# Archrock, Inc. (AROC) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Archrock, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1389050/000138905023000013/aroc-20221231x10k.htm
Accession: 0001389050-23-000013
Filing date: 2023-02-22
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/AROC/
All MD&A years: /company/AROC/mda/
Previous year: /company/AROC/mda/fy2021/ (FY 2021)
Next year: /company/AROC/mda/fy2023/ (FY 2023)

ITEM 7. 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 Financial Statements, the notes thereto, and the other financial information appearing elsewhere in this 2022 Form 10–K. The following discussion includes forward–looking statements that involve certain risks and uncertainties. See “Forward–Looking Statements” and Part I, Item 1A. “Risk Factors” in this 2022 Form 10–K.

This section primarily discusses 2022 and 2021 items and comparisons between these years. For a discussion of changes from 2020 to 2021 and other financial information related to 2020, refer to Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10–K for the year ended December 31, 2021 filed with the SEC on February 23, 2022.

33

Table Archrock, Contents

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., in terms of total compression fleet horsepower, and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. Our business supports a must–run service that is essential to the production, processing, transportation and storage of natural gas. The natural gas that we help transport satisfies demand from electricity generation, heating and cooking and the industrial and manufacturing sectors. Our geographic diversity, technically experienced personnel and large fleet of natural gas compression equipment enable us to provide reliable contract operations services to our customers.

We operate in two business segments:

[[GREPCENT_TABLE]]
[["","\u2022","Contract Operations. Our contract operations business is comprised of our owned fleet of natural gas compression equipment that we use to provide compression operations services to our customers."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Aftermarket Services. Our aftermarket services business provides a full range of services to support the compression needs of our customers that own compression equipment, including operations, maintenance, overhaul and reconfiguration services and sales of parts and components."]]
[[/GREPCENT_TABLE]]

Significant 2022 Transactions

During the year ended December 31, 2022, we completed sales of certain contract operations customer service agreements and approximately 770 compressors, comprising approximately 172,000 horsepower, used to provide compression services under those agreements, as well as other assets used to support the operations. We recorded an aggregate gain on the sales of $28.1 million. See Note 3 to our Financial Statements for additional information about these dispositions.

In April 2022, we agreed to acquire for cash a 25% equity interest in ECOTEC, a company specializing in methane emissions detection, monitoring and management. As of December 31, 2022, we own 22.7% of ECOTEC. We acquired the remaining equity interest of 2.3% in January 2023. See Note 11 to our Financial Statements for additional information about this investment.

Trends and Outlook

The key driver of our business is the production of U.S. oil and natural gas. Approximately 79% of our operating fleet is deployed for midstream natural gas gathering applications, with the remaining fleet being used in gas lift applications to enhance oil production. As our business is so closely aligned with production and is typically less directly impacted by commodity prices, we are not exposed to the volatility often faced in shorter–cycle oil field service businesses.

Domestic natural gas production generally occurs in either primarily natural gas basins, such as the Marcellus, Utica and Haynesville Shales, or in basins where natural gas is produced alongside oil, also known as “associated” gas, such as the Permian and Delaware Basins, Eagle Ford and the Mid–Continent. Relative stability in commodity prices over much of the past decade encouraged investment in domestic exploration and production and midstream infrastructure across the energy industry, particularly in the low–cost basins characterized by oil and associated natural gas production. The development of these basins producing both commodities has created additional incremental demand for natural gas compression over the recent past as it is a critical method to transport associated gas volumes or enhance oil production through gas lift.

34

Table Archrock, Contents

Current Trends

According to the EIA Outlook, average U.S. oil and dry natural gas and production were as follows:

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","","Year Ended December 31,"],["\u200b","\u200b","2022","","2021","","2020"],["Average dry natural gas production (Bcf/d)","","98.0","","93.6","","91.3"],["Average oil production (MMb/d)","","11.9","","11.2","","11.3"]]
[[/GREPCENT_TABLE]]

