Archrock, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Archrock provides U.S. natural-gas compression contract operations and aftermarket services. Results consolidate Archrock Partners, L.P. (“the Partnership”), in which public unitholders held approximately 57% before the subsequent merger.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $212.0 million | $189.9 million |
| Gross margin | $105.1 million | $92.1 million |
| Income (loss) before taxes | $2.4 million | ($13.7 million) |
| Consolidated net income (loss) | $2.1 million | ($14.0 million) |
| Net loss attributable to Archrock stockholders | ($3.8 million); ($0.06) per share | ($11.7 million); ($0.17) per share |
| Operating cash flow | $62.5 million | $54.8 million |
| Capital expenditures | $70.0 million | $30.9 million |
- Revenue rose 12% year over year. Contract operations revenue increased 7% to $161.2 million; aftermarket services revenue increased 27% to $50.8 million.
- Gross margin increased 14%. Contract operations gross margin was $96.6 million (60% of segment revenue), versus $85.9 million (57%); aftermarket services gross margin was $8.5 million (17%), versus $6.2 million (15%). Gross margin is a company-defined non-GAAP measure.
- Operating horsepower averaged 3.289 million, up 6%; average utilization was 85%, compared with 82%.
- Cash and equivalents were $3.6 million at quarter-end, down from $10.5 million at year-end 2017. Cash from operations less capital expenditures was negative $7.5 million, before $14.8 million of asset-sale proceeds.
- Long-term debt was $1.427 billion, versus $1.417 billion at December 31, 2017. Stockholders’ equity was $782.3 million; total equity, including noncontrolling interest, was $737.9 million.
- Quarterly dividend was $0.12 per common share, unchanged from Q1 2017. The board declared another $0.12 dividend for payment in May 2018.
Material changes and unusual items
- Archrock recorded $4.1 million of merger-related costs. Long-lived asset impairment declined to $4.7 million from $8.2 million; depreciation and amortization fell 7% to $44.5 million. Interest expense increased 5% to $22.5 million.
- Adoption of the new revenue-recognition standard affected timing and classification, including capitalization of certain freight, mobilization and commission costs and recognition of aftermarket service revenue over time. For Q1 2018, the company reported that adoption increased revenue by $4.1 million and Archrock-attributable results by $2.6 million compared with amounts excluding the new standard; comparisons with 2017 are not restated.
- Results included a $4.7 million benefit to ad valorem tax expense tied to the Texas heavy-equipment tax litigation. Archrock had recorded $82.9 million of aggregate benefits since 2012; $67.0 million remained disputed.
- On April 26, 2018, after quarter-end, Archrock completed its acquisition of the Partnership’s remaining 41.2 million common units, issuing 57.6 million Archrock shares at a 1.40 exchange ratio (approximately $625.3 million implied consideration). The Partnership became wholly owned and its incentive distribution rights were canceled. The transaction will be accounted for as an equity transaction, with no merger gain or loss in earnings.
Liquidity, outlook and risks
- At March 31, before the merger-related facility changes, Archrock reported $224.2 million available to borrow under its revolver and the Partnership $177.2 million under its facility, after covenant limitations. Both entities reported covenant compliance. Archrock said operating cash flow and Partnership facility borrowings should meet liquidity needs through at least March 31, 2019.
- Effective with the April 26 merger, the Partnership facility commitment increased to $1.25 billion; Archrock terminated its separate facility and repaid $63.2 million of borrowings, accrued interest and fees. The Partnership facility generally matures in March 2022, but may mature in December 2020 if the April 2021 notes remain outstanding at the specified date.
- Management planned 2018 capital expenditures of $300–$320 million, including $230–$250 million for growth and $40–$45 million for maintenance. Management anticipated higher average operating horsepower and revenue in both segments, citing strong orders and improved market conditions. These are expectations, not guarantees.
- Key risks include energy-market and customer-spending volatility, substantial leverage and covenant-limited borrowing availability, execution and potential synergies from the merger, and the Texas tax litigation. An adverse tax outcome could require repayment of recorded benefits, penalties and interest, and could raise future costs and affect dividends.
- Other items to monitor include the SEC investigation concerning prior-period errors and possible irregularities at a former international operation (the SEC and DOJ said they would not pursue FCPA enforcement), ongoing restatement-related costs, and exposure to uninsured operational and workers’ compensation claims. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Investor verification priorities
- Track post-merger share dilution, integration and realized benefits, and the combined company’s debt, facility availability and covenant headroom.
- Assess whether operating cash flow can support the planned growth investment and dividends, given low quarter-end cash and capital expenditures exceeding operating cash flow.
- Verify underlying segment demand, utilization, rates and margins, separating operating improvement from the new revenue-recognition accounting effects.
- Monitor the Texas heavy-equipment tax cases, the $67.0 million disputed recorded benefit, and any associated penalties, interest or future tax expense.
- Review subsequent filings for final 2017 tax-reform measurements, restatement-related developments and any changes to management’s outlook.