Archrock, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Archrock provides U.S. natural-gas compression contract operations and aftermarket services. It consolidates Archrock Partners, L.P., in which it held an approximately 45% interest.
Financial performance and liquidity
- Q2 revenue: $198.0 million, down 3% from $204.1 million. Contract operations revenue fell 7% to $151.1 million; aftermarket services revenue rose 14% to $46.9 million.
- First-half revenue: $387.9 million, down 7% from $417.4 million. Contract operations revenue declined 11% to $301.1 million; aftermarket services rose 11% to $86.8 million.
- Profitability: Q2 net loss attributable to Archrock stockholders was $6.7 million, or $0.10 per share, versus a $4.5 million loss, or $0.07 per share, a year earlier. First-half attributable net loss was $18.4 million, or $0.27 per share, versus $6.3 million, or $0.10 per share.
- Gross margin: Company-defined gross margin, a non-GAAP measure, was $96.1 million in Q2 versus $110.9 million; for the first half it was $188.2 million versus $225.7 million. Contract operations margin percentage fell to 59% in Q2 and 58% for the first half, from 64% and 63%, respectively. Aftermarket services margin percentage was 15% for both periods, versus 17% a year earlier.
- Cash flow and capital spending: First-half operating cash flow was $101.3 million, down from $137.0 million. Capital expenditures were $99.4 million, versus $72.2 million. Cash declined to $2.6 million from $3.1 million at year-end 2016.
- Debt and liquidity: Long-term debt was $1.443 billion at June 30, 2017. The company had $65.5 million drawn on its $350 million revolver; $179.5 million of its stated $269.4 million undrawn capacity was available for additional borrowing after covenant limits. The Partnership had $692 million drawn on its $1.1 billion facility; $217.4 million of $408 million undrawn capacity was available after covenant limits. Both entities reported compliance with their financial covenants.
- Dividends: Archrock declared a $0.12-per-share quarterly dividend payable August 15, 2017. The Partnership separately approved a $0.285-per-unit distribution for Q2.
Material changes and management outlook
- Lower customer demand and pricing pressure following 2016 industry weakness reduced contract operations revenue and margins. Average operating horsepower was down 4% year over year in Q2 and 7% for the first half. Aftermarket services revenue improved, but higher activity-related costs limited margin gains.
- Management said more stable commodity prices had supported stronger compression orders and stabilized first-half 2017 contract operations revenue compared with the second half of 2016. It nevertheless expected full-year 2017 contract operations revenue and operating cash flow to decline versus 2016.
- Management planned 2017 capital expenditures of approximately $230 million to $250 million, including $175 million to $195 million for growth and $35 million to $40 million for equipment maintenance. It said operating cash flow and borrowing availability should meet liquidity needs through at least June 30, 2018.
- In March 2017, the Partnership refinanced its former revolving facility and term loan with a five-year, $1.1 billion asset-based revolver. The refinancing generated approximately $15 million of transaction costs, and the company recorded related debt-extinguishment costs.
Risks, contingencies, and unusual items
- First-half impairment charges were $13.8 million, relating mainly to idle compressor units retired from the active fleet. The company retired 140 units representing 51,000 horsepower during the period.
- Archrock recorded an $8.4 million first-half benefit in ad valorem tax expense under its disputed interpretation of Texas Heavy Equipment Statutes. The cumulative benefit recorded since 2012 was $69.1 million, of which $55.4 million remained disputed in litigation. An adverse outcome could require repayment, penalties and interest, and could increase future tax expense and affect dividends.
- Unrecognized tax benefits were $21.4 million at June 30, 2017, up from $9.7 million at year-end, following appellate decisions affecting uncertain tax positions. The filing also reports $1.4 million of potential related interest and penalties.
- The SEC was investigating previously disclosed errors and possible irregularities at a former international operation. Archrock and Exterran Corporation were cooperating; related inquiries include restatement matters and Foreign Corrupt Practices Act compliance. Archrock recorded $2.7 million of first-half restatement and other charges, primarily professional and legal fees.
- Other risks include customer and energy-market conditions, competition, high indebtedness, covenant restrictions, and potential uninsured operating losses. Management reported no material changes to previously disclosed risk factors and said disclosure controls were effective.
- Archrock expects to adopt the new revenue-recognition standard in 2018 using the modified retrospective method. It anticipated no material change for contract operations or parts sales, but expected aftermarket service revenue to be recognized over time and certain costs to be deferred; the full financial impact was still under evaluation.
Important facts for investors to verify
- Whether operating horsepower, contract rates, and contract operations margins recover, and whether planned growth spending earns the expected returns.
- Actual 2017 capital expenditures and operating cash flow, and the amount of borrowing capacity available after covenant restrictions.
- Developments and potential exposure in the Texas ad valorem tax litigation, including penalties and interest.
- Changes in uncertain tax positions and the outcome or cost of the SEC and related investigations.
- The final impact of the 2018 revenue-recognition adoption and the sustainability of Archrock and Partnership distributions.