​

Looking back to 2021, the economic recovery from the effects of the COVID–19 pandemic brought a rebound in energy demand around the globe; however, producers limited drilling and completion activity to achieve maintenance levels of production and cash flows in the course of the pandemic. In 2022, the rebound in energy demand triggered supply constraints and price spikes for multiple commodities. That, coupled with the conflict in Ukraine, increased market uncertainty and price spikes as the market and consumers balance supply security and affordability. Even given this uncertainty in the market, oil and natural gas production in 2022 continued to rebound, particularly natural gas production. The increases in production in 2022 resulted in strong demand for our compression services and we increased our investment in new fleet units. Our contract operations revenue and total operating horsepower increased 5% and 6%, respectively in 2022. Similar increases in demand in 2022 were seen in our aftermarket services business, where we experienced an increase of 26% in aftermarket services revenue in 2022.

Outlook

The EIA Outlook forecasts the following year–over–year changes:

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,"],["\u200b","\u200b","2023","\u200b","2024","\u200b"],["U.S. dry natural gas production","","2","%","\u200b","2","%"],["U.S. oil production","","5","%","\u200b","3","%"],["U.S. natural gas domestic consumption","\u200b","(2)","%","\u200b","(1)","%"],["Liquefied natural gas exports","","13","%","\u200b","4","%"]]
[[/GREPCENT_TABLE]]

The events of 2022 drove broad realization that a more diverse energy mix is needed to satisfy global energy demand and preserve energy security, making it a rewarding time to be in the business of transporting U.S. natural gas. The EIA Outlook expects natural gas production to continue to increase primarily in the Permian region in West Texas and Southeast New Mexico and in the Haynesville region in Louisiana and East Texas due to the expected completion of new pipeline infrastructure expansions in 2023 and 2024. Although the EIA expects natural gas production to increase, natural gas consumption is expected to decrease slightly, reflecting a decrease in the usage of natural gas in the electric power generation sector, as a result of increased power generation from renewables, partially offset by increased LNG exports and exports of natural gas via pipeline to Mexico.

We believe the outlook for the energy industry in the U.S. is positive. While we anticipate that the combination of commodity prices and demand may likely have a positive impact on activity levels in both the upstream and midstream sectors, we cannot predict the ultimate magnitude of that impact on our business and expect it to be varied across our operations, depending on the region, customer, nature of our services, contract term and other factors. However, we continue to believe that overall the long–term demand for our compression services will continue given the necessity of compression in facilitating the transportation and processing of natural gas.

Regarding our aftermarket services business, the base of owned compression in the U.S. has increased over the past several years, which we believe will help sustain our aftermarket services business over the long term.

35

Table Archrock, Contents

Key Challenges and Uncertainties

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

Capital Requirements and the Availability of External Sources of Capital. We have funded a significant portion of our capital expenditures and acquisitions through borrowings under our Credit Facility and have issued a substantial amount of debt, which could limit our ability to fund future planned capital expenditures. Current conditions could limit our ability to access the debt and equity markets to raise capital on affordable terms in 2023 and beyond. If we are not successful in raising capital within the time period required or at all, we may not be able to fund these capital expenditures, which could impair our ability to grow or maintain our business.

Cost Management. In order to improve our operations and further reduce operating expenses, we are investing significant resources into a process and technology transformation project that has, among other things, replaced our existing ERP, supply chain and inventory management systems and expanded the remote monitoring capabilities of our compression fleet. Cost management continues to be challenging, however, and there is no guarantee that our efforts will result in a reduction in our operating expenses. Natural gas production growth and resulting demand for our services could cause us to experience increased operating expenses as we hire employees and incur additional expenses needed to support the rebound in market demand.

Further, we depend on suppliers for the materials, parts, equipment and lube oil necessary to our operations, which exposes us to volatility in prices. Significant price increases for these inputs could adversely affect our operating profits. Supply chain disruptions could also adversely affect our ability to obtain, or increase the cost of, such items. While we generally attempt to mitigate the impact of increased prices through strategic purchasing decisions, diversification of our supplier base, where possible, and the passing along of increased costs to customers, there may be a time delay between the increased commodity prices and the ability to increase the price of our services.

Labor. We believe that our ability to hire, train and retain qualified personnel will continue to be important. Although we have been able to historically satisfy our personnel needs, retaining employees in our industry continues to be a challenge. Our ability to grow and to continue our current level of service to our customers will depend in part on our success in hiring, training and retaining our employees. Further, the cost of labor has increased and may continue to increase in the future with increases in demand, which will require us to incur additional costs.

