilize an aging schedule to determine our allowance for credit losses and measure expected credit losses on a collective (pool) basis when similar risk characteristics exist. We rely primarily on ratings assigned by external rating agencies and credit monitoring services to assess credit risk and aggregate customers first by low, medium or high risk asset pools, and then by delinquency status. We also consider the internal risk associated with geographic location and the services we provide to the customer when determining asset pools. 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. Trade receivables evaluated individually are not included in our collective assessment. 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.

The contractual life of our trade receivables is primarily 30 days based on the payment terms specified in the contract. Contract operations services are generally billed monthly at the beginning of the month in which service is being provided. Aftermarket services billings typically occur when parts are delivered or service is completed. Loss rates are separately determined for each asset pool based on the length of time a trade receivable has been outstanding. We analyze two years of internal historical loss data, including the effects of prepayments, write-offs and subsequent recoveries, to determine our historical loss experience. Our historical loss information is a relevant data point for estimating credit losses, as the data closely aligns with trade receivables due from our customers. Ratings assigned by external rating agencies and credit monitoring services consider past performance and forecasts of future economic conditions in assessing credit risk. We routinely update our historical loss data to reflect our customers’ current risk profile, to ensure the historical data and loss rates are relevant to the pool of assets for which we are estimating expected credit losses.

Our allowance for credit losses balance changed as follows during the nine months ended September 30, 2021:


(in thousands)
Balance at December 31, 2020	$	3,370
Provision for credit losses		151
Write-offs charged against allowance		(464)
Balance at September 30, 2021	$	3,057

Contract Liabilities

Freight billings to customers for the transport of compression assets, customer-specified modifications of compression assets and milestone billings on aftermarket services often result in a contract liability. Our contract liabilities were $4.6 million as of both September 30, 2021 and December 31, 2020, and were included in deferred revenue and other liabilities in our condensed consolidated balance sheets. During the nine months ended September 30, 2021, we deferred revenue of $8.2 million and recognized $8.1 million as revenue. The revenue recognized and deferred during the period primarily related to freight billings and milestone billings on aftermarket services.

13. Long-Lived and Other 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 compressors from our active fleet, indicate that the carrying amount of an asset may not be recoverable.

In the first quarter of 2020, we determined that the impairment of our contract operations reporting unit’s goodwill was an indicator of potential impairment of the carrying amount of our long-lived assets, including our compressor fleet and associated customer and contract-based intangible assets. Accordingly, we performed a quantitative impairment test of our long-lived assets, by which we determined that they were not also impaired. No similar impairment has been indicated subsequent to the first quarter of 2020.

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Compression Fleet

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 compressors 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 compression fleet impairment review as recorded to our contract operations segment:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(dollars in thousands)	2021		2020		2021		2020
Idle compressors retired from the active fleet		60		105		175		640
Horsepower of idle compressors retired from the active fleet		24,000		28,000		61,000		235,000
Impairment recorded on idle compressors retired from the active fleet	$	5,120	$	8,137	$	14,964	$	69,542

Other Impairment

During the three and nine months ended September 30, 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 8 (“Hosting Arrangements”) for further details.

14. Restructuring Charges

During the first quarter of 2020, we completed restructuring activities to further streamline our organization and more fully align our teams to improve our customer service and profitability. We incurred severance costs of $1.7 million related to these activities during the first quarter of 2020. No additional costs will be incurred for this organizational restructuring.

In response to the decreased activity level of our customers that resulted from the COVID-19 pandemic beginning in the second quarter of 2020, we incurred severance costs of $7.0 million to right-size our business. No additional costs will be incurred under this restructuring plan.

During the third quarter of 2020, a plan to dispose of certain non-core properties was approved by management. We have incurred $1.5 million of restructuring costs as a result of these property disposals and do not expect to incur additional material property disposal costs under this restructuring plan.

During the third quarter of 2021, management approved and initiated a plan to exit a facility no longer deemed economical for our business. Closing costs incurred during the third quarter were not material, however, we expect to incur approximately $0.8 million to complete the exit of this facility in the fourth quarter of 2021.

The severance and property disposal costs incurred under the above restructuring plans were recorded to restructuring charges in our condensed consolidated statements of operations.

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The following table presents restructuring charges incurred by segment:


	Contract		Aftermarket
(in thousands)	Operations		Services		Other⁽¹⁾		Total
Three months ended September 30, 2021
Pandemic restructuring	$	—	$	—	$	224	$	224
Property restructuring - other exit costs		—		—		19		19
Other restructuring		—		—		70		70
Total restructuring charges	$	—	$	—	$	313	$	313

Three months ended September 30, 2020
Organizational restructuring	$	(20)	$	—	$	(13)	$	(33)
Pandemic restructuring		546		644		245		1,435
Property restructuring
Loss on sale		—		—		915		915
Impairment loss		—		—		583		583
Total property restructuring		—		—		1,498		1,498
Total restructuring charges	$	526	$	644	$	1,730	$	2,900

Nine months ended September 30, 2021
Pandemic restructuring	$	616	$	145	$	956	$	1,717
Property restructuring
Impairment loss		—		—		9		9
Other exit costs		—		—		26		26
Total property restructuring		—		—		35		35
Other restructuring		—		—		201		201
Total restructuring charges	$	616	$	145	$	1,192	$	1,953

Nine months ended September 30, 2020
Organizational restructuring	$	458	$	625	$	612	$	1,695
Pandemic restructuring		1,932		931		980		3,843
Property restructuring
Loss on sale		—		—		915		915
Impairment loss		—		—		583		583
Total property restructuring		—		—		1,498		1,498
Total restructuring charges	$	2,390	$	1,556	$	3,090	$	7,036

(1)	Represents expense incurred within our corporate function and not directly attributable to our segments.

