Archrock, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed February 22, 2018. The filing is an annual report, not a standalone Q4 filing. 2017 results cover Archrock’s continuing U.S. natural-gas compression and aftermarket-services businesses; Exterran Corporation’s spun-off operations are presented as discontinued operations.
Business context and financial performance
Archrock provides U.S. natural-gas compression contract operations and aftermarket parts and services. It consolidated Archrock Partners, L.P. (the Partnership), while holding approximately 43% of its equity at year-end. Contract operations generated 77% of 2017 revenue and 93% of gross margin.
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Revenue | $794.7 million | $807.1 million | Down 1.5% |
| Gross margin (non-GAAP) | $375.7 million; 47.3% of revenue | $427.2 million; 52.9% | Down 12.0%; margin down 5.6 percentage points |
| Net income (loss) attributable to Archrock stockholders | $19.0 million | $(54.6) million | Improved |
| Net cash from operating activities | $201.9 million | $274.3 million | Down 26.4% |
| Cash capital expenditures | $221.7 million | $117.6 million | Up materially |
| Cash and cash equivalents at year-end | $10.5 million | $3.1 million | Increased |
| Long-term debt, carrying value | $1,417.1 million | $1,441.7 million | Down modestly |
| Working capital | $90.3 million | $109.2 million | Down |
Contract operations revenue fell 6% to $610.9 million and segment gross margin declined 13% to $347.9 million, with margin narrowing from 62% to 57%. Aftermarket revenue increased 15% to $183.7 million, while its gross margin rose 6% to $27.8 million; segment margin declined from 17% to 15%.
Contract operations averaged 3.152 million operating horsepower, down 3% year over year; year-end horsepower utilization was 85%, versus 82% in 2016. The 2017 net income result included a $61.1 million income-tax benefit, including a provisional $53.4 million benefit from remeasuring deferred taxes under the Tax Cuts and Jobs Act. Pretax loss was $42.6 million.
Material changes versus the prior year
- Revenue declined slightly, but gross margin fell more sharply, principally because contract operations faced lower rates and lower average operating horsepower, alongside higher start-up, lube-oil and other operating costs.
- Aftermarket services recovered from the 2016 downturn, supported by higher service and parts sales.
- Operating cash flow decreased while capital spending rose, reflecting renewed investment in compression equipment as market conditions and new orders improved.
- Long-lived asset impairment was $29.1 million, down from $87.4 million in 2016. In 2017, Archrock retired 325 idle compressor units representing about 100,000 horsepower.
- Interest expense increased to $88.8 million from $83.9 million, despite lower average debt, primarily due to higher effective rates and financing-cost write-offs.
Liquidity, debt, and capital allocation
- At December 31, 2017, reported long-term debt was $1.417 billion; contractual face-value debt was approximately $1.430 billion. Consolidated debt includes Partnership borrowings, which Archrock states it is not obligated to repay directly.
- Archrock’s $350 million revolving facility had $56.0 million drawn and $200.7 million available for additional borrowing after covenant limits. The Partnership’s $1.1 billion facility had $674.3 million drawn and $128.4 million available after borrowing-base and covenant limits. Both entities reported covenant compliance at year-end.
- Operating cash flow of $201.9 million was below cash capital expenditures of $221.7 million. Cash dividends paid to Archrock stockholders were $34.1 million; the 2017 dividend was $0.12 per share each quarter. The board declared another $0.12 quarterly dividend in January 2018.
- Management expected operating cash flows and revolving-facility borrowing capacity to meet liquidity needs through at least December 31, 2018. This is management’s assessment, not a guarantee.
Outlook, transactions, and risks
- Outlook: Management anticipated higher operating horsepower and revenue in 2018 in both segments, citing 2017 compression orders, improved market conditions and forecasts for increased customer spending. It planned 2018 capital expenditures of approximately $270–$290 million, including $200–$220 million for growth and $40–$45 million for maintenance. Management cautioned that revenue and margin improvement may lag demand by several quarters or more. No specific revenue or earnings target was provided.
- Proposed Partnership merger: Announced January 1, 2018, after the reporting year. Archrock proposed exchanging 1.40 Archrock shares for each public Partnership common unit and canceling its incentive distribution rights. Closing was expected in Q2 2018, subject to approvals and other conditions; HSR waiting-period early termination was granted February 9, 2018. Partnership debt was expected to remain outstanding. Certain termination circumstances could trigger a $10 million fee.
- Texas property-tax litigation: Archrock recorded a cumulative $78.2 million benefit under the Texas Heavy Equipment Statutes, of which $62.3 million remained disputed in litigation. The 2017 benefit was $17.5 million. An adverse outcome could require repayment, penalties and interest, and increase future costs.
- Restatement and investigations: Prior-period financial statements were restated. The SEC was investigating accounting errors and possible irregularities at a former international operation, including FCPA matters; Archrock and Exterran were cooperating, and DOJ had requested related information. The filing notes potential additional legal, accounting and other costs and possible proceedings.
- Customer and operating exposure: Williams Partners represented 13% of revenue in 2017; the five largest customers represented approximately 29%. Contracts often become terminable on 30 days’ notice after initial terms. Customer financial weakness, pricing competition, equipment availability, workforce retention and operational incidents could affect results.
- Other risks: Substantial debt and covenant restrictions; dependence on Partnership distributions; floating-rate exposure (a 1 percentage-point rate increase was estimated to add $2.3 million annual interest expense); environmental and emissions regulation; self-insured claims; and possible nonpayment of $20.9 million of remaining PDVSA-related proceeds expected to be passed through from Exterran.
Most important facts for investors to verify
- Whether the proposed merger closed, the final share issuance and ownership dilution, and the resulting guarantees or treatment of Partnership debt.
- Progress and outcomes in the Texas property-tax cases, including whether the disputed $62.3 million benefit is sustained and any associated penalties or interest.
- Whether operating horsepower, pricing, segment margins and cash generation improved as management expected, and how 2018 capital spending was funded.
- The status and potential financial consequences of the SEC/DOJ investigations and restatement-related costs.
- Actual borrowing availability and covenant headroom, the sustainability of dividends, and collection of the remaining PDVSA-related proceeds.
- The effects of the 2018 revenue-recognition adoption; management estimated a $14–$18 million after-tax cumulative adjustment to retained deficit.