EXTERRAN CORPORATION
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
report. The following discussion includes forward-looking statements that
involve certain risks and uncertainties. See Part I ("Disclosure Regarding
Forward-Looking Statements") and Part I, Item 1A ("Risk Factors") in this
report.
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This section of the Form 10-K discusses the results of operations for the year
ended
Overview
We are a global systems and process company offering solutions in the oil, gas, water and power markets. We are a leader in natural gas processing and treatment and compression products, solutions, and services providing critical midstream infrastructure solutions to customers throughout the world. We provide our products, solutions, and services to a global customer base consisting of companies engaged in all aspects of the oil and natural gas industry, including large integrated oil and natural gas companies, national oil and natural gas companies, independent oil and natural gas producers and oil and natural gas processors, gatherers and pipeline operators. We operate in three primary business lines: contract operations, aftermarket services and product sales. The nature and inherent interactions between and among our business lines provide us with opportunities to cross-sell and offer integrated product and service solutions to our customers. In our contract operations business line, we provide processing, treating, compression and water treatment services through the operation of our natural gas compression equipment, crude oil and natural gas production and process equipment and water treatment equipment for our customers. In our aftermarket services business line, we sell parts and components and provide operations, maintenance, repair, overhaul, upgrade, startup and commissioning and reconfiguration services to customerswho own their own oil and natural gas compression, production, processing, treating and related equipment. In our product sales business line, we design, engineer, manufacture, install and sell equipment used in the treating and processing of crude oil, natural gas and water as well as natural gas compression packages to our customers throughout the world and for use in our contract operations business line. We also offer our customers, on either a contract operations basis or a sale basis, the engineering, design, project management, procurement and construction services necessary to incorporate our products into production, processing and compression facilities, which we refer to as integrated projects. We have continued to work toward our strategy to be a company that leverages sustainable technology and operational excellence to provide complete systems and process solutions in energy and industrial applications. Over the past several years, we have made significant progress in this journey by taking actions to protect our core business, develop important organizational capabilities, commercialize new products, solutions, and services and implement new processes to positionExterran for success. We are focused on optimizing our portfolio of products, solutions, and services to better serve our global customers while providing a more attractive investment option for our investors. As we continue on this path, we decided that ourU.S. compression fabrication business was non-core to our strategy going forward and during the third quarter of 2020, we entered into an agreement to sell the business which closed onNovember 2, 2020 . During the third quarter of 2020, this business met the held for sale criteria and is also now reflected as discontinued operations in our financial statements for all periods presented. TheU.S. compression fabrication business was previously included in our product sales segment and has been reclassified to discontinued operations in our financial statements for all periods presented. Compression revenue from sales to international customers continues to be included in our product sales segment. Our chief operating decision maker manages business operations, evaluates performance and allocates resources based on the Company's three primary business lines, which are also referred to as our segments. In order to more efficiently and effectively identify and serve our customer needs, we classify our worldwide operations into four geographic regions. TheNorth America region is primarily comprised of our operations in theU.S. TheLatin America region is primarily comprised of our operations inArgentina ,Bolivia ,Brazil , andMexico . TheMiddle East andAfrica region is primarily comprised of our operations inBahrain ,Iraq ,Oman ,Nigeria and theUnited Arab Emirates . TheAsia Pacific region is primarily comprised of our operations inChina ,Indonesia ,Singapore andThailand . 44
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InJanuary 2022 , we announced a business combination with Enerflex to create a premier integrated global provider of energy infrastructure. The combination is an all-share transaction pursuant to which Enerflex will acquire all of the outstanding common stock ofExterran on the basis of 1.021 Enerflex shares for each outstanding share of common stock ofExterran , resulting in approximately 124 million Enerflex common shares outstanding upon closing, representing an implied combined enterprise value of approximately$1.5 billion . The transaction value forExterran is approximately$735 million , which represents an 18% premium toExterran's enterprise value as of the date of the announcement. We expect the deal to close by the second or the third quarter of 2022.
Industry Conditions and Trends
Our business environment and corresponding operating results are affected by the level of energy industry spending for the exploration, development and production of oil and natural gas reserves, along with spending within the midstream space. Spending by oil and natural gas exploration and production companies and midstream providers is dependent upon these companies' forecasts regarding the expected future supply, demand and pricing of oil and natural gas products as well as their estimates of risk-adjusted costs to find, develop, produce, transport, and treat these reserves. Although we believe our contract operations business is typically less impacted by short-term commodity prices than certain other energy products, solutions, and service providers, changes in oil and natural gas exploration and production spending normally result in changes in demand for our products, solutions and services. Beginning in 2019, there has been a shift in the industry that was exacerbated by the COVID-19 pandemic. The industry has seen a structural change in the behavior of exploration and production producers and midstream providers, predominately in theU.S. , but internationally as well, to change their focus from growth to one emphasizing cash flow and returns. This caused a significant reduction in their capital spending plans in order to drive incremental cash flow and has put constraints on the amount of new projects that customers sanction. In 2020 the COVID-19 pandemic created a demand shock to the system that further exacerbated the supply demand imbalance that was already taking place. As the global economy improved in 2021, commodity pricing improved due to increased demand and still constrained supplies as a result of the 2020 demand shock. Looking out into 2022, we are seeing increased interest inExterran products and services, but the landscape is still volatile, due to the continued uncertainty around COVID-19 and its variants as well as possible geopolitical events that could impact oil and gas prices.
Our Performance Trends and Outlook
Our revenue, earnings and financial position are affected by, among other things, market conditions that impact demand and pricing for natural gas compression, oil and natural gas production and processing and produced water treatment solutions along with our customers' decisions to use our products, solutions and services, use our competitors' products and services or own and operate the equipment themselves. Aggregate booking activity levels for our product sales segment inNorth America and international markets during the year endedDecember 31, 2021 was approximately$33.7 million , which represents a decrease of 93% compared to the year endedDecember 31, 2020 . The decrease in bookings was primarily driven by a large processing plant booking in theMiddle East during the first quarter of 2020. Fluctuations in the size and timing of customers' requests for bid proposals and awards of new contracts tend to create variability in booking activity levels from period to period. Historically, oil, natural gas and natural gas liquids and the level of drilling and exploration activity inNorth America have been volatile. The Henry Hub spot price for natural gas was$3.82 per MMBtu atDecember 31, 2021 , which was 62% higher than prices atDecember 31, 2020 , and theU.S. natural gas liquid composite price was$12.15 per MMBtu for the month ofOctober 2021 , which was 111% higher than prices for the month ofDecember 2020 . In addition, the West Texas Intermediate crude oil spot price as ofDecember 31, 2021 was 56% higher than prices atDecember 31, 2020 . Volatility in demand for energy and in commodity prices as well as an industry trend towards disciplined capital spending and improving returns have caused timing uncertainties in demand for our products recently. Booking activity levels for our product sales segment inNorth America during the year endedDecember 31, 2021 were$24.7 million , which represents an increase of 673% compared to the year endedDecember 31, 2020 . 45
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Longer-term fundamentals in our international markets partially depend on international oil and gas infrastructure projects, many of which are based on the longer-term plans of our customers that can be driven by their local market demand and local pricing for natural gas. As a result, we believe our international customers make decisions based more on longer-term fundamentals that may be less tied to near term commodity prices than our North American customers. Over the long term, we believe the demand for our products, solutions and services in international markets will continue, and we expect to have opportunities to grow our international businesses. Booking activity levels for our manufactured products in international markets during the year endedDecember 31, 2021 were$9.0 million , which represents a decrease of 98% compared to the year endedDecember 31, 2020 . The timing of customer orders and change in activity levels by our customers is difficult to predict. As a result, our ability to project the anticipated activity booking levels for our business, and particularly our product sales segment, is limited. Given the volatility of the global energy markets and industry capital spending levels, we plan to monitor and continue to control our expense levels as necessary to protect our profitability. Additionally, volatility in commodity prices could continue to delay investments by our customers in significant projects, which could result in a material adverse effect on our business, financial condition, results of operations and cash flows. Our level of capital spending largely depends on the demand for our contract operations services and the equipment required to provide such services to our customers. Based on our contract operations business backlog of jobs in process and opportunities we anticipate in international markets, we expect to invest more capital in our contract operations business in 2022 than we did in 2021. A decline in demand for oil and natural gas or prices for those commodities, or instability and rationalization of capital funding in the global energy markets may cause a reduction in demand for our products, solutions and services. We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressor units from our active fleet, indicate that the carrying amount of an asset may not be recoverable.