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The following table presents restructuring charges incurred by cost type:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Severance costs
Organizational restructuring	$	—	$	(33)	$	—	$	1,695
Pandemic restructuring		224		1,435		1,717		3,843
Total severance costs		224		1,402		1,717		5,538
Property disposal costs
Loss on sale		—		915		—		915
Impairment loss		—		583		9		583
Other exit costs		19		—		26		—
Total property disposal costs		19		1,498		35		1,498
Other restructuring costs		70		—		201		—
Total restructuring charges	$	313	$	2,900	$	1,953	$	7,036

15. Income Taxes

Valuation Allowance

The amount of our deferred tax assets considered realizable could be adjusted if projections of future taxable income are reduced or objective negative evidence in the form of a three-year cumulative loss is present or both. Should we no longer have a level of sustained profitability, excluding nonrecurring charges, we will have to rely more on our future projections of taxable income to determine if we have an adequate source of taxable income for the realization of our deferred tax assets, namely net operating loss carryforwards and tax credit carryforwards. This may result in the need to record a valuation allowance against all or a portion of our deferred tax assets.

Effective Tax Rate

The year-to-date effective tax rate for the nine months ended September 30, 2021 differed significantly from our statutory rate primarily due to unrecognized tax benefits and the limitation on executive compensation.

Unrecognized Tax Benefits

As of September 30, 2021, we believe it is reasonably possible that $2.8 million of our unrecognized tax benefits, including penalties, interest and discontinued operations, will be reduced prior to September 30, 2022 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 that could materially differ from this estimate.

16. Earnings per Share

Basic net income (loss) 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) per common share is determined by dividing net income (loss), 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, only distributed earnings (dividends) are allocated to participating securities, as participating securities do not have a contractual obligation to participate in our undistributed losses.

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Diluted net income (loss) 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 ESPP unless their effect would be anti-dilutive.

The following table shows the calculation for net income (loss) attributable to common stockholders, which is used in the calculation of basic and diluted net income (loss) per common share:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Net income (loss)	$	9,304	$	18,332	$	22,225	$	(73,236)
Less: Earnings attributable to participating securities		(456)		(439)		(909)		(1,083)
Net income (loss) attributable to common stockholders	$	8,848	$	17,893	$	21,316	$	(74,319)

The following table shows the potential shares of common stock that were included in computing diluted net income (loss) per common share:


	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(in thousands)	2021	2020	2021	2020
Weighted average common shares outstanding including participating securities	154,041	152,973	153,422	152,790
Less: Weighted average participating securities outstanding	(1,883)	(1,999)	(1,807)	(2,060)
Weighted average common shares outstanding used in basic net income (loss) per common share	152,158	150,974	151,615	150,730
Net dilutive potential common shares issuable:
On exercise of options and vesting of performance-based restricted stock units	138	57	152	—
On settlement of ESPP shares	1	7	2	—
Weighted average common shares outstanding used in diluted net income (loss) per common share	152,297	151,038	151,769	150,730

The following table shows the potential shares of common stock issuable that were excluded from computing diluted net income (loss) per common share as their inclusion would have been anti-dilutive:


	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(in thousands)	2021	2020	2021	2020
On exercise of options where exercise price is greater than average market value for the period	15	85	27	102
On exercise of options and vesting of performance-based restricted stock units	—	—	—	57
On settlement of ESPP shares	—	—	—	19
Net dilutive potential common shares issuable	15	85	27	178

17. Derivatives

We are exposed to market risks associated with changes in the variable interest rate of our 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.

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As of September 30, 2021, we had $300.0 million notional value of interest rate swaps outstanding, which expire in March 2022 and were entered into to offset changes in expected cash flows due to fluctuations in the associated variable interest rates. The counterparties to these derivative agreements are major financial institutions. We monitor the credit quality of these financial institutions and do not expect nonperformance by any counterparty, although such nonperformance could have an adverse effect on us. We have no collateral posted for our derivative instruments.

During the three months ended September 30, 2021, we dedesignated $125.0 million notional value of our interest rate swaps. The fair value of this interest rate swap immediately prior to dedesignation was a liability of $1.6 million. The associated amount in accumulated other comprehensive loss related to this interest rate swap is being amortized into interest expense over the remaining term of the swap through March 2022. Future changes in the fair value of the dedesignated interest rate swap will be recorded in interest expense.

The remaining $175.0 million notional value of our interest rate swaps continue to be designated as cash flow hedging instruments. Changes in the fair value of cash flow hedging instruments are 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 which 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 interest rate 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 estimate that $2.6 million of the deferred pre-tax loss attributable to interest rate swaps included in accumulated other comprehensive loss at September 30, 2021 will be reclassified into earnings as interest expense at then-current values during the next 12 months as the underlying hedged transactions occur.

As of September 30, 2021, the weighted average effective fixed interest rate of our interest rate swaps was 1.8%.

The following table presents the effect of our derivative instruments on our condensed consolidated balance sheets:


(in thousands)	September 30, 2021		December 31, 2020
Interest rate swaps designated as cash flow hedging instruments
Accrued liabilities	$	1,502	$	4,810
Other liabilities		—		1,527
Total derivatives designated as cash flow hedging instruments		1,502		6,337

Interest rate swaps not designated as hedging instruments
Accrued liabilities		1,079		—

Total derivative liabilities	$	2,581	$	6,337

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The following table presents the effect of our derivative instruments on our condensed consolidated statements of operations:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Total amount of interest expense in which the effects of cash flow hedges and undesignated interest rate swaps are recorded	$	25,508	$	25,221	$	82,711	$	80,664

Interest rate swaps designated as cash flow hedging instruments
Pre-tax loss recognized in other comprehensive income (loss)	$	(581)	$	(87)	$	(670)	$	(8,399)
Pre-tax loss reclassified from accumulated other comprehensive loss into interest expense		(1,867)		(1,271)		(4,440)		(2,594)

Interest rate swaps not designated as hedging instruments
Gain recognized in interest expense	$	532	$	—	$	532	$	—

See Note 10 (“Accumulated Other Comprehensive Loss”) and Note 18 (“Fair Value Measurements”) for further details on our derivative instruments.