Increasing customer focus on free cash flow. Many of our customers have begun transitioning their business model to focus on sustainable free cash flow generation rather than growth, and the COVID–19 pandemic further fueled this change in focus. We expect this transition to have a positive impact on the industry in the long term, as we anticipate the change will reduce volatility through cycles and improve the financial strength of our customers. In the near term, however, we expect this transition to result in a modest natural gas production growth rate, to which demand for our products and services is closely aligned.

Demand for natural gas-powered compression. Demand for our services is dependent on the demand for natural gas in the markets we serve. Although the EIA currently forecasts natural gas demand will grow through 2050, technological advances and accelerated adoption of renewable sources of energy could reduce demand for natural gas in our markets and have an adverse effect on our business. In addition, increased focus of our customers on reducing emissions from, or the use of, combustion engines in compression could increase demand for electric motor-driven compressors or require us to make modifications to our existing natural gas-powered units.

36

Table Archrock, Contents

Operating Highlights

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,","\u200b"],["(horsepower in thousands)","\u200b","2022","\u200b","2021","\u200b","2020","\u200b"],["Total available horsepower (at period end)(1)","\u200b","3,726","","3,878","","4,120","\u200b"],["Total operating horsepower (at period end)(2)","\u200b","3,448","","3,247","","3,388","\u200b"],["Average operating horsepower","\u200b","3,328","","3,282","","3,657","\u200b"],["Horsepower utilization:","\u200b","","","","","","\u200b"],["Spot (at period end)","\u200b","93","%","84","%","82","%"],["Average","\u200b","87","%","82","%","86","%"]]
[[/GREPCENT_TABLE]]

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

[[GREPCENT_TABLE]]
[["(2)","Defined as horsepower that is operating under contract and horsepower that is idle but under contract and generating revenue such as standby revenue."]]
[[/GREPCENT_TABLE]]

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 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.

37

Table Archrock, Contents

The reconciliation of net income (loss) to gross margin is as follows:

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,"],["(in thousands)","\u200b","2022","","2021","","2020"],["Net income (loss)","\u200b","$","44,296","\u200b","$","28,217","\u200b","$","(68,445)"],["Selling, general and administrative","\u200b","","117,184","\u200b","","107,167","\u200b","","105,100"],["Depreciation and amortization","\u200b","","164,259","\u200b","","178,946","\u200b","","193,138"],["Long-lived and other asset impairment","\u200b","","21,442","\u200b","","21,397","\u200b","","79,556"],["Goodwill impairment","\u200b","\u200b","\u2014","\u200b","\u200b","\u2014","\u200b","\u200b","99,830"],["Restructuring charges","\u200b","\u200b","\u2014","\u200b","\u200b","2,903","\u200b","\u200b","8,450"],["Interest expense","\u200b","","101,259","\u200b","","108,135","\u200b","","105,716"],["Debt extinguishment loss","\u200b","\u200b","\u2014","\u200b","\u200b","\u2014","\u200b","\u200b","3,971"],["Gain on sale of assets, net","\u200b","\u200b","(40,494)","\u200b","\u200b","(30,258)","\u200b","\u200b","(10,643)"],["Other expense (income), net","\u200b","","1,845","\u200b","","(4,707)","\u200b","","(1,359)"],["Provision for (benefit from) income taxes","\u200b","","16,293","\u200b","","10,744","\u200b","","(17,537)"],["Gross margin","\u200b","$","426,084","\u200b","$","422,544","\u200b","$","497,777"]]
[[/GREPCENT_TABLE]]

​

RESULTS OF OPERATIONS

Summary of Results

Revenue was $845.6 million and $781.5 million during the years ended December 31, 2022 and 2021, respectively. The increase in revenue was due to increased revenue from both our contract operations business and aftermarket services business. See “Contract Operations” and “Aftermarket Services” below for further details.