Certain Key Challenges and Uncertainties
Market conditions and competition in the oil and natural gas industry and the
risks inherent in international markets continue to represent key challenges and
uncertainties. In addition to these challenges, we believe the following
represent some of the key challenges and uncertainties we will face in the
future:
Global Energy Markets and Oil and Natural Gas Pricing. Our results of operations
depend upon the level of activity in the global energy markets, including oil
and natural gas development, production, processing and transportation. Oil and
natural gas prices and the level of drilling and exploration activity can be
volatile. If oil and natural gas exploration and development activity and the
number of well completions decline due to the reduction in oil and natural gas
prices or significant instability in energy markets, we would anticipate a
decrease in demand and pricing for our natural gas compression and oil and
natural gas production and processing equipment and services. For example,
unfavorable market conditions or financial difficulties experienced by our
customers may result in cancellation of contracts or the delay or abandonment of
projects, which could cause our cash flows generated by our product sales and
services to decline and have a material adverse effect on our results of
operations and financial condition.
Execution on Larger Contract Operations and Product Sales Projects. Some of our
projects are significant in size and scope, which can translate into more
technically challenging conditions or performance specifications for our
products, solutions and services. Contracts with our customers generally specify
delivery dates, performance criteria and penalties for our failure to perform.
Any failure to execute such larger projects in a timely and cost effective
manner could have a material adverse effect on our business, financial
condition, results of operations and cash flows.
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Personnel, Hiring, Training and Retention. We believe our ability to grow may be challenged by our ability to hire, train and retain qualified personnel. Although we have been able to satisfy our personnel needs thus far, retaining employees in our industry continues to be a challenge. Our ability to continue our growth will depend in part on our success in hiring, training and retaining these employees.
Impact of COVID-19 on our Business
InMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19 a pandemic. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption across most industries. Efforts to mitigate the spread of COVID-19 resulted in decreased energy demand and weakness in energy pricing in 2020. In 2021 energy demand and energy pricing improved as the world economies began to recover; demand forExterran products began to show improvement in late 2021, and that demand improvement is expected to continue to improve in 2022.
The Company took proactive steps earlier in the first quarter of 2020 to enable and verify the ability to ensure the safety of our employees while still carrying on the majority of business functions. These steps included:
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Establishing a daily global operating process to identify, monitor and discuss impacts to our business whether originating from governmental actions or as a direct result of employee illness;
•
Investing in additional IT capabilities to enable employees to work remotely;
•
Closing operations where and until assessments were completed to ensure we could operate in a safe manner; and
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Reestablishing operations once safety mechanisms were in place. This included the acquisition of additional personal protective equipment and establishing screening and other workplace processes.
To date our actions in response to the pandemic and the primary impacts on our business are summarized below:
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As most of our operations are considered essential by local government authorities, our service operations that are provided under long-term contracts have to a large extent continued to operate under substantially normal conditions;
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We are following local governmental guidance for viral spread mitigation,
including having many of our employees
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We have put in place additional health and safety measures to protect our
employees, customers and other parties
•
Although early in 2020 we recorded significant new product sales bookings, as 2020 and 2021 progressed, we saw decreased purchasing activity from our customers which we believe was due to both the work at home mitigation measures our customers are also taking and weakness in commodity prices. With the improvements in energy pricing and energy demand we expect to see improved booking activity in the near term;
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Given travel restrictions and other mitigation efforts, certain of our employees were not able to travel to work assignments, therefore although we have taken additional steps to be able to continue to provide services required by our customers, some services were delayed until mitigation measures were eased;
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While our operations have been impacted by lower product sale bookings in the recent years, we have continued our cost reduction efforts which began prior to the current pandemic. We have continued our efforts to optimize our cost structure to align with the expected demand in our business including making work force reductions;
•
We evaluated our accounts receivable and given the current energy environment and expected impact to the financials of our customers, we increased our reserve for uncollectible accounts by$4.8 million atDecember 31, 2020 . We kept the reserve for uncollectible accounts at approximately the same level atDecember 31, 2021 ;
•
Given COVID-19's impact on demand for energy and decreased commodity prices
which impact our customer's capital spending, during the three months ended
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As many of our suppliers increased delivery times including as a result of disruptions, we are working with customers on revising expected due-dates for delivery, and have pushed out the timing of our recognition of revenue and adjusted gross margin on certain projects as a result of these and other delays caused by the pandemic; and
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We have participated in certain COVID-19 tax incentive programs in certain jurisdictions in which we operate. These primarily allowed a delay in filing and/or paying of taxes for short periods of time. In theU.S. , we filed a request for refund and received a$4.9 million Alternative Minimum Tax refund in 2020, which was earlier than originally scheduled due to the 47
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provisions of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). We have not participated in any government sponsored loan programs under the CARES Act. We are unable to predict the impact that COVID-19 will have on our long-term financial position and operating results due to numerous uncertainties. The long-term impact of the pandemic on our customers and the global economy will depend on various factors, including the scope, severity and duration of the pandemic. A prolonged economic downturn or recession resulting from the pandemic could adversely affect many of our customers which could, in turn, adversely impact our business, financial condition and results of operations. We will continue to assess the evolving impact of the COVID-19 pandemic and intend to make adjustments to its responses accordingly.