18. Fair Value Measurements

Assets and Liabilities Measured at Fair Value on a Recurring Basis

On a quarterly basis, our interest rate swap derivative instruments are valued based on the income approach (discounted cash flow) using market observable inputs, including LIBOR forward curves. These fair value measurements are classified as Level 2. The following table presents our derivative position measured at fair value on a recurring basis, with pricing levels as of the date of valuation:


(in thousands)	September 30, 2021		December 31, 2020
Derivative liabilities	$	2,581	$	6,337

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Goodwill

In the first quarter of 2020, we determined that the significant deterioration in global macroeconomic conditions caused by the COVID-19 pandemic was an indicator of potential impairment of our goodwill, and we performed a quantitative impairment test as of March 31, 2020 that resulted in a $99.8 million impairment of our goodwill. Significant estimates used in our impairment analysis included cash flow forecasts, our estimate of the market’s weighted average cost of capital and market multiples, which are Level 3 inputs. See Note 7 (“Goodwill”) for further details of the valuation methodology used in connection with the goodwill impairment.

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Compressors

During the nine months ended September 30, 2021, we recorded nonrecurring fair value measurements related to our idle and previously-culled compressors. Our estimate of the compressors’ 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 following table presents the fair value of our compressors impaired during 2021 and 2020:


(in thousands)	September 30, 2021		December 31, 2020
Impaired compressors	$	3,896	$	19,046

The significant unobservable inputs used to develop the above fair value measurements were weighted by the relative fair value of the compressors being measured. Additional quantitative information related to our significant unobservable inputs follows:


	Range	Weighted Average ⁽¹⁾
Estimated net sale proceeds:
As of September 30, 2021	$0 - $621 per horsepower	$31 per horsepower
As of December 31, 2020	$0 - $289 per horsepower	$20 per horsepower

(1)	Calculated based on an estimated discount for market liquidity of 68% and 81% as of September 30, 2021 and December 31, 2020, respectively.

See Note 13 (“Long-Lived and Other 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 our Credit Facility approximates fair value due to its variable interest rate. The fair value of these outstanding borrowings is a Level 3 measurement.

The fair value of our fixed rate debt is estimated using yields observable in active markets, which are Level 2 inputs, and was as follows:


(in thousands)	September 30, 2021		December 31, 2020
Carrying amount of fixed rate debt ⁽¹⁾	$	1,296,135	$	1,295,867
Fair value of fixed rate debt		1,352,000		1,371,000

(1)	Carrying amounts are shown net of unamortized debt premium and unamortized deferred financing costs. See Note 9 (“Long-Term Debt”).

19. Stock-Based Compensation


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Equity award expense	$	2,900	$	2,645	$	8,741	$	8,423
Liability award expense		127		243		1,121		537
Total stock-based compensation expense	$	3,027	$	2,888	$	9,862	$	8,960

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The following table presents the activity of our stock-settled restricted stock awards, restricted stock units and performance-based restricted stock units and our cash-settled performance-based restricted stock units during the nine months ended September 30, 2021:


		Weighted
		Average
		Grant Date
		Fair Value
(shares in thousands)	Shares	Per Share
Non-vested, December 31, 2020	2,446	$	9.69
Granted	1,287		11.20
Vested	(1,023)		9.95
Canceled	(72)		9.81
Non-vested, September 30, 2021 ⁽¹⁾	2,638		10.32

(1)	Comprised of 523 cash-settled units and 2,115 stock-settled awards and units.

As of September 30, 2021, we expect $16.2 million of unrecognized compensation cost related to our non-vested awards and units to be recognized over the weighted average period of 1.9 years.

20. 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 2021 through the fourth quarter of 2022, and maximum potential future payments of $1.5 million. As of September 30, 2021, we were in compliance with all obligations to which the performance bonds pertain.

Tax Matters

We are subject to a number of state and local taxes that are not income-based. As many of these taxes are subject to audit by the taxing authorities, it is possible that an audit could result in additional taxes due. We accrue for such additional taxes when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the liability. As of September 30, 2021 and December 31, 2020, we accrued $5.7 million and $5.6 million, respectively, for the outcomes of non-income-based tax audits. We do not expect that the ultimate resolutions of these audits will result in a material variance from the amounts accrued. We do not accrue for unasserted claims for tax audits unless we believe the assertion of a claim is probable, it is probable that it will be determined that the claim is owed and we can reasonably estimate the claim or range of the claim. We believe the likelihood is remote that the impact of potential unasserted claims from non-income-based tax audits could be material to our consolidated financial position, but it is possible that the resolution of future audits could be material to our consolidated results of operations or cash flows.

Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. The tax contingencies mentioned above relate to tax matters for which we are responsible in managing the audit. As of December 31, 2020, we had an indemnification liability (including penalties and interest), in addition to the tax contingency above, of $1.6 million for our share of non-income-based tax contingencies related to audits being managed by Exterran Corporation. During the nine months ended September 30, 2021, these audits were settled and our indemnification liability was reduced to zero.

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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. We are also self-insured for property damage to our offshore assets.

Litigation and Claims

In the ordinary course of business, we are involved in various pending or threatened legal actions. While we are unable to predict the ultimate outcome of these actions, we believe 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.

21. Related Party Transactions

In connection with the closing of the Elite Acquisition, we issued 21.7 million shares of our common stock to JDH Capital, an affiliate of our customer Hilcorp. As long as JDH Capital, together with affiliates of Hilcorp, owns at least 7.5% of our outstanding common stock, it will have the right to designate one director to our Board of Directors. As of September 30, 2021, JDH Capital owned 11.1% of our outstanding common stock.