Net income was $44.3 million and $28.2 million during the years ended December 31, 2022 and 2021, respectively. The increase was primarily driven by a higher gross margin from our aftermarket services business, decreased depreciation and amortization expense and interest expense and an increased gain on sale of assets, net, partially offset by higher SG&A expenses and lower gross margin from our contract operations business and higher SG&A.

​

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

Contract Operations

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,","\u200b","Increase","\u200b"],["(dollars in thousands)","\u200b","2022","","2021","","(Decrease)","\u200b"],["Revenue","\u200b","$","677,801","\u200b","$","648,311","\u200b","5","%"],["Cost of sales (excluding depreciation and amortization)","\u200b","","278,898","\u200b","","244,486","\u200b","14","%"],["Gross margin","\u200b","$","398,903","\u200b","$","403,825","\u200b","(1)","%"],["Gross margin percentage (1)","\u200b","","59","%","","62","%","(3)","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Defined as gross margin divided by revenue."]]
[[/GREPCENT_TABLE]]

Revenue in our contract operations business increased primarily due to higher rates and an increase in average operating horsepower in response to improving market conditions, partially offset by the impact of the strategic dispositions in 2022 and 2021.

38

Table Archrock, Contents

Despite the increase in revenues, the decrease in gross margin in our contract operations business reflects the impact of a larger increase in cost of sales. Start–up, maintenance, lube oil and other operating expenses increased, driven by higher pricing throughout our supply chain, as well as increased volumes associated with unit redeployment as customer activity accelerated. Partially offsetting these cost increases was the decrease in expense attributable to the horsepower sold in 2022 and 2021.

Aftermarket Services

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","\u200b","","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,","\u200b","Increase","\u200b"],["(dollars in thousands)","\u200b","2022","","2021","","(Decrease)","\u200b"],["Revenue","\u200b","$","167,767","\u200b","$","133,150","","26","%"],["Cost of sales (excluding depreciation and amortization)","\u200b","","140,586","\u200b","","114,431","","23","%"],["Gross margin","\u200b","$","27,181","\u200b","$","18,719","","45","%"],["Gross margin percentage","\u200b","","16","%","","14","%","2","%"]]
[[/GREPCENT_TABLE]]

Revenue in our aftermarket services business increased due to the increase in both service activities and sales of parts and components driven by increased customer demand during 2022 compared to 2021.

Gross margin increased due to the increase in revenue mentioned above, partially offset by the increase in cost of sales. The increase in cost of sales was primarily driven by increases in the cost associated with parts and labor.

Costs and Expenses

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,"],["(in thousands)","","2022","","2021"],["Selling, general and administrative","","$","117,184","\u200b","$","107,167"],["Depreciation and amortization","","","164,259","\u200b","","178,946"],["Long-lived and other asset impairment","","","21,442","\u200b","","21,397"],["Restructuring charges","\u200b","\u200b","\u2014","\u200b","\u200b","2,903"],["Interest expense","","","101,259","\u200b","","108,135"],["Gain on sale of assets, net","\u200b","\u200b","(40,494)","\u200b","\u200b","(30,258)"],["Other expense (income), net","\u200b","\u200b","1,845","\u200b","\u200b","(4,707)"]]
[[/GREPCENT_TABLE]]

​

Selling, general and administrative. The increase in SG&A was primarily due to a $4.7 million increase in employee compensation costs, a $1.7 million increase in information technology expenses related to increased amortization expense of capitalized implementation costs and service agreements related to the substantial completion of our process and technology transformation project at the end of 2021, a $1.6 million increase in sales and use tax related to audit settlements and a $1.1 million increase in travel and meeting expenses.

Depreciation and amortization. The decrease in depreciation and amortization was primarily due the impact of assets reaching the end of their depreciable lives, compression and other asset sales and impairments and certain intangible assets reaching the end of their useful lives, partially offset by the increased depreciation and amortization expenses associated with fixed asset additions.

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 20 to our Financial Statements for further details.