Summary of Results
Revenue. Revenue during the years endedDecember 31, 2021 and 2020 was$630.2 million and$613.1 million , respectively. The increase in revenue during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was due to an increase in revenue in the product sales segment, partially offset by a decrease in the aftermarket services segment. The increase in our product sales segment was primarily due to increases in processing and treating revenue, partially offset by decreases in compression revenue. The decrease in aftermarket services revenue was primarily due to decreases in revenue in operation and maintenance and overhaul services in theLatin America andMiddle East andAfrica regions Net income (loss). We generated a net loss of$112.7 million and$101.3 million during the years endedDecember 31, 2021 and 2020, respectively. The increase in net loss during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to increases in depreciation and amortization expense, SG&A expense and interest expense, a decrease in adjusted gross margin of our aftermarket service and contract operations segment and a decrease in gain on extinguishment of debt. This was partially offset by an increase in adjusted gross margin for our product sales segment and decreases in loss from discontinued operations, net of tax, impairment expense and restructuring expense. Net loss during the years endedDecember 31, 2021 and 2020 included losses from discontinued operations, net of tax, of$1.8 million and$15.3 million , respectively. EBITDA, as adjusted. Our EBITDA, as adjusted, was$146.6 million and$133.8 million during the years endedDecember 31, 2021 and 2020, respectively. EBITDA, as adjusted, during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 increased primarily due to an increase in adjusted gross margin in our product sales segment and an increase in other income. This was partially offset by an increase in SG&A and decreases in adjusted gross margin in our contract operations and aftermarket services segments. EBITDA, as adjusted, is a non-GAAP financial measure. For a reconciliation of EBITDA, as adjusted, to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please read Part II, Item 6 ("Selected Financial Data - Non-GAAP Financial Measures") of this report.
As discussed in Note 5 to the Financial Statements, the results from
continuing operations for all periods presented exclude the results of our
Belleli EPC business and
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Results by Business Segment. The following table summarizes revenue, adjusted gross margin and adjusted gross margin percentages for each of our business segments (dollars in thousands):
Years Ended December 31,
2021 2020
Revenue:
Contract Operations $ 338,507 $ 338,423
Aftermarket Services 109,033 113,246
Product Sales(1) 182,705 161,392
Total Revenue $ 630,245 $ 613,061
Segment Adjusted Gross Margin: (2)
Contract Operations $ 228,947 $ 233,041
Aftermarket Services 23,839 25,531
Product Sales(1) 23,680 3,294
Total Adjusted Gross Margin $ 276,466 $ 261,866
Segment Adjusted Gross Margin Percentage: (3)
Contract Operations 68 % 69 %
Aftermarket Services 22 % 23 %
Product Sales(3) 13 % 2 %
(1)
The compression fabrication business for sales to
(2)
Segment adjusted gross margin is defined as revenue less cost of sales (excluding depreciation and amortization expense) broken out by the different segments. We evaluate the performance of each of our segments based on adjusted gross margin.
(3)
Segment adjusted gross margin percentage is defined as segment adjusted gross margin divided by segment revenue.
Operating Highlights
The following table summarizes the expected timing of revenue recognition from our contract operations backlog (in thousands):
December 31,
2021
Contract Operations Backlog: (1)
2022 $ 260,062
2023 263,526
2024 239,660
2025 218,224
2026 178,879
Thereafter 239,507
Total contract operations backlog
(1) As ofDecember 31, 2021 , the total value of our contract operations backlog accounted for as operating leases was approximately$495 million , of which$44 million is expected to be recognized in 2022,$104 million is expected to be recognized in 2023,$94 million is expected to be recognized in 2024 and$80 million is expected to be recognized in 2025. Contract operations revenues recognized as operating leases for the year endedDecember 31, 2021 was approximately$35 million . 49
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The following table summarizes our product sales backlog (in thousands):
December 31,
2021 2020
Product Sales Backlog: (1)
Processing and treating equipment $ 289,718 $ 425,292
Compression equipment(2) 4,036 10,218
Other product sales 22,616 29,835
Total product sales backlog $ 316,370 $ 465,345
(1)
We expect that approximately
(2)
Compression equipment includes sales to customers outside of theU.S. TheU.S. compression fabrication business that was previously included in our product sales segment, is now included in discontinued operations.
Results of Operations
The Year EndedDecember 31, 2021 Compared to the Year EndedDecember 31, 2020 Contract Operations (dollars in thousands) Years Ended December 31, 2021 2020 Change % change Revenue$ 338,507 $ 338,423 $ 84 0 % Cost of sales (excluding depreciation and amortization expense) 109,560 105,382 4,178 4 % Adjusted gross margin$ 228,947 $ 233,041 $ (4,094 ) (2 )% Adjusted gross margin percentage 68 % 69 % (1 )% (1 )% Revenue remained flat during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 . Revenue increased by$13.2 million for the start-up of a new project in theMiddle East andAfrica region and by$24.8 million primarily driven by an increase of deferred revenue recognized resulting from a change in the remaining term of a contract in the third quarter of 2020 and the early termination of a contract in the current year period. These increases were offset by approximately$30.9 million in contract stops and$7.5 million from the sale of equipment. The increase in costs is primarily due to labor rate adjustments inArgentina during the current year period. Adjusted gross margin and adjusted gross margin percentage decreased during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 primarily due to the cost increases explained above. Aftermarket Services (dollars in thousands) Years Ended December 31, 2021 2020 Change % change Revenue$ 109,033 $ 113,246 $ (4,213 ) (4 )% Cost of sales (excluding depreciation and amortization expense) 85,194 87,715 (2,521 ) (3 )% Adjusted gross margin$ 23,839 $ 25,531 $ (1,692 ) (7 )% Adjusted gross margin percentage 22 % 23 % (1 )% (4 )% 50
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The decrease in revenue during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to a decrease in operation and maintenance and overhaul services in theLatin America andMiddle East andAfrica regions, partially offset by an increase in part sales in theLatin America andAsia Pacific regions. Adjusted gross margin and adjusted gross margin percentage during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 decreased primarily due to the product mix with part sales historically having lower margins than other areas of our aftermarket services business. Product Sales (dollars in thousands) Years Ended December 31, 2021 2020 Change % change Revenue$ 182,705 $ 161,392 $ 21,313 13 % Cost of sales (excluding depreciation and amortization expense) 159,025 158,098 927 1 % Adjusted gross margin$ 23,680 $ 3,294 $ 20,386 619 % Adjusted gross margin percentage 13 % 2 %
11 % 550 %
The increase in revenue during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to an increase of$92.8 million in processing and treating equipment revenue, partially offset by a decrease of$69.3 million in compression revenue. The increase in processing and treating equipment revenue was due to projects in theMiddle East andAfrica region partially offset by a decrease in theNorth America region due to less activity. The decrease in compression revenue was mainly due to a decrease in revenue in theMiddle East andAfrica region in the current year period and the completion of projects in theAsia Pacific region during the first quarter of 2021. Adjusted gross margin increased during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 due to higher expenses on a specific project in the prior year period. Adjusted gross margin percentage increase during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 due to the higher expenses discussed above during the prior year period and a shift in product mix during the current year period. Costs and Expenses (dollars in thousands) Years Ended December 31, 2021 2020 Change % change Selling, general and administrative$ 132,510 $ 123,406 $ 9,104 7 % Depreciation and amortization 175,063 145,043 30,020 21 % Impairments 7,959 11,648 (3,689 ) (32 )% Restructuring and other charges 1,338 3,550 (2,212 ) (62 )% Interest expense 41,574 38,817 2,757 7 % Gain on extinguishment of debt - (3,571 ) 3,571 (100 )% Other (income) expense, net (1,292 ) 589 (1,881 ) (319 )%
Selling, general and administrative
SG&A expense increased during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 primarily due to increases in compensation, legal and network related expenses in the current year period. SG&A expense as a percentage of revenue was 21% and 20% during the year endedDecember 31, 2021 and 2020, respectively. 51
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Depreciation and amortization
Depreciation and amortization expense during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 increased primarily due to approximately$23.7 million of additional depreciation expense recognized in the current year period on two contract operations projects due to changes in the remaining terms of a contract during the third quarter of 2020 and the early termination of a contract in the current year period; and approximately$8.1 million in depreciation for equipment on a contract operations project that was not operating in the prior year period.