Jeffery D. Hildebrand, founder and executive chairman of Hilcorp, was appointed Director in August 2019 and served until his resignation on July 29, 2020, at which time Jason C. Rebrook, President of Hilcorp, was appointed Director to fill the resulting vacancy. Mr. Hildebrand did not receive compensation in his role as Director and Mr. Rebrook received no compensation in his role as Director in 2020. In December 2020, the Board of Directors voted to approve the payment of Director cash and equity compensation to Mr. Rebrook beginning in 2021.

Revenue from Hilcorp and affiliates was $9.5 million and $9.8 million during the three months ended September 30, 2021 and 2020, respectively, and $28.6 million and $30.7 million during the nine months ended September 30, 2021 and 2020, respectively. Accounts receivable, net due from Hilcorp and affiliates was $3.5 million and $3.9 million as of September 30, 2021 and December 31, 2020, respectively.

22. 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 parts 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.

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	Contract		Aftermarket
(in thousands)	Operations		Services		Total
Three months ended September 30, 2021
Revenue	$	158,911	$	36,255	$	195,166
Gross margin		97,631		5,603		103,234

Three months ended September 30, 2020
Revenue	$	175,223	$	30,408	$	205,631
Gross margin		114,779		4,699		119,478

Nine months ended September 30, 2021
Revenue	$	488,810	$	97,402	$	586,212
Gross margin		304,778		13,477		318,255

Nine months ended September 30, 2020
Revenue	$	570,146	$	105,498	$	675,644
Gross margin		367,661		16,112		383,773

The following table reconciles total gross margin to income (loss) before income taxes:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Total gross margin	$	103,234	$	119,478	$	318,255	$	383,773
Less:
Selling, general and administrative		28,839		18,681		80,000		78,052
Depreciation and amortization		45,280		47,279		135,185		145,950
Long-lived and other asset impairment		5,121		10,727		15,154		72,132
Goodwill impairment		—		—		—		99,830
Restructuring charges		313		2,900		1,953		7,036
Interest expense		25,508		25,221		82,711		80,664
Debt extinguishment loss		—		—		—		3,971
Gain on sale of assets, net		(15,393)		(9,146)		(29,549)		(11,073)
Other (income) expense, net		337		(324)		(1,634)		(1,317)
Income (loss) before income taxes	$	13,229	$	24,140	$	34,435	$	(91,472)

23. Impact of Hurricane

Hurricane Ida made landfall in Louisiana on August 29, 2021, causing operational disruptions, damage to compressors and a temporary shutdown of facilities in Louisiana that negatively impacted our financial performance in the quarter. During the three months ended September 30, 2021, we recorded $2.0 million in depreciation expense associated with the damaged assets.

We have notified our insurance underwriters and filed a claim for damages caused by Hurricane Ida and are working with an adjuster. We are evaluating and documenting the damage caused including finalizing inspections of damaged compressors and other property. As of September 30, 2021, we are unable to estimate the expected amount to be recovered from insurance, which will be subject to a deductible currently estimated at $0.9 million.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q and in conjunction with our 2020 Form 10-K.

Overview

We are an energy infrastructure company with a pure-play focus on midstream natural gas compression. We are the leading provider of natural gas compression services to customers in the oil and natural gas industry throughout the 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.

Recent Business Developments

July 2021 Dispositions

In July 2021, we completed sales of certain contract operations customer service agreements and approximately 575 compressors, comprising approximately 100,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We received cash consideration of $60.3 million for the sales and recorded gains on the sales of $13.0 million during the three and nine months ended September 30, 2021. The proceeds received from the sales were used to repay borrowings outstanding under our Credit Facility. See Note 3 (“Business Transactions”) to our Financial Statements for further details of this transaction.

February 2021 Disposition

In February 2021, we completed the sale of certain contract operations customer service agreements and approximately 300 compressors, comprising approximately 40,000 horsepower, used to provide compression services under those agreements as well as other assets used to support the operations. We recorded a gain on the sale of $6.0 million during the nine months ended September 30, 2021. See Note 3 (“Business Transactions”) to our Financial Statements for further details of this transaction.

COVID-19 Pandemic

Beginning in the first quarter of 2020, the COVID-19 pandemic caused a deterioration in global macroeconomic conditions, including a collapse in the demand for natural gas and crude oil coupled with an oversupply of crude oil, which led to substantial spending cuts by our customers and a decline in natural gas and crude oil production. This global response to the pandemic has adversely impacted our revenue and cash flows. Though demand and commodity prices have shown improvement since the lows reached in the second quarter of 2020 as economies have reopened and vaccine rollout is underway globally, the potential for additional surges and variants of the disease remains and as such, uncertainty still exists around the timing and magnitude of a full economic recovery.

The key driver of our business is the production of U.S. natural gas and crude oil. Changes in natural gas and crude oil production spending therefore typically result in changes in demand for our services. According to the U.S. Energy Information Administration’s October 2021 Short-Term Energy Outlook, U.S. dry natural gas and crude oil production is expected to increase 1% and decline 2%, respectively, in 2021 as producers continue to limit drilling and completion activity to achieve maintenance levels of production and cash flows in the course of the COVID-19 pandemic. U.S. production of both commodities is expected to increase in 2022 at a rate of 4% for dry natural gas and 6% for crude oil.

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Our customers substantially cut spending and activity beginning in the second quarter of 2020 as a result of the significant declines in natural gas and crude oil prices and demand. Our horsepower, utilization and revenue have experienced declines and are expected to remain at lower levels in 2021 as compared to early 2020 and periods prior in both our contract operations and aftermarket services businesses. However, U.S. onshore activity is on the rise, which we expect will gradually result in higher demand for our business as we move into 2022.

The impact of the COVID-19 pandemic on our results is primarily visible in the $99.8 million non-cash impairment of goodwill and the impairment’s resulting $22.7 million tax benefit in the first quarter of 2020. Revenue, cost of sales, SG&A, long-lived and other asset impairment and restructuring charges have also been significantly impacted. See “Financial Results of Operations” below and Note 7 (“Goodwill”), Note 13 (“Long-Lived and Other Asset Impairment”) and Note 14 (“Restructuring Charges”) to our Financial Statements for further discussion.