39

Table Archrock, Contents

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

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,"],["(dollars in thousands)","\u200b","2022","","2021"],["Idle compressors retired from the active fleet","\u200b","\u200b","145","","\u200b","230"],["Horsepower of idle compressors retired from the active fleet","\u200b","\u200b","100,000","","\u200b","85,000"],["Impairment recorded on idle compressors retired from the active fleet","\u200b","$","21,431","\u200b","$","21,208"]]
[[/GREPCENT_TABLE]]

​

Restructuring charges. Restructuring charges recorded in 2021 primarily related to reductions in headcount and costs to exit a facility no longer deemed economical for our business. We recorded no such restructuring charges during 2022. See Note 19 to our Financial Statements for further details.

Interest expense. The decrease in interest expense was primarily due to a decrease in the average outstanding balance of long–term debt and the $4.9 million write–off of unamortized deferred financing costs related to an amendment to our Credit Facility in 2021, which were partially offset by an increase in the weighted average effective interest rate.

Gain on sale of assets, net. The net gain on sales of assets during 2022 was the result of $28.1 million of gains recognized on sales of certain contract operations customer service agreements and approximately 770 compressors and $12.4 million of gains recognized on other compression and transportation asset sales.

The net gain on the sales of assets during 2021 was primarily the result of $19.0 million of gains recognized on sales of certain contract operations customer service agreements and approximately 875 compressors, $9.3 million of gains recognized on other compression asset sales and $3.3 million of gains recognized on other transportation and shop asset sales during the period.

Other expense (income), net. The change in other expense (income), net was primarily due to a $2.4 million decrease in insurance proceeds related to damages to facilities and compressors caused by Hurricane Ida, a $1.9 million unrealized change in the fair value of our investment in an unconsolidated affiliate and a $0.9 million decrease in indemnification expense remitted pursuant to our tax matters agreement with Exterran Corporation.

Provision for Income Taxes

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","\u200b","","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,","\u200b","Increase","\u200b"],["(dollars in thousands)","\u200b","2022","","2021","","(Decrease)","\u200b"],["Provision for income taxes","\u200b","$","16,293","\u200b","$","10,744","","52","%"],["Effective tax rate","\u200b","","27","%","","28","%","(1)","%"]]
[[/GREPCENT_TABLE]]

The increase in the provision for income taxes is primarily due to the tax effect of the increase in book income during the year ended December 31, 2022 compared to the year ended December 31, 2021. See Note 22 to our Financial Statements for additional details.

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. 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.

40

Table Archrock, Contents

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.

Cash 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 consisted primarily of, and we anticipate will continue to consist of, the following:

[[GREPCENT_TABLE]]
[["","\u2022","operating expenses, namely employee compensation and benefits, inventory and lube oil purchases;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","growth capital expenditures;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","maintenance capital expenditures;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","interest on our outstanding debt obligations; and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","dividend payments to our stockholders."]]
[[/GREPCENT_TABLE]]

Capital Expenditures

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

Growth capital expenditures were $146.3 million and $37.2 million during the years ended December 31, 2022 and 2021, respectively. The increase in growth capital expenditures from 2021 to 2022 was the result of increased investment in new compression equipment as a result of higher customer demand.

Maintenance Capital Expenditures. 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.

Maintenance capital expenditures were $84.2 million and $47.3 million during the years ended December 31, 2022 and 2021, respectively. The increase in maintenance capital expenditures from 2021 to 2022 was the result of an increase in scheduled maintenance activities due to maintenance cycle requirements as well as additional make–ready investment as we return idle equipment to work to meet customer demand.

Projected Capital Expenditures. We currently plan to spend approximately $270.0 million to $295.0 million in capital expenditures during the year ended December 31, 2023, primarily consisting of approximately $180.0 million to $200.0 million for growth capital expenditures and approximately $75.0 million to $80.0 million for maintenance capital expenditures. We anticipate increased 2023 capital expenditures, particularly growth capital expenditures, as compared to 2022 due to increased investment in new compression equipment as a result of higher customer demand.

41

Table Archrock, Contents

Dividends

On January 26, 2023, our Board of Directors declared a quarterly dividend of $0.15 per share of common stock, or approximately $23.6 million, which was paid on February 14, 2023 to stockholders of record at the close of business on February 7, 2023. Any future determinations to pay cash dividends to our stockholders will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, and credit and loan agreements in effect at that time and other factors deemed relevant by our Board of Directors.