Impairments
During the year endedDecember 31, 2021 , we determined that there was no visibility to continuing a contract with a customer in theLatin America region. This contract included installation costs, deferred start-up costs and demobilization costs that were previously capitalized where it is highly unlikely we will generate future cash flows. As a result, we recorded an$8.0 million asset impairment to reduce the book value of these assets to zero, which is its estimated fair value as ofDecember 31, 2021 . During the year endedDecember 31, 2020 , in an effort to generate cash from idle assets and reduce holding costs, we reviewed the future deployment of our idle assets used in our contract operations segment for units that were not of the type, configuration, condition, make or model that are cost efficient to maintain and operate. Based on this review, we determined that certain idle compressor units and other assets would be retired from future service. The retirement of these units from the active fleet triggered a review of these assets for impairment. As a result, we recorded a$10.0 million asset impairment to reduce the book value of each unit to its estimated fair value during the year endedDecember 31, 2020 . The fair value of each unit was estimated based on either 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 or scrap value of each compressor unit. During the third quarter of 2020, we impaired certain assets inArgentina due to the termination of a contract operations project where it was not cost effective to move the assets and try to utilize them with a different customer. As a result, we removed them from the fleet and recorded an impairment of$1.7 million to write-down these assets to their approximate fair values for the year endedDecember 31, 2020 .
Restructuring and other charges
The energy industry's focus on capital discipline and improving returns has caused delays in the timing of new equipment orders. As a result, in the third quarter of 2019, we announced a cost reduction plan primarily focused on workforce reductions. We incurred restructuring and other charges associated with these activities of$0.2 million and$3.6 million during the years endedDecember 31, 2021 and 2020, respectively. InJanuary 2022 , Enerflex andExterran announced a proposed merger to create an integrated global provider of energy infrastructure. As a result of this deal, we have already started incurring legal and other costs and will continue to incur such costs until the deal is finalized, which we expect to happen in the second or third quarter of 2022. We incurred restructuring and other charges associated with these activities of$1.1 million for the year endedDecember 31, 2021 . These charges are reflected as restructuring and other charges in our statements of operations and accrued liabilities on our balance sheets. We estimate the total restructuring charges related to this plan will be approximately$15-20 million and represents our best estimate based on the facts and circumstances known at this time.
Interest expense
The increase in interest expense during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to a higher average balance of long-term debt. During the year endedDecember 31, 2021 and 2020, the average daily outstanding borrowings of long-term debt were$582.1 million and$511.0 million , respectively. 52
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Extinguishment of debt
During the year endedDecember 31, 2020 , we purchased and retired$25.0 million principal amount of our 8.125% senior unsecured notes due 2025 (the "2017 Notes") for$21.5 million including$0.3 million of accrued interest. During the year endedDecember 31, 2020 , we recognized a gain on extinguishment of debt of$3.6 million , which was calculated as the difference between the repurchase price and the carrying amount of the 8.125% senior unsecured notes due 2025, partially offset by$0.2 million in related deferred financing costs.
Other (income) expense, net
The change in other (income) expense, net, was primarily due to an increase of$10.1 million in interest income in the current year period. This is partially offset by foreign currency losses of$11.0 million during the year endedDecember 31, 2021 compared to foreign currency losses of$5.9 million during the year endedDecember 31, 2020 as well as an increase of$3.4 million in derivative losses in the current year period. Income Taxes (dollars in thousands) Years Ended December 31, 2021 2020 Change % change Provision for income taxes$ 30,238 $ 28,403 $ 1,835 7 % Effective tax rate (37.5 )% (49.3 )% 11.8 % (24 )% Our effective tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amounts of income we earn, or losses we incur, in those jurisdictions. It is also affected by discrete items that may occur in any given year but are not consistent from year to year. Our effective tax rate is also affected by valuation allowances recorded against loss carryforwards in theU.S. and certain other jurisdictions, foreign withholding taxes and changes in foreign currency exchange rates.
For the year ended
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A
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A$11.5 million increase (14.2% decrease) resulting from the addition of valuation allowances primarily recorded against certain net operating losses of our foreign subsidiaries, partially offset by a release of valuation allowance recorded againstU.S. foreign tax credits.
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A
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A
•
A
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A
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A
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A
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A
For the year ended
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A
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A
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A
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A
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A
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Discontinued Operations
(dollars in thousands)
Years Ended December 31,
2021 2020 Change % change
Income (loss) from discontinued
operations, net of tax $ (1,784 ) $ (15,272 ) $ 13,488 (88 )%
Loss from discontinued operations, net of tax, includes our Belleli EPC business
and our
Loss from discontinued operations, net of tax, during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 decreased due to a$16.4 million decrease in loss fromU.S. compression partially offset by changes in Belleli EPC. The decrease in loss inU.S. compression fabrication business was primarily driven by the decrease in activity for the business and$6.5 million impairment recorded during the year endedDecember 31, 2020 . For further details on our discontinued operations, see Note 5 to the Financial Statements.
Liquidity and Capital Resources
Our unrestricted cash balance was$56.3 million atDecember 31, 2021 compared to$40.3 million atDecember 31, 2020 . Working capital decreased to$118.3 million atDecember 31, 2021 from$154.7 million atDecember 31, 2020 . The decrease in working capital was primarily due to a decrease in accounts receivables and an increase in accrued liabilities, partially offset by a decrease in contract liabilities and an increase in cash. The decrease in accounts receivables was due to the timing of payments from customers. The increase in accrued liabilities was due to an increase in activity in theMiddle East andAfrica region as well as increases in demobilization liabilities and compensation related expenses. The decrease in contract liabilities was primarily due to progression on a specific project in theMiddle East andAfrica region. The increase in cash was primarily due to increases in operating and financing activities partially offset by decreases in investing activities and activities related to our discontinued operations. Our cash flows from operating, investing and financing activities, as reflected in the statements of cash flows, are summarized in the following table (in thousands): Years Ended December 31, 2021 2020 Net cash provided by (used in) continuing operations: Operating activities$ 49,911 $ 4,959 Investing activities (36,156 ) (75,295 ) Financing activities 9,586 119,502 Effect of exchange rate changes on cash, cash equivalents and restricted cash (435 ) (566 ) Discontinued operations (4,583 ) (21,574 ) Net change in cash, cash equivalents and restricted cash$ 18,323 $ 27,026 Operating Activities. The increase in net cash provided by operating activities during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily attributable to the changes in assets and liabilities, which resulted in$35.6 million used in operating activities during the year endedDecember 31, 2021 compared to$73.4 million used in operating activities during the year endedDecember 31, 2020 . Asset and liability cash changes during the year endedDecember 31, 2021 included an increase of$43.1 million in contract assets, a decrease of$24.5 million of contract liabilities and an increase in accounts payable and other liabilities of$26.2 million . Asset and liability cash changes during the year endedDecember 31, 2020 included a decrease of$34.8 million in contract liabilities, an increase of$24.8 million in accounts receivables and an increase of$23.0 million in contract assets. Investing Activities. The decrease in net cash used in investing activities during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily attributable to a$36 million decrease in capital expenditures. The decrease in capital expenditures was primarily driven by the timing of awards and growth capital expenditures for new contract operations projects. 54
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Financing Activities. The decrease in net cash provided by financing activities during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily attributable to a decrease in net borrowings of$112.7 million on our long-term debt.