Operating Highlights


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Total available horsepower (at period end)⁽¹⁾	3,913		4,153		3,913		4,153
Total operating horsepower (at period end)⁽²⁾	3,196		3,465		3,196		3,465
Average operating horsepower	3,225		3,536		3,298		3,731
Horsepower utilization:
Spot (at period end)	82	%	83	%	82	%	83	%
Average	82	%	85	%	82	%	86	%

(1)	Defined as idle and operating horsepower. Includes new compressors completed by third party manufacturers that have been delivered to us.

(2)	Defined as horsepower that is operating under contract and horsepower that is idle but under contract and generating revenue such as standby revenue.

Non-GAAP Financial Measures

Management uses a variety of financial and operating metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include the non-GAAP financial measure of gross margin.

We define gross margin as total revenue less cost of sales (excluding depreciation and amortization). Gross margin is included as a supplemental disclosure because it is a primary measure used by our management to evaluate the results of revenue and cost of sales (excluding depreciation and amortization), which are key components of our operations. We believe gross margin is important because it focuses on the current operating performance of our operations and excludes the impact of the prior historical costs of the assets acquired or constructed that are utilized in those operations, the indirect costs associated with our SG&A activities, our financing methods and income taxes. In addition, depreciation and amortization may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs of current operating activity. As an indicator of our operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income (loss) as determined in accordance with GAAP. Our gross margin may not be comparable to a similarly-titled measure of other entities because other entities may not calculate gross margin in the same manner.

Gross margin has certain material limitations associated with its use as compared to net income (loss). These limitations are primarily due to the exclusion of SG&A, depreciation and amortization, impairments, restructuring charges, interest expense, debt extinguishment loss, (gain) loss on sale of assets, net, other (income) expense, net and provision for (benefit from) income taxes. Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue. Additionally, because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue and SG&A is necessary to support our operations and required corporate activities. To compensate for these limitations, management uses this non-GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2021		2020		2021		2020
Net income (loss)	$	9,304	$	18,332	$	22,225	$	(73,236)
Selling, general and administrative		28,839		18,681		80,000		78,052
Depreciation and amortization		45,280		47,279		135,185		145,950
Long-lived and other asset impairment		5,121		10,727		15,154		72,132
Goodwill impairment		—		—		—		99,830
Restructuring charges		313		2,900		1,953		7,036
Interest expense		25,508		25,221		82,711		80,664
Debt extinguishment loss		—		—		—		3,971
Gain on sale of assets, net		(15,393)		(9,146)		(29,549)		(11,073)
Other (income) expense, net		337		(324)		(1,634)		(1,317)
Provision for (benefit from) income taxes		3,925		5,808		12,210		(18,236)
Gross margin	$	103,234	$	119,478	$	318,255	$	383,773

Results of Operations: Summary of Results

Revenue

Revenue decreased to $195.2 million from $205.6 million during the three months ended September 30, 2021 and 2020, respectively, due to a decrease in revenue from our contract operations business that was partially offset by an increase in revenue from our aftermarket services business.

Revenue decreased to $586.2 million from $675.6 million during the nine months ended September 30, 2021 and 2020, respectively, due to decreases in revenue from our contract operations and aftermarket services businesses.

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

Net Income (Loss)

Net income was $9.3 million and $18.3 million during the three months ended September 30, 2021 and 2020, respectively. The decrease in net income was primarily driven by a decrease in gross margin of our contract operations business and an increase in SG&A, partially offset by an increase in gain on sale of assets, net and decreases in long-lived and other asset impairment, restructuring charges, depreciation and amortization and provision for income taxes.

We had net income of $22.2 million and a net loss of $73.2 million during the nine months ended September 30, 2021 and 2020, respectively. The change from net loss to net income was primarily driven by decreases in goodwill impairment, long-lived and other asset impairment, depreciation and amortization, restructuring charges and debt extinguishment loss, as well as an increase in gain on sale of assets, net. These changes were partially offset by decreases in gross margin of our contract operations and aftermarket services businesses and the change from a benefit from to a provision for income taxes.

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Results of Operations: Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020

Contract Operations


	Three Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Revenue	$	158,911		$	175,223		(9)	%
Cost of sales (excluding depreciation and amortization)		61,280			60,444		1	%
Gross margin	$	97,631		$	114,779		(15)	%
Gross margin percentage ⁽¹⁾		61	%		66	%	(5)	%

(1)	Defined as gross margin divided by revenue.

Revenue decreased primarily due to returns of horsepower amidst the market downturn, as well as the strategic disposition of horsepower in 2020 and 2021. Partially offsetting these decreases was an increase in contract operations rates, which was driven by customer shifts from standby to operating status.

Gross margin decreased due to the overall decrease in revenue discussed above, as total cost of sales was relatively unchanged quarter over quarter. Cost of sales increased due to a decrease in our sales and use tax benefit as the result of audit settlements in 2020 and no comparable settlements in 2021, and increases in lube oil expense, which was primarily due to an increase in commodity price, and start-up expense, which resulted from an increase in unit redeployment in 2021. These increases were substantially offset by decreases in maintenance and other operating expenses, which were driven by the lower operating horsepower discussed above.

Aftermarket Services


	Three Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Revenue	$	36,255		$	30,408		19	%
Cost of sales (excluding depreciation and amortization)		30,652			25,709		19	%
Gross margin	$	5,603		$	4,699		19	%
Gross margin percentage		15	%		15	%	0	%

Revenue increased primarily due to an increase in parts sales and service activities as a result of an increase in customer demand that began in the second quarter of 2021.

Gross margin increased due to this increase in revenue and despite an increase in cost of sales, which was driven by the same increase in parts sales and service activities.