Contractual Obligations

Our material contractual obligations as of December 31, 2022 consisted of the following:

[[GREPCENT_TABLE]]
[["","\u2022","Long\u2013term debt of $1.5 billion, of which $1.3 billion is due in 2027 and 2028, with the remainder due in 2024;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Estimated interest on our long\u2013term debt of $444.0 million, consisting of annual payments of approximately $103.5 million in 2023, approximately $100.7 million in 2024, and approximately $84.4 million or less in 2025 through 2028;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Purchase commitments of $210.7 million, of which $178.0 million is due in 2023, that primarily consist of commitments to purchase fleet assets and information technology\u2013related costs; and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","Operating lease payments of $21.4 million that are spread relatively evenly in 2023 through 2032."]]
[[/GREPCENT_TABLE]]

In addition, we had $19.7 million of unrecognized tax benefits (including discontinued operations) recorded as liabilities related to uncertain tax positions and a liability of $2.1 million recorded for potential penalties and interest (including discontinued operations) related to these unrecognized tax benefits at December 31, 2022, which we are uncertain as to if or when such amounts may be settled.

Sources of Cash

Revolving Credit Facility

During the years ended December 31, 2022 and 2021, our Credit Facility had an average daily balance of $235.4 million and $295.3 million, respectively. The weighted average annual interest rate on the outstanding balance under the Credit Facility, excluding the effect of interest rate swaps, was 6.9% and 2.6% at December 31, 2022 and 2021, respectively. As of December 31, 2022, there were $5.7 million of letters of credit outstanding under the Credit Facility and the applicable margin on borrowings outstanding was 2.4%.

Our Credit Facility matures in November 2024 and has an aggregate revolving commitment of $750.0 million. Portions of the Credit Facility up to $50.0 million are available for the issuance of swing line loans and $50.0 million is available for the issuance of letters of credit. Subject to certain conditions, including approval by the lenders, we are able to increase the aggregate commitments under the Credit Facility by up to an additional $250.0 million.

Our Credit Facility agreement requires that we meet certain financial ratios (see Note 14 to our Financial Statements) and contains various additional covenants including, but not limited to, mandatory prepayments from the net cash proceeds of certain asset transfers, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay distributions. As a result of the financial ratio requirements, $487.6 million of the $493.0 million of undrawn capacity was available for additional borrowings as of December 31, 2022. We were in compliance with all other covenants under our Credit Facility agreement.

42

Table Archrock, Contents

Senior Notes

As of both December 31, 2022 and 2021, we had a principal balance of $1.3 billion of outstanding senior notes that consisted of the following:

[[GREPCENT_TABLE]]
[["","\u2022","$800.0 million of 6.25% senior notes due in April 2028 and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","$500.0 million of 6.875% senior notes due in April 2027."]]
[[/GREPCENT_TABLE]]

See Note 14 to our Financial Statements for further details of these notes.

At–the–Market Continuous Equity Offering Program

Under our ATM Agreement, we may sell, from time to time, shares of our common stock having an aggregate offering price of up to $50.0 million. The agreement terminates upon the earlier of (i) the sale of all shares of common stock subject to the agreement or (ii) the termination of the agreement by us or by each of the sales agents. Any sales agent may also terminate the agreement but only with respect to itself. We used the net proceeds of these offerings for general corporate purposes. During the years ended December 31, 2022 and 2021, we sold 447,020 and 357,148 shares of common stock, respectively, for net proceeds of $4.2 million and $3.4 million, respectively, pursuant to the ATM Agreement.

Other Sources of Cash

We received proceeds of $120.3 million and $112.9 million from business dispositions and other asset sales during the years ended December 31, 2022 and 2021, respectively. We typically use the proceeds from these sales to repay borrowings outstanding under our Credit Facility, however, we are not able to estimate the timing of asset sales nor the amount of proceeds to be received and as such, we do not rely on asset sale proceeds as a future source of capital.