Discontinued Operations. The decrease in net cash used in discontinued
operations during the year ended
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 equipment required for us to render those contract operations services to our customers. Our capital requirements have consisted primarily 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, whether through construction, acquisition or modification; 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 installation costs on contract operations services projects and acquisition costs of new compressor units and processing and treating equipment that we add to our contract operations fleet. In addition, growth capital expenditures can include the upgrading of major components on an existing compressor unit where the current configuration of the compressor unit is no longer in demand and the compressor unit is not likely to return to an operating status without the capital expenditures. These latter expenditures substantially modify the operating parameters of the compressor unit 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 compressor unit, such as the engine, compressor and cooler, that return the components to a "like new" condition, but do not modify the applications for which the compressor unit was designed. Growth capital expenditures were$17.3 million and$56.6 million during the years endedDecember 31, 2021 and 2020, respectively. The decrease in growth capital expenditures during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily due to the timing of awards for new contract operations projects. Maintenance capital expenditures were$9.1 million and$8.1 million during the years endedDecember 31, 2021 and 2020, respectively. The increase in maintenance capital expenditures during the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 was primarily driven by increased overhaul activities due to delayed discretionary spending during 2020. We generally invest funds necessary to manufacture contract operations fleet additions when our idle equipment cannot be reconfigured to economically fulfill a project's requirements and the new equipment expenditure is expected to generate economic returns over its expected useful life that exceeds our targeted return on capital. We currently plan to spend approximately$195 million to$210 million in capital expenditures during 2022, including (1) approximately$175 million to$185 million on contract operations growth capital expenditures based on contracts currently in our backlog and (2) approximately$20 million to$25 million on equipment maintenance capital related to our contract operations business and other capital expenditures. These capital expenditures are expected to be funded through upfront payments from customers for which the capital is being spent and additional borrowing on our revolver where necessary. Historically, we have financed capital expenditures with a combination of net cash provided by operating and financing activities. Our ability to access the capital markets may be restricted at the time when we would like, or need, to do so, which could have an adverse impact on the cost and access to capital and our ability to maintain our operations and to grow. For example, COVID-19 disrupted the broader financial markets and the capital markets for energy service related companies continue to be impacted. If any of our lenders become unable to perform their obligations under the Credit Agreement, our borrowing capacity under our revolving credit facility could be reduced. Inability to borrow additional amounts under our revolving credit facility could limit our ability to fund our future 55
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growth and operations. Based on current market conditions, we expect that net cash provided by operating activities and borrowings under our revolving credit facility will be sufficient to finance our operating expenditures, capital expenditures and other contractual cash obligations, including our debt obligations. However, if net cash provided by operating activities and borrowings under our revolving credit facility are not sufficient, we may seek additional debt or equity financing. The COVID-19 pandemic negatively impacted the global economy, disrupted global supply chains and financial markets and created significant volatility and disruption across most industries. Efforts to mitigate the spread of COVID-19 have also resulted in volatile energy demand and energy pricing. There has been recovery in the global economy, supply chains and energy demand and pricing, but the possible future impact of the ongoing COVID-19 pandemic on our customers and our long-term future results of operations and overall financial condition remains uncertain. Long-Term Debt. We and our wholly owned subsidiary, EESLP, are parties to an amended and restated Credit Agreement (the "Amended Credit Agreement") consisting of a$650.0 million revolving credit facility expiring inOctober 2023 . During the years endedDecember 31, 2021 and 2020, the average daily borrowings of long-term debt were$582.1 million and$511.0 million respectively. The weighted average annual interest rate on outstanding borrowings under our revolving credit facility atDecember 31, 2021 and 2020 was 3.1% and 3.2%, respectively. LIBOR and certain other "benchmarks" are the subject of recent national, international and other regulatory guidance and proposals for reform. In particular, onJuly 27, 2017 , theUnited Kingdom's Financial Conduct Authority , which regulates LIBOR, publicly announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The Alternative Reference Rates Committee, a steering committee consisting of largeU.S. financial institutions convened by theU.S. Federal Reserve Board and theFederal Reserve Bank of New York , has recommended replacing LIBOR with the Secured Overnight Financing Rate ("SOFR"), an index supported by short-termTreasury repurchase agreements. OnNovember 30, 2020 ,ICE Benchmark Administration ("IBA"), the administrator of USD LIBOR announced that it does not intend to cease publication of the remaining USD LIBOR tenors untilJune 30, 2023 , providing additional time for existing contracts that are dependent on LIBOR to mature. It is unclear whether, at that time, LIBOR will cease to exist or if new methods of calculating LIBOR will be established. Central banks and regulators in a number of major jurisdictions (for example,U.S. ,United Kingdom ,European Union ,Switzerland , andJapan ) have convened working groups to find and implement the transition to suitable replacement benchmarks. We are continuing to evaluate and monitor financial and non-financial impacts and risks that may result when LIBOR rates are no longer published. As ofDecember 31, 2021 , we had$52.2 million in outstanding letters of credit under our revolving credit facility and, taking into account guarantees through outstanding letters of credit, we had undrawn capacity of$372.8 million under our revolving credit facility. Our Amended Credit Agreement limits our Total debt to EBITDA ratio (as defined in the Amended Credit Agreement) on the last day of the fiscal quarter to no greater than 4.50 to 1.0. As a result of this limitation,$160.4 million of the$372.8 million of undrawn capacity under our revolving credit facility was available for additional borrowings as ofDecember 31, 2021 . The Amended Credit Agreement contains various covenants with which we, EESLP and our respective restricted subsidiaries must comply, including, but not limited to, limitations on the incurrence of indebtedness, investments, liens on assets, repurchasing equity, making distributions, transactions with affiliates, mergers, consolidations, dispositions of assets and other provisions customary in similar types of agreements. We are required to maintain, on a consolidated basis, a minimum interest coverage ratio (as defined in the Amended Credit Agreement) of 2.25 to 1.00; a maximum total leverage ratio (as defined in the Amended Credit Agreement) of 4.50 to 1.00; and a maximum senior secured leverage ratio (as defined in the Amended Credit Agreement) of 2.75 to 1.00. As ofDecember 31, 2021 ,Exterran Corporation maintained a 6.5 to 1.0 interest coverage ratio, a 3.5 to 1.0 total leverage ratio and an 1.4 to 1.0 senior secured leverage ratio. As ofDecember 31, 2021 , we were in compliance with all financial covenants under the Amended Credit Agreement. InApril 2017 , our 100% owned subsidiariesEESLP and EES Finance Corp. issued the 2017 Notes, which consisted of$375.0 million aggregate principal amount of senior unsecured notes which have$350 million outstanding as ofDecember 31, 2021 . The 2017 Notes are guaranteed by us on a senior unsecured basis. 56