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Costs and Expenses


	Three Months Ended
	September 30,
(in thousands)	2021		2020
Selling, general and administrative	$	28,839	$	18,681
Depreciation and amortization		45,280		47,279
Long-lived and other asset impairment		5,121		10,727
Restructuring charges		313		2,900
Interest expense		25,508		25,221
Gain on sale of assets, net		(15,393)		(9,146)
Other (income) expense, net		337		(324)

Selling, general and administrative. The increase in SG&A was primarily due to a $6.6 million change in sales and use tax from a benefit to expense as the result of audit settlements in 2020 and no comparable settlements in 2021, a $1.6 million increase in compensation and benefits, increases of $0.4 million in each of bad debt expense, professional expenses and information technology expenses, and a $0.3 million increase in employee travel and meeting expense.

Depreciation and amortization. The decrease in depreciation and amortization expense was primarily due to a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives, the impact of compression and other asset sales during 2020 and early 2021 and a decrease in amortization expense as certain intangible assets reached the end of their useful lives. These decreases were partially offset by increases in depreciation expense associated with fixed asset additions during 2020 and early 2021 and the write-off of compression and building assets damaged by Hurricane Ida in the third quarter of 2021.

Long-lived and other asset impairment. We periodically review the future deployment of our idle compressors for units that are not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. In addition, we evaluate for impairment idle units that have been culled from our compression fleet in prior years and are available for sale. See Note 13 (“Long-Lived and Other Asset Impairment”) to our Financial Statements for further details. The following table presents the results of our compression fleet impairment review, as recorded in our contract operations segment:


	Three Months Ended
	September 30,
(dollars in thousands)	2021		2020
Idle compressors retired from the active fleet		60		105
Horsepower of idle compressors retired from the active fleet		24,000		28,000
Impairment recorded on idle compressors retired from the active fleet	$	5,120	$	8,137

Also during the three months ended September 30, 2020, we impaired $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. See Note 8 (“Hosting Arrangements”) to our Financial Statements for further details.

Restructuring charges. Restructuring charges of $0.3 million and $2.9 million during the three months ended September 30, 2021 and 2020, respectively, primarily consisted of severance and property disposal costs related to our restructuring activities. See Note 14 (“Restructuring Charges”) to our Financial Statements for further details.

Interest expense. Total interest expense was relatively unchanged due to a decrease in the average outstanding balance of long-term debt that offset the impact of an increase in the weighted average effective interest rate.

Gain on sale of assets, net. Our net gain on sale of assets during the three months ended September 30, 2021 was primarily the result of $13.0 million of gains recognized on the July 2021 Dispositions, which primarily related to the compression assets sold, and $2.2 million of gains recognized on other compression asset sales during the quarter.

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Our net gain on sale of assets during the three months ended September 30, 2020 was primarily due to the $9.3 million gain on the July 2020 Disposition.

Other (income) expense, net. The change from net other income to net other expense was primarily driven by a $0.3 million reduction in indemnification expense recorded during the three months ended September 30, 2020 due to the settlement of an audit pursuant to our tax matters agreement with Exterran Corporation.

Provision for Income Taxes


	Three Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Provision for income taxes	$	3,925		$	5,808		(32)	%
Effective tax rate		30	%		24	%	6	%

The decrease in provision for income taxes was primarily due to the tax effect of the decrease in book income during the three months ended September 30, 2021 compared to the three months ended September 30, 2020.

Results of Operations: Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020

Contract Operations


	Nine Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Revenue	$	488,810		$	570,146		(14)	%
Cost of sales (excluding depreciation and amortization)		184,032			202,485		(9)	%
Gross margin	$	304,778		$	367,661		(17)	%
Gross margin percentage		62	%		64	%	(2)	%

Revenue decreased primarily due to returns of horsepower amidst the market downturn, as well as the strategic disposition of horsepower in 2020 and 2021.

Gross margin decreased due to the decrease in revenue, however, the decline was partially mitigated by the decrease in cost of sales. The lower operating horsepower discussed above drove a decrease in maintenance, freight and other operating expenses. Offsetting these decreases was a decrease in our sales and use tax benefit, which resulted from audit settlements in 2020 and no comparable settlements in 2021.

Aftermarket Services


	Nine Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Revenue	$	97,402		$	105,498		(8)	%
Cost of sales (excluding depreciation and amortization)		83,925			89,386		(6)	%
Gross margin	$	13,477		$	16,112		(16)	%
Gross margin percentage		14	%		15	%	(1)	%

Revenue decreased due to the impact of the sale of our turbocharger business in July 2020, as well as a decrease in service activities, which was primarily driven by customer deferral of maintenance activities amidst the market downturn. These decreases were partially offset by an increase in parts sales that resulted from an increase in customer demand beginning in the second quarter of 2021.

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Gross margin decreased due to the decrease in revenue, however, the decline was partially mitigated by the decrease in cost of sales. The decrease in cost of sales was driven by the decrease in service activities and the sale of our turbocharger business, and was partially offset by the increase in parts sales. Excluding the impact of the July 2020 Disposition, gross margin was relatively unchanged.

Costs and Expenses


	Nine Months Ended
	September 30,
(in thousands)	2021		2020
Selling, general and administrative	$	80,000	$	78,052
Depreciation and amortization		135,185		145,950
Long-lived and other asset impairment		15,154		72,132
Goodwill impairment		—		99,830
Restructuring charges		1,953		7,036
Interest expense		82,711		80,664
Debt extinguishment loss		—		3,971
Gain on sale of assets, net		(29,549)		(11,073)
Other income, net		(1,634)		(1,317)

Selling, general and administrative. The increase in SG&A was primarily due to a $4.3 million increase in sales and use tax that was mainly driven by audit settlements in 2020 and no comparable settlements in 2021, partially offset by a $2.1 million decrease in bad debt expense and a $0.5 million decrease in employee travel and meeting expense.