Cash Flows

Cash flows provided by (used in) each type of activity were as follows:

[[GREPCENT_TABLE]]
[["\u200b","\u200b","\u200b","\u200b","\u200b","\u200b","\u200b"],["\u200b","\u200b","\u200b"],["\u200b","\u200b","Year Ended December 31,"],["(in thousands)","\u200b","2022","","2021"],["Net cash provided by (used in):","\u200b","\u200b","","","\u200b"],["Operating activities","\u200b","$","203,450","\u200b","$","237,400"],["Investing activities","\u200b","","(130,916)","\u200b","","16,107"],["Financing activities","\u200b","\u200b","(72,537)","\u200b","","(253,035)"],["Net (decrease) increase in cash and cash equivalents","\u200b","$","(3)","\u200b","$","472"]]
[[/GREPCENT_TABLE]]

​

Operating Activities.

The decrease in net cash provided by operating activities was primarily due to increased cash outflow for cost of sales, contract costs, and SG&A, as well as decreased cash inflow from accounts receivable. Partially offsetting these decreases in operating cash were increased cash inflow from revenue and deferred revenue.

Investing Activities.

The change in net cash used in investing activities was primarily due to a $142.0 million increase in capital expenditures and a $14.7 million increase in our investment in unconsolidated affiliates, partially offset by a $7.4 million increase in proceeds from the sale of business and other assets.

43

Table Archrock, Contents

Financing Activities.

The decrease in net cash used in financing activities was primarily due to $16.8 million of net borrowings of long–term debt during 2022 compared with $158.5 million of net repayments of long–term debt during 2021, and a $3.1 million decrease in payments for settlements of interest rate swaps that include financing elements.

Critical Accounting Estimates

We describe our significant accounting policies more fully in Note 2 to our Financial Statements. As disclosed in Note 2, the preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosures of contingent assets and liabilities. We evaluate our estimates and accounting policies on an ongoing basis and base our estimates on historical experience and other assumptions that we believe are reasonable under the circumstances. The results of this process form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and these differences can be material to our financial condition, results of operations and cash flows.

Depreciation

Property, plant and equipment are carried at cost and depreciated using the straight–line basis over the estimated useful life of the asset. As of December 31, 2022, property, plant and equipment, net was $2.2 billion and depreciation expense was $155.4 million for the year ended December 31, 2022.

Our estimate of useful lives and salvage values are based on assumptions and judgments that reflect both historical experience and expectations regarding future use of our assets, including wear and tear, obsolescence, technical standards, market demand and geographic location. The use of different assumptions and judgments in the calculation of depreciation, especially those involving useful lives, would likely result in significantly different net book values and results of operations.

The estimated useful life of an asset is monitored to determine its appropriateness, especially when business circumstances change. For example, changes in technology, excessive wear and tear, or unanticipated government actions may result in a shorter estimated useful life than originally anticipated. In these cases, we would depreciate the remaining net book value over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis. Likewise, if the estimated useful life is increased, the adjustment to the useful life would decrease depreciation expense per year on a prospective basis.

Impairment of Assets

During the year ended December 31, 2022, we recorded long–lived and other asset impairments of $21.4 million. We review long–lived assets, which include property, plant and equipment and intangibles assets 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. An impairment loss may exist when the estimated undiscounted cash flows expected from the use of the asset and its eventual disposition are less than its carrying amount. Determining whether the carrying amount of an asset is recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the asset subject to review. These forecasts are uncertain as they require significant assumptions about future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and specific times, it is not possible to reasonably quantify the impact of changes in these assumptions.

For compressors that are removed from our active fleet, the fair value of a compressor 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. See Note 20 and Note 25 to our Financial Statements for further details of our fleet asset impairments.

44

Table Archrock, Contents

Income Taxes

Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. Significant judgments and estimates are required in determining consolidated income tax expense.

Deferred income taxes arise from temporary differences between the financial statements and the tax basis of assets and liabilities. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including scheduled reversals of deferred tax liabilities, projected future taxable income, tax–planning strategies and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for changes in accounting policies and incorporate assumptions, including the amount of future U.S. federal and state pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax–planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative income (loss) before income taxes.

Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on our financial position, results of operations or cash flows. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various state and local jurisdictions.

GAAP provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. We adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the liabilities. Such differences are reflected as increases or decreases to income tax expense in the period in which the new information becomes available.

Recent Accounting Developments

See Note 2 to our Financial Statements.