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We may redeem all or a portion of the 2017 Notes at redemption prices (expressed as percentages of principal amount) equal to 102.031% for the twelve-month period beginning onMay 1, 2022 and 100.000% for the twelve-month period beginning onMay 1, 2023 and at any time thereafter, plus accrued and unpaid interest, if any, to the applicable redemption date of the 2017 Notes. During the year endedDecember 31, 2020 , we purchased and retired$25.0 million principal amount of our 2017 Notes for$21.5 million (including$0.3 million of accrued interest) resulting in a gain on extinguishment of debt of$3.6 million . The gain was calculated as the difference between the repurchase price and the carrying amount of the 2017 Notes, partially offset by$0.2 million in related deferred financing costs. The gain on extinguishment of debt is included as a separate item in our statements of operations. We may from time to time seek to retire, extend or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such extensions, repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Unrestricted Cash. Of our$56.3 million unrestricted cash balance atDecember 31, 2021 ,$55.9 million was held by our non-U.S. subsidiaries. In the event of a distribution of earnings to theU.S. in the form of dividends, we may be subject to foreign withholding taxes. We do not believe that the cash held by our non-U.S. subsidiaries has an adverse impact on our liquidity because we expect that the cash we generate in theU.S. , the available borrowing capacity under our revolving credit facility and the repayment of intercompany liabilities from our non-U.S. subsidiaries will be sufficient to fund the cash needs of ourU.S. operations for the foreseeable future. Share Repurchase Program. OnFebruary 20, 2019 , our board of directors approved a share repurchase program under which the Company is authorized to purchase up to$100.0 million of its outstanding common stock throughFebruary 2022 . The timing and method of any repurchases under the program will depend on a variety of factors, including prevailing market conditions among others. Purchases under the program may be suspended or discontinued at any time and we have no obligation to repurchase any amount of our common shares under the program. Shares of common stock acquired through the repurchase program are held in treasury at cost. During the year endedDecember 31, 2020 , we did not repurchase any shares under this program. During the year endedDecember 31, 2021 , we did not repurchase any shares under this program. As ofDecember 31, 2021 , the remaining authorized repurchase amount under the share repurchase program was$57.7 million . Dividends. We do not currently anticipate paying cash dividends on our common stock. We currently intend to retain our future earnings to support the growth and development of our business. The declaration of any future cash dividends and, if declared, the amount of any such dividends, will be subject to our financial condition, earnings, capital requirements, financial covenants, applicable law and other factors our board of directors deems relevant.
Supplemental Guarantor Financial Information
In
•
Senior unsecured obligations of each of the Issuers and the Parent, as applicable;
•
Equal in right of payment with all of the existing and future senior unsecured indebtedness and senior unsecured guarantees of each of the Issuers and the Parent, as applicable;
•
Senior in right of payment to all subordinated indebtedness and subordinated guarantees of each of the Issuers and the Parent, as applicable;
•
Effectively junior in right of payment to all existing and future secured
indebtedness and secured guarantees of each of the Issuers and the Parent, as
applicable, to the extent of the value of the assets securing such indebtedness
or guarantees; and
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•
Structurally junior in right of payment to all existing and future indebtedness, guarantees and other liabilities (including trade payables) and any preferred equity of each of the Parent's subsidiaries (other than the Issuers) that are not guarantors of the 2017 Notes. Parent's guarantee will be automatically and unconditionally released and discharged upon (i) the merger of the Parent into the Issuers, (ii) a legal defeasance, covenant defeasance or satisfaction and discharge of the indenture governing the 2017 Notes or (iii) the liquidation or dissolution of the Parent, provided in each case no default or event of default has occurred and is continuing under the indenture governing the 2017 Notes. Federal bankruptcy and state fraudulent transfer laws permit a court to void all or a portion of the obligations of the Parent pursuant to its guarantee, or to subordinate the Parent's obligations under its guarantee to claims of the Parent's other creditors, reducing or eliminating the ability to recover under the guarantee. Although laws differ among jurisdictions, in general, under applicable fraudulent transfer or conveyance laws, the guarantee could be voided as a fraudulent transfer or conveyance if (i) the guarantee was incurred with the intent of hindering, delaying or defrauding creditors or (ii) the Parent received less than reasonably equivalent value or fair consideration in return for incurring the guarantee and either (x) the Parent was insolvent or rendered insolvent by reason of the incurrence of the guarantee or subsequently became insolvent for other reasons, (y) the incurrence of the guarantee left the Parent with an unreasonably small amount of capital to carry on the business, or (z) the Parent intended to, or believed that it would, incur debts beyond its ability to pay such debts as they mature. A court would likely find that Parent did not receive reasonably equivalent value or fair consideration for its guarantee if it determined that the Parent did not substantially benefit directly or indirectly from the issuance of the 2017 Notes. If a court were to void a guarantee, noteholders would no longer have a claim against the Parent. In addition, the court might direct noteholders to repay any amounts that you already received from the Parent. Parent's guarantee contains a provision intended to limit the Parent's liability under the guarantee to the maximum amount that the Parent could incur without causing the incurrence of obligations under its guarantee to be deemed a fraudulent transfer. This provision may not be effective to protect the guarantee from being voided under fraudulent transfer law. All consolidated subsidiaries ofExterran other than the Issuers are collectively referred to as the "Non-Guarantor Subsidiaries." The 2017 Notes are structurally subordinated to any indebtedness and other liabilities (including trade payables) of any of the Non-Guarantor Subsidiaries. The Non-Guarantor Subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the 2017 Notes, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Holders of the 2017 Notes will have no claim as a creditor against any Non-Guarantor Subsidiaries. In the event of bankruptcy, liquidation or reorganization of any of the Non-Guarantor Subsidiaries, such subsidiaries will pay current outstanding obligations to the holders of their debt and their trade creditors before they will be able to distribute any of their assets to the Parent or the Issuers. As a result, in the context of a bankruptcy, liquidation or reorganization, holders of the 2017 Notes would likely receive less, ratably, than holders of indebtedness and other liabilities (including trade payables of such entities). The Parent and EESLP are also parties to our credit agreement, which covenants with which the Parent, EESLP and our respective restricted subsidiaries must comply, including, but not limited to, limitations on the incurrence of indebtedness, investments, liens on assets, repurchasing equity, making distributions, transactions with affiliates, mergers, consolidations, dispositions of assets and other provisions customary in similar types of agreements. These covenants may impact the ability of the Parent and EESLP to repay the 2017 Notes or amounts owing under Parent's guarantee. 58
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Summarized Financial Information (in thousands)
As a result of the Parent's guarantee, we are presenting the following summarized financial information for the Issuers' and Parent (collectively referred to as the "Obligated Group ") pursuant to Rule 13-01 of Regulation S-X, Guarantors and Issuers of Guaranteed Securities Registered or Being Registered. For purposes of the following summarized financial information, transactions between the Parent and the Issuers, presented on a combined basis, have been eliminated and information for the Non-Guarantor Subsidiaries have been excluded. Amounts due from or due to the Non-Guarantor Subsidiaries and other related parties, as applicable, have been separately presented within the summarized financial information. Year Ended December 31, 2021 Summarized Statement of Operations: Revenues(1) $ 106,737 Cost of sales(1) 70,972 Loss from continuing operations (217,696 ) Net loss (219,822 ) (1)
Includes
December 31, 2021 December 31, 2020
Summarized Balance Sheet:
ASSETS
Intercompany receivables due from non-guarantors $ 184,071 $ 206,267
Total current assets 306,396 334,675
Total long-term assets 189,508 230,334
LIABILITIES AND STOCKHOLDERS' EQUITY
Intercompany payables due to non-guarantors $ 337,898 $ 362,221
Total current liabilities 422,162 439,707
Long-term liabilities 622,040 613,994
Contractual Obligations. The following table summarizes our cash contractual
obligations as of December 31, 2021 and the effect such obligations are expected
to have on our liquidity and cash flow in future periods (in thousands):
Total 2022 2023-2024 2025-2026 Thereafter
Debt:(1)
Revolving credit facility due
October 2023 $ 225,000 $ - $ 225,000 $ - $ -
8.125% senior notes due May 2025
(2) 350,000 - - 350,000 -
Other debt 1,397 1,397 - - -
Total debt 576,397 1,397 225,000 350,000 -
Interest on debt 115,910 38,696 65,286 11,928 -
Purchase commitments 39,290 27,640 11,606 44 -
Facilities and other operating
leases 39,958 6,585 10,256 9,182 13,935
Total contractual obligations
$ 371,154 $ 13,935 (1)
For more information on our debt, see Note 10 to the Financial Statements.