Depreciation and amortization. The decrease in depreciation and amortization expense was primarily due to a decrease in depreciation expense resulting from assets reaching the end of their depreciable lives, the impact of compression and other asset impairments and sales during 2020 and early 2021 and a decrease in amortization expense as certain intangible assets reached the end of their useful lives. These decreases were partially offset by increases in depreciation expense associated with fixed asset additions during 2020 and early 2021 and the write-off of compression and building assets damaged by Hurricane Ida in 2021.


	Nine Months Ended
	September 30,
(dollars in thousands)	2021		2020
Idle compressors retired from the active fleet		175		640
Horsepower of idle compressors retired from the active fleet		61,000		235,000
Impairment recorded on idle compressors retired from the active fleet	$	14,964	$	69,542

Also during the nine months ended September 30, 2020, we impaired $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. See Note 8 (“Hosting Arrangements”) to our Financial Statements for further details.

Goodwill impairment. During the nine months ended September 30, 2020, we recorded goodwill impairment of $99.8 million due to the decline in the fair value of our contract operations reporting unit. See Note 7 (“Goodwill”) to our Financial Statements for further details.

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Restructuring charges. Restructuring charges of $2.0 million and $7.0 million during the nine months ended September 30, 2021 and 2020, respectively, primarily consisted of severance and property disposal costs related to our restructuring activities. See Note 14 (“Restructuring Charges”) to our Financial Statements for further details.

Interest expense. The increase in interest expense was primarily due to an increase in the weighted average effective interest rate and the $4.9 million write-off of unamortized deferred financing costs related to Amendment No. 3, partially offset by a decrease in the average outstanding balance of long-term debt.

Debt extinguishment loss. We recorded a debt extinguishment loss of $4.0 million during the nine months ended September 30, 2020 as a result of the redemption of the 2022 Notes. See Note 9 (“Long-Term Debt”) to our Financial Statements for further details.

Gain on sale of assets, net. Our net gain on sale of assets during the nine months ended September 30, 2021 was primarily the result of $13.0 million of gains recognized on the July 2021 Dispositions, the $6.0 million gain on the February 2021 Disposition and $8.6 million of gains recognized on other compression asset sales during the period.

Our net gain on sale of assets during the nine months ended September 30, 2020 was primarily due to the $9.3 million gain on the July 2020 Disposition, the $3.2 million gain on the March 2020 Disposition and a $2.5 million gain on other transportation and shop asset sales. These gains were partially offset by a $3.9 million loss on other compression asset sales during the period.

Other income, net. The increase in other income, net was primarily driven by a $0.4 million decrease in indemnification expense remitted pursuant to our tax matters agreement with Exterran Corporation.

Provision for (Benefit from) Income Taxes


	Nine Months Ended
	September 30,						Increase
(dollars in thousands)	2021			2020			(Decrease)
Provision for (benefit from) income taxes	$	12,210		$	(18,236)		(167)	%
Effective tax rate		35	%		20	%	15	%

The change from a benefit from to a provision for income taxes was primarily due to the tax effect of the increase in book income during the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.

Liquidity and Capital Resources

Overview

Our ability to fund operations, finance capital expenditures and pay dividends depends on the levels of our operating cash flows and access to the capital and credit markets. Our primary sources of liquidity are cash flows generated from our operations and our borrowing availability under our Credit Facility. Our cash flow is affected by numerous factors including prices and demand for our services, oil and natural gas exploration and production spending, conditions in the financial markets and other factors. Beginning in the first quarter of 2020, the COVID-19 pandemic caused a deterioration in global macroeconomic conditions, which adversely impacted our estimates of future revenues and cash flows. However, we have no near-term maturities and believe that our operating cash flows and borrowings under the Credit Facility will be sufficient to meet our future liquidity needs.

We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

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Capital Requirements

Our contract operations business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Our capital spending is primarily dependent on the demand for our contract operations services and the availability of the type of compression equipment required for us to provide those contract operations services to our customers. Our capital requirements have primarily consisted of, and we anticipate will continue to consist of, the following:

●

growth capital expenditures, which are made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue-generating capabilities of existing or new assets; and

●

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

The majority of our growth capital expenditures are related to the acquisition cost of new compressors when our idle equipment cannot be reconfigured to economically fulfill a project’s requirements and the new compressor is expected to generate economic returns over its expected useful life that exceed our cost of capital. In addition to newly-acquired compressors, growth capital expenditures include the upgrading of major components on an existing compression package where the current configuration of the compression package is no longer in demand and the compressor is not likely to return to an operating status without the capital expenditures. These expenditures substantially modify the operating parameters of the compression package such that it can be used in applications for which it previously was not suited.

Maintenance capital expenditures are related to major overhauls 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 application for which the compression package was designed.

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

Credit Facility

During the nine months ended September 30, 2021 and 2020, the Credit Facility had an average daily balance of $310.9 million and $711.8 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 2.6% and 2.7% at September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021, there were $12.5 million letters of credit outstanding under the Credit Facility.

We must maintain certain consolidated financial ratios as defined in our Credit Facility agreement. As of September 30, 2021, the ratio requirements did not constrain our undrawn capacity and as such, $517.5 million was available for additional borrowings. As of September 30, 2021, we were in compliance with all covenants under the Credit Facility agreement.

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Amendment No. 3. On February 22, 2021, we amended our 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 and Total Debt to EBITDA ratios, as defined in the Credit Facility agreement, to the following:


Senior Secured Debt to EBITDA		3.00 to 1.0
Total Debt to EBITDA
Through fiscal year 2022		5.75 to 1.0
January 1, 2023 through September 30, 2023		5.50 to 1.0
Thereafter ⁽¹⁾		5.25 to 1.0

(1)	Subject to a temporary increase to 5.50 to 1.0 for any quarter during which an acquisition satisfying certain thresholds is completed and for the two quarters immediately following such quarter.

