Archrock, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Archrock provides U.S. natural-gas compression contract operations and aftermarket services. Unless otherwise noted, amounts are in U.S. dollars.
Business context and material developments
- On April 26, 2018, Archrock completed its acquisition of the Partnership’s publicly held common units, issuing 57.6 million Archrock shares for 41.2 million units at an implied consideration of $625.3 million. The Partnership became wholly owned; the transaction was accounted for as an equity transaction, not an acquisition gain or loss.
- The merger materially increased Archrock’s share count and ended the public unitholders’ noncontrolling interest. Archrock had 129.3 million common shares outstanding on October 25, 2018.
- Archrock adopted the new revenue-recognition standard on January 1, 2018. Prior-year comparisons were not restated. For the first nine months, adoption increased reported revenue by $9.9 million and Archrock-attributable net income by $9.0 million versus the former accounting; reported Q3 attributable net income was $4.4 million higher. The changes principally reflect over-time recognition of aftermarket services and deferral and amortization of certain contract costs and billings.
Financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $232.4 million | $197.9 million | $671.3 million | $585.7 million |
| Gross margin | $113.3 million | $87.4 million | $326.6 million | $275.6 million |
| Income (loss) attributable to Archrock stockholders | $10.0 million | $(10.2) million | $8.1 million | $(28.6) million |
| EPS attributable to Archrock common stockholders | $0.08 | $(0.15) | $0.07 | $(0.42) |
| Interest expense | $23.5 million | $22.9 million | $69.4 million | $66.8 million |
- Q3 contract operations revenue rose 10% to $169.5 million; segment gross margin rose 23% to $100.5 million, with a 59% margin versus 53%. Average operating horsepower was 3.406 million, up 8%; average utilization was 87% versus 82%.
- Q3 aftermarket services revenue increased 42% to $62.9 million; gross margin increased 119% to $12.8 million, with a 20% margin versus 13%.
- For the first nine months, contract operations revenue grew 9% and aftermarket services revenue grew 34%. Management attributed growth to higher customer demand, operating horsepower and rates, and stronger service activity and parts sales.
- Q3 income improvement reflected higher segment gross margin and lower depreciation and SG&A. Nine-month results also included $10.0 million of merger costs and a $2.5 million debt-extinguishment loss.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow was $170.7 million, investing cash outflow was $216.9 million, and financing cash inflow was $39.1 million. Capital expenditures were $241.2 million. Cash declined $7.1 million to $3.4 million.
- Long-term debt was $1.516 billion at September 30, 2018, compared with $1.417 billion at year-end 2017. Debt included $826.5 million outstanding under the Partnership Credit Facility and $700 million principal of 6% senior notes due 2021 and 2022.
- The $1.25 billion Partnership Credit Facility had $408.1 million of undrawn capacity, of which $324.0 million was available after covenant requirements. Archrock reported compliance with its covenants. The facility’s stated maturity is March 2022, but may move to December 2020 if the 2021 notes remain outstanding on December 2, 2020.
- After interest-rate swaps, $326.5 million of debt was effectively variable-rate; a 1 percentage-point rate increase would raise annual interest expense by an estimated $3.3 million.
- Quarterly dividends were $0.132 per share in Q3, up from $0.120 a year earlier. The board declared another $0.132 dividend payable in November 2018.
Outlook, risks and unusual items
- Management expected operating cash flow and Partnership Credit Facility borrowings to meet liquidity needs through at least September 30, 2019. It planned approximately $320 million of 2018 capital expenditures, including approximately $250 million for growth and $50 million for maintenance. No earnings or revenue guidance was provided in the filing text.
- Management said new compression orders were strong in 2017 and continued at elevated rates into 2018. It cited improved market conditions and customer demand as drivers, while noting exposure to oil and natural-gas industry conditions, customer finances, competition, equipment and workforce availability, and access to capital.
- Long-lived asset impairment was $6.7 million in Q3 and $18.3 million for the first nine months, related primarily to idle compressor units retired from the active fleet. Nine-month retirements covered 73,000 horsepower.
- The SEC investigation into previously disclosed errors and possible irregularities at a former international operation remained ongoing. Archrock and Exterran were cooperating; Archrock said it could not predict the investigation’s duration, scope or outcome, or whether legal action would follow. Restatement-related costs and possible further costs remain uncertain.
- Archrock prevailed in a Texas Supreme Court heavy-equipment tax case; two related cases remained pending. Management expected consistent outcomes and said remaining exposure appeared remote. Other ordinary-course litigation and tax matters remain subject to uncertainty.
- Management concluded disclosure controls were effective as of September 30, 2018, and reported no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Separate underlying operating growth from the accounting effects of 2018 revenue-recognition adoption; assess its impact on reported revenue, earnings and contract costs.
- Track leverage, borrowing-base availability, covenant headroom, interest rates and the potential 2020 facility maturity trigger.
- Compare planned 2018 capital spending with actual spending, cash generation, equipment utilization and returns on growth investment.
- Monitor SEC investigation developments, restatement-related expenses or claims, and the remaining heavy-equipment tax cases.
- Assess dividend sustainability against operating cash flow, capital requirements, debt agreements and the low reported cash balance.