(2)
Amounts represent the full face value of the 2017 Notes and do not include
unamortized debt financing costs of
As ofDecember 31, 2021 ,$34.8 million of unrecognized tax benefits (including discontinued operations) have been recorded as liabilities in accordance with the accounting standard for income taxes related to uncertain tax positions, and we are uncertain as to if or when such amounts may be settled. Related to these unrecognized tax benefits, we have also recorded a liability for potential penalties and interest (including discontinued operations) of$2.9 million . 59
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Indemnifications. In conjunction with, and effective as of the completion of, the Spin-off, we entered into the separation and distribution agreement with Archrock, which governs, among other things, the treatment between Archrock and us relating to certain aspects of indemnification, insurance, confidentiality and cooperation. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Archrock's business with Archrock. Pursuant to the agreement, we and Archrock will generally release the other party from all claims arising prior to the Spin-off that relate to the other party's business, subject to certain exceptions. Additionally, in conjunction with, and effective as of the completion of, the Spin-off, we entered into the tax matters agreement with Archrock. Under the tax matters agreement and subject to certain exceptions, we are generally liable for, and indemnify Archrock against, taxes attributable to our business, and Archrock is generally liable for, and indemnify us against, all taxes attributable to its business. We are generally liable for, and indemnify Archrock against, 50% of certain taxes that are not clearly attributable to our business or Archrock's business. Any payment made by us to Archrock, or by Archrock to us, is treated by all parties for tax purposes as a nontaxable distribution or capital contribution, respectively, made immediately prior to the Spin-off.
Off-Balance Sheet Arrangements
AtDecember 31, 2021 , we had no material off balance sheet arrangements. In addition to guarantees issued under our credit facility, we have agreements with financial institutions under which approximately$47.4 million of letters of credit or bank guarantees were outstanding as ofDecember 31, 2021 . These are put in place in certain situations to guarantee our performance obligations under contracts with counterparties.
Effects of Inflation
Our revenues and results of operations have not been materially impacted by inflation in the past three fiscal years.
Critical Accounting Policies, Practices and Estimates
This discussion and analysis of our financial condition and results of
operations is based upon the Financial Statements, which have been prepared in
accordance with GAAP. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates and accounting
policies, including those related to bad debt, inventories, accrued
demobilization costs, fixed assets, intangible assets, income taxes, revenue
recognition, contingencies and litigation. We base our estimates on historical
experience and on other assumptions that we believe are reasonable under the
circumstances. The results of this process form the basis of our judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions, and these differences can be material to our
financial condition, results of operations and liquidity. See Note 2 to our
Financial Statement for a summary of significant accounting policies.
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Allowances and Reserves
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The determination of the collectability of amounts due from our customers requires us to use estimates and make judgments regarding future events and trends, including monitoring our customers' payment history and current creditworthiness to determine that collectibility is reasonably assured, as well as consideration of the overall business climate in which our customers operate. Inherently, these uncertainties require us to make judgments and estimates regarding our customers' ability to pay amounts due to us in order to determine the appropriate amount of valuation allowances required for doubtful accounts. We review the adequacy of our allowance for doubtful accounts quarterly. We determine the allowance needed based on historical write-off experience and by evaluating significant balances aged greater than 90 days individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. During the years endedDecember 31, 2021 and 2020, we recorded bad debt expense of$1.1 million and$4.8 million , respectively. The decrease in bad debt expenses during the year endedDecember 31, 2021 was primarily due to increased impact of energy prices and COVID-19 on our customers in 2020. Our allowance for doubtful accounts was approximately 6% and 5% of our gross accounts receivable balance atDecember 31, 2021 and 2020, respectively.
Inventory
Inventory is a significant component of current assets and is stated at the lower of cost and net realizable value. This requires us to record provisions and maintain reserves for obsolete and slow moving inventory. To determine these reserve amounts, we regularly review inventory quantities on hand and compare them to historical demand and management estimates of market conditions and production requirements. These estimates and forecasts inherently include uncertainties and require us to make judgments regarding potential outcomes. We recorded inventory write-downs for obsolete or slow moving inventory of$2.2 million during the years endedDecember 31, 2021 and 2020. Significant or unanticipated changes to our estimates and forecasts could impact the amount and timing of any additional provisions for obsolete or slow moving inventory that may be required. Our write-downs for obsolete and slow moving inventory was approximately 2% of our inventory balance atDecember 31, 2021 and 2020.
