Archrock, Inc. quarterly report, Q1 FY2012

Business context and reporting period

This is Exterran Holdings, Inc.’s unaudited Form 10-Q for the quarter ended March 31, 2012. The filing describes a global natural-gas compression and oil-and-gas equipment and services business with four reportable segments: North America contract operations, international contract operations, aftermarket services and fabrication. The filing cover names Exterran Holdings, Inc.; investors should verify the relationship to the requested company, Archrock, Inc.

Financial results and liquidity

Net cash used in investing activities was $69.4 million, while financing activities provided $32.1 million; cash increased $1.5 million during the quarter. Working capital was $483.3 million, up from $454.0 million at year-end. The company reported $423.9 million of undrawn capacity on its revolving facility, of which $400.8 million was available for additional borrowing under the stated covenant limitation; the Partnership separately reported $264.5 million of available revolver capacity.

Segment gross margins were: North America contract operations $78.1 million (51% margin), international contract operations $68.9 million (61%), aftermarket services $17.2 million (18%), and fabrication $26.6 million (10%).

Material changes versus the prior comparable period

• Revenue rose 1% overall. Aftermarket services revenue increased 19% and North America and international contract operations revenue increased 2% and 7%, respectively; fabrication revenue declined 6%.
• Gross margin improved by $5.7 million, with stronger North America contract operations and aftermarket services partly offset by a $14.1 million decline in fabrication gross margin. Q1 2011 fabrication margin included $8.6 million of change-order recoveries.
• The company returned to positive net income attributable to stockholders, but adjusted EBITDA was essentially unchanged. Q1 2012 earnings included $37.6 million recognized from the sale of assets held by two Venezuelan joint ventures; the prior-year loss included different operating and impairment-related effects.
• Operating cash flow increased, but capital expenditures more than doubled. The filing attributes the improved operating cash flow mainly to lower cash use for working capital.
• In March 2012, the Partnership acquired contract operations assets and customer agreements from Exterran for approximately $182.8 million of consideration, including $105.4 million of debt assumed and $77.4 million in cash paid. The Partnership also raised $114.6 million from a unit offering and used the proceeds to repay revolver borrowings.

Outlook, management commentary, risks and unusual items

• Management expected 2012 net capital expenditures of approximately $325 million to $375 million, including $105 million to $115 million of contract-operations maintenance capital.
• Management stated that operating cash flow and credit-facility availability were expected to fund operating and capital expenditures, scheduled interest and debt repayments through December 31, 2012, while noting additional debt or equity financing might be sought if needed.
• Management described robust North American drilling and fabrication bookings, especially in shale and oil/liquids-focused areas, but cited uncertainty from North American natural-gas prices at more than decade lows, potential reductions in dry-gas production, and competitor investment in new equipment. International fabrication backlog was affected by longer project lead times.
• Fabrication backlog was $883.0 million at March 31, up from $665.7 million at year-end and $751.0 million a year earlier. Total horsepower utilization was 78%, unchanged from both comparison dates.
• Q1 included a $4.3 million impairment of idle compression assets and $3.0 million of restructuring charges. Management estimated a further $1.6 million of charges for its profit-improvement initiative, expected to be cash expenditures.
• Exterran reported $1.7 billion of debt and compliance with its financial covenants at quarter-end. Its leverage ratio was 3.6x against a 5.0x maximum; the interest-coverage ratio was 3.9x against a 2.25x minimum. The Partnership also reported covenant compliance. Covenant breaches could trigger defaults and cross-default provisions.
• Interest-rate sensitivity: after swaps, approximately $195.5 million of debt was effectively floating-rate; a 1 percentage-point rate increase would add about $2.0 million to annual interest expense. The company also reported a $5.3 million foreign-currency gain in Q1, versus a $2.6 million loss in Q1 2011.
• International political risk is significant. Argentina assumed control of YPF in April 2012; Exterran reported 542,000 horsepower in Argentina and $16.2 million of Q1 revenue from YPF, and could not predict the impact. In Venezuela, PDVSA had taken control of substantially all operations in 2009; arbitration over expropriated assets was scheduled for July 2012, with any compensation uncertain and not recognized as an asset.
• The company was due approximately $74.8 million in additional periodic payments through Q1 2016 from the joint-venture asset sale; payments are recognized in earnings as received. The filing also cites environmental compliance costs, customer credit and contract-renewal risks, and the possibility of uninsured losses.
• The filing corrected the classification of Q1 2011 Partnership-unit proceeds from investing to financing activities; the correction did not affect operating cash flow. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

• Confirm issuer identity and corporate continuity: this filing is for Exterran Holdings, Inc., while the request identifies Archrock, Inc.
• Assess the quality and recurrence of reported earnings, especially the $37.6 million joint-venture asset-sale proceeds and the future payment schedule.
• Compare the $325 million to $375 million capital-spending plan with cash generation, available borrowing capacity and covenant headroom.
• Review fabrication backlog conversion, segment margins and exposure to low natural-gas prices and project delays.
• Monitor Argentina and Venezuela developments, including customer exposure, arbitration outcomes and any potential compensation.
• Verify debt maturities and refinancing needs, covenant compliance, and the effect of interest-rate and foreign-exchange movements.