See Note 9 (“Long-Term Debt”) to our Financial Statements for further details on Amendment No. 3.

At-the-Market Continuous Equity Offering Program

On February 23, 2021, we entered into the ATM Agreement whereby we may sell from time to time shares of our common stock having an aggregate offering price of up to $50.0 million. We intend to use the net proceeds of these offerings for general corporate purposes. During the nine months ended September 30, 2021, we sold 357,148 shares of common stock for net proceeds of $3.4 million pursuant to the ATM Agreement. See Note 11 (“Equity”) to our Financial Statements for further details on the ATM Agreement.

Cash Flows

Our cash flows from operating, investing and financing activities, as reflected in our condensed consolidated statements of cash flows, are summarized below:


	Nine Months Ended
	September 30,
(in thousands)	2021		2020
Net cash provided by (used in):
Operating activities	$	208,725	$	266,834
Investing activities		37,854		(81,995)
Financing activities		(244,188)		(187,048)
Net increase (decrease) in cash and cash equivalents	$	2,391	$	(2,209)

Operating Activities

The decrease in net cash provided by operating activities was primarily due to reduced cash inflows from revenue, deferred revenue and accounts receivable, as well as increased cash outflow for inventory, partially offset by decreased cash outflows for cost of sales, accounts payable and other liabilities, SG&A expenses, restructuring charges and interest paid on long-term debt and the receipt of additional cash proceeds from the July 2020 Disposition in the third quarter of 2021.

Investing Activities

The change from net cash used in to net cash provided by investing activities was primarily due to a $60.8 million increase in proceeds from business dispositions and other sales of property, plant and equipment and a $59.5 million decrease in capital expenditures.

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Financing Activities

The increase in net cash used in financing activities was primarily due to a $56.0 million increase in net repayments of long-term debt, partially offset by $3.4 million of net proceeds from the issuance of common stock under the ATM Agreement during the nine months ended September 30, 2021.

Dividends

On October 28, 2021, our Board of Directors declared a quarterly dividend of $0.145 per share of common stock to be paid on November 16, 2021 to stockholders of record at the close of business on November 9, 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, results of operations and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.

Off-Balance Sheet Arrangements

For information on our obligations with respect to letters of credit and performance bonds see Note 9 (“Long-Term Debt”) and Note 20 (“Commitments and Contingencies”), respectively, to our Financial Statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative disclosures about market risk, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk” of our 2020 Form 10-K. Our exposures as of September 30, 2021 have not changed materially since December 31, 2020.

Item 4. Controls and Procedures

This Item 4 includes information concerning the controls and controls evaluation referred to in the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a-14 of the Exchange Act included in this Quarterly Report as Exhibits 31.1 and 31.2.

Management’s Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that such information is accumulated and communicated to management to allow timely decisions regarding required disclosures.

As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act), which are designed to provide reasonable assurance that we are able to record, process, summarize and report the information required to be disclosed in our reports under the Exchange Act within the time periods specified in the rules and forms of the SEC. Based on the evaluation, as of September 30, 2021 our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to management, and made known to our principal executive officer and principal financial officer, on a timely basis to ensure that it is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

There have been no material changes or updates to the risk factors previously disclosed in our 2020 Form 10-K.

Item 2. Purchases of Equity Securities by Issuer and Affiliated Purchasers

The following table summarizes our purchases of equity securities during the three months ended September 30, 2021:


					Maximum
					Number of Shares
				Total Number of	That May Yet be
		Average		Shares Purchased	Purchased Under
	Total Number	Price		as Part of Publicly	the Publicly
	of Shares	Paid per		Announced Plans	Announced Plans
	Purchased ⁽¹⁾	Share		or Programs	or Programs
July 1, 2021 — July 31, 2021	—	$	—	N/A	N/A
August 1, 2021 — August 31, 2021	92,540		7.30	N/A	N/A
September 1, 2021 — September 30, 2021	—		—	N/A	N/A
Total	92,540		7.30	N/A	N/A

(1)	Represents shares withheld to satisfy employees’ tax withholding obligations in connection with the vesting of restricted stock awards during the period.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits



Exhibit No.		Description
2.1		Asset Purchase Agreement, dated as of June 23, 2019, by and among Archrock Services, L.P., Archrock, Inc. and Elite Compression Services, LLC, incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed on June 24, 2019
2.2		Asset Purchase Agreement, dated as of June 23, 2019, by and between Archrock Services, L.P. and Harvest Four Corners, LLC, incorporated by reference to Exhibit 2.2 of the Registrant’s Current Report on Form 8-K filed on June 24, 2019
3.1		Composite Certificate of Incorporation of Archrock, Inc. (as amended as of November 3, 2015), incorporated by reference to Exhibit 3.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2015
3.2		Third Amended and Restated Bylaws of Exterran Holdings, Inc. (now Archrock, Inc.), incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on March 20, 2013
3.3		Amendment No. 1 to Third Amended and Restated Bylaws of Archrock, Inc., incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed on May 5, 2020
4.1		Indenture, dated as of March 21, 2019, by and among Archrock Partners, L.P., Archrock Partners Finance Corp., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee, incorporated by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed on March 21, 2019
4.2		Indenture, dated as of December 20, 2019, by and among Archrock Partners, L.P., Archrock Partners Finance Corp., the guarantors party thereto and Wells Fargo Bank, National Association, as trustee, incorporated by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed on December 20, 2019
31.1*		Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.1*		Interactive data files pursuant to Rule 405 of Regulation S-T
104.1*		Cover page interactive data files pursuant to Rule 406 of Regulation S-T

* Filed herewith.

** Furnished, not filed.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Archrock, Inc.

	By:	/s/ Douglas S. Aron
		Douglas S. Aron
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer)

	By:	/s/ Donna A. Henderson
		Donna A. Henderson
		Vice President and Chief Accounting Officer
		(Principal Accounting Officer)

		November 2, 2021