Accrued Demobilization Costs
The majority of our contract operations services contracts contain contractual requirements for us to perform demobilization activities at the end of the contract, with the scope of those activities varying by contract. Demobilization activities typically include, among other requirements, civil work and the removal of our equipment and installation from the customer's site. Demobilization activities represent costs to fulfill obligations under our contracts and are not considered distinct within the context of our contract operations services contracts. Accrued demobilization costs are recorded, if applicable, at the time we become contractually obligated to perform these activities, which generally occurs upon our completion of the installation and commissioning of our equipment at the customer's site. We record accrued demobilization costs as a liability and an equivalent demobilization asset as a capitalized fulfillment cost. As ofDecember 31, 2021 , we had current and long-term accrued demobilization costs liability balances of$25.5 million and$25.6 million , respectively. Accrued demobilization costs are subsequently increased by interest accretion throughout the expected term of the contract. As ofDecember 31, 2021 , we had capitalized fulfillment cost demobilization assets of$9.5 million . Demobilization assets are amortized on a straight-line basis over the expected term of the contract. Any difference between the actual costs realized for the demobilization activities and the estimated liability established are recognized in our statement of operations. 61
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Accrued demobilization costs recorded represent the fair value of the estimated cost for future demobilization activities. The initial obligation is measured at its estimated fair value using various judgments and assumptions. Fair value is calculated using an expected present value technique that is based on assumptions of market participants and estimated demobilization costs in current period dollars that are inflated to the anticipated demobilization date and then discounted back to the date the demobilization obligations are expected to be incurred. Changes in assumptions and estimates included within the calculations of the value of the accrued demobilization costs could result in significantly different results than those identified and recorded in our financial statements. In future periods, we may also make adjustments to accrued demobilization costs as a result of the availability of new information, contract amendments, technology changes, changes in labor costs and other factors. Accrued demobilization costs are based on a number of assumptions requiring professional judgment. These include estimates for: (1) expected future cash flows related to contractual obligations; (2) anticipated timing of the expected cash flows; (3) our credit-adjusted risk free rate that considers our estimated credit rating; (4) the market risk premiums; and (5) relevant inflation factors. If the expected future cash flows relating to our estimated accrued demobilization costs had been higher or lower by 10% in 2021, accrued demobilization costs would have decreased or increased by approximately$10.9 million atDecember 31, 2021 . We are unable to predict the type of revisions to these assumptions that will be required in future periods due to the availability of additional information, contract amendments, technology changes, the price of labor costs and other factors.
Depreciation
Property, plant and equipment is carried at cost. Depreciation for financial reporting purposes is computed on a straight-line basis using estimated useful lives and salvage values, including idle assets in our active fleet. The assumptions and judgments we use in determining the estimated useful lives and salvage values of our property, plant and equipment reflect both historical experience and expectations regarding future use of our assets. We periodically analyze our estimates of useful lives of our property, plant and equipment to determine if the depreciable periods and salvage values continue to be appropriate. The use of different estimates, assumptions and judgments in the establishment of property, plant and equipment accounting policies, especially those involving their useful lives, would likely result in significantly different net book values of our assets and results of operations.
Long-Lived Assets
We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressor units from active service, indicate that the carrying amount of an asset may not be recoverable. Compressor units in our active fleet that were idle as ofDecember 31, 2021 comprise a net book value of approximately$55.1 million . The determination that the carrying amount of an asset may not be recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the assets subject to review. For idle compression units that are removed from the active fleet and that will be sold to third parties as working compression units, significant assumptions include forecasted sale prices based on future market conditions and demand, forecasted costs to maintain the assets until sold and the forecasted length of time necessary to sell the assets. 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. An impairment loss may exist when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. When necessary, an impairment loss is recognized and represents the excess of the asset's carrying value as compared to its estimated fair value and is charged to the period in which the impairment occurred. 62
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Income Taxes
Our income tax provision, 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. We operate in approximately 25 countries and, as a result, we and our subsidiaries file consolidated and separate income tax returns in theU.S. federal jurisdiction and in numerous state and foreign jurisdictions. Significant judgments and estimates are required in determining our consolidated income tax provision. Deferred income taxes arise from temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, 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 the results of discontinued operations and changes in accounting policies and incorporate assumptions including the amount of futureU.S. federal, state and foreign 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 are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income (loss). The accounting standard for income taxes provides that a tax benefit from an uncertain tax position is only 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. In addition, guidance is provided on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adjust reserves for unrecognized tax benefits 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 tax liabilities. These differences will be reflected as increases or decreases to income tax provision in the period in which new information is available. We consider the earnings of many of our subsidiaries to be indefinitely reinvested, and accordingly, we have not provided for taxes on the unremitted earnings of these subsidiaries. If we were to make a distribution from the unremitted earnings of these subsidiaries, we could be subject to taxes payable to various jurisdictions. If our expectations were to change regarding future tax consequences, we may be required to record additional deferred taxes that could have a material effect on our consolidated statement of financial position, results of operations or cash flows.
Revenue Recognition
We recognize revenue related to performance obligations satisfied over time using the input method of percentage-of-completion accounting whereby the actual amounts incurred to date as a percentage of the estimated total is used as a basis for determining the extent to which performance obligations are satisfied. During the year endedDecember 31, 2021 , approximately 94% of our total product sales revenues were recognized over time. This calculation requires management to estimate the total costs required for each project and to estimate the profit expected on the project. The recognition of revenue over time depends largely on our ability to make reasonable dependable estimates related to the extent of progress toward completion of the contract, contract revenues and contract costs. Recognized revenues and profits are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known using the cumulative catch-up method. Due to the nature of some of our contracts, developing the estimates of costs often requires significant judgment. 63
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Factors that must be considered in estimating the work to be completed and ultimate profit include labor productivity and availability, the nature and complexity of work to be performed, the impact of change orders, availability of raw materials and the impact of delayed performance. Although we continually strive to accurately estimate our progress toward completion and profitability, adjustments to overall contract revenue and contract costs could be significant in future periods due to several factors including but not limited to, settlement of claims against customers, supplier claims by or against us, customer change orders, changes in cost estimates, changes in project contingencies and settlement of customer claims against us, such as liquidated damage claims. If the aggregate combined cost estimates for uncompleted contracts that are recognized over time had been higher or lower by 5% in 2021, our income before income taxes would have decreased or increased by approximately$11.2 million .
Contingencies and Litigation
We are substantially self-insured for workers' compensation, employer's liability, property, auto liability, general liability 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 deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. We review these estimates quarterly and believe such accruals to be adequate. However, insurance liabilities are difficult to estimate due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, the timeliness of reporting of occurrences, ongoing treatment or loss mitigation, general trends in litigation recovery outcomes and the effectiveness of safety and risk management programs. Therefore, if our actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period in which the difference becomes known. As ofDecember 31, 2021 and 2020, we had recorded approximately$0.6 million and$1.0 million , respectively, in insurance claim reserves. 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, the accounting standard for contingencies requires management to make judgments about future events that are inherently uncertain. We are required to record (and have recorded) a loss during any period in which we believe a loss contingency is probable and can be reasonably estimated. In making determinations of likely outcomes of pending or threatened legal matters, we consider the evaluation of counsel knowledgeable about each matter. We regularly assess and, if required, establish accruals for income tax as well as non-income-based tax contingencies pursuant to the applicable accounting standards that could result from assessments of additional tax by taxing jurisdictions in countries where we operate. Tax contingencies are subject to a significant amount of judgment and are reviewed and adjusted on a quarterly basis in light of changing facts and circumstances considering the outcome expected by management. As ofDecember 31, 2021 and 2020, we had recorded approximately$39.6 million and$38.0 million , respectively, of accruals for tax contingencies (including penalties and interest and discontinued operations). Of these amounts,$37.7 million and$34.5 million are accrued for income taxes as ofDecember 31, 2021 and 2020, respectively, and$1.9 million and$3.5 million are accrued for non-income-based taxes as ofDecember 31, 2021 and 2020, respectively. Furthermore, as ofDecember 31, 2020 , we had an indemnification receivable from Archrock related to non-income-based taxes of$1.5 million . There was no indemnification receivable amount from Archrock related to non-income-based taxes as ofDecember 31, 2021 . If our actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period in which the difference becomes known.
Recent Accounting Pronouncements
See Note 2 to the Financial Statements.
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