Archrock, Inc. quarterly report, Q3 FY2017

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Archrock, Inc. — Q3 2017 Form 10-Q

Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2017. Archrock provides U.S. natural-gas compression contract operations and aftermarket services. It consolidates Archrock Partners, in which it held an approximately 43% interest; public unitholders held approximately 57%. Figures below are in U.S. dollars; financial statement amounts are shown in millions unless stated otherwise.

Financial performance and position

  • Q3 revenue: $197.9 million, up 1% from $195.8 million. Contract operations revenue fell 2% to $153.5 million; aftermarket services revenue rose 13% to $44.3 million.
  • Q3 gross margin: $87.4 million versus $103.3 million; gross margin as a share of revenue was approximately 44% versus 53%. Gross margin is a company-defined non-GAAP measure. Contract operations margin declined to $81.6 million from $96.8 million, while aftermarket margin declined to $5.8 million from $6.5 million.
  • Q3 earnings: Net loss attributable to Archrock stockholders was $10.2 million, or $0.15 per share, versus a $9.6 million loss, or $0.14 per share.
  • Nine-month results: Revenue was $585.7 million, down 4% from $613.3 million; gross margin was $275.6 million versus $329.0 million. Net loss attributable to Archrock stockholders widened to $28.6 million from $15.9 million, or $0.42 versus $0.24 loss per share.
  • Cash flow and investment: Nine-month operating cash flow was $151.1 million, down from $220.1 million. Capital expenditures were $152.2 million, compared with $97.0 million. Investing cash outflow was $129.6 million; financing cash outflow was $22.0 million. Cash at September 30 was $2.6 million, down from $3.1 million at year-end 2016.
  • Debt and liquidity: Long-term debt was $1.393 billion at September 30, versus $1.442 billion at year-end. Archrock’s $350 million revolver had $75.5 million drawn and $156.5 million available for additional borrowing after covenant limits. The Partnership’s $1.1 billion asset-based revolver had $631.5 million drawn and $213.6 million available after covenant limits. Both entities reported covenant compliance.
  • Dividends: Archrock declared and paid $0.12 per common share for Q3; the board declared another $0.12 dividend payable November 15, 2017. The Partnership approved a $0.285-per-unit distribution, of which approximately $8.7 million was expected to go to Archrock.

Material changes and management commentary

  • Contract operations remained pressured by lower rates and the effects of weaker customer demand in 2016. Q3 operating horsepower improved modestly: average operating horsepower was 3.166 million versus 3.151 million, and period-end utilization was 83% versus 79%. Higher start-up, lube-oil and other operating costs reduced margins.
  • Aftermarket services revenue recovered, driven by higher parts sales and service activity, but costs rose faster and margins declined.
  • Management expected full-year 2017 contract operations revenue to decline versus 2016, despite stronger 2017 orders, and expected moderate aftermarket revenue recovery. It also expected 2017 operating cash flow to decrease from 2016, while stating that operating cash flow and revolver availability should meet liquidity needs through at least September 30, 2018.
  • Management planned approximately $225 million of 2017 capital expenditures, including approximately $175 million for growth and $35 million for equipment maintenance.
  • In March 2017, the Partnership replaced its former credit facilities with a $1.1 billion asset-based revolver, and in August raised $60.3 million net through a common-unit offering, using the proceeds to repay facility borrowings. Archrock reported $25 million received from Exterran Corporation in April under the separation agreement; a further approximately $20.9 million remained due to Exterran from PDVSA Gas, with Archrock entitled to a corresponding contribution when collected.

Risks, contingencies and unusual items

  • Texas ad valorem tax litigation: Archrock recorded a $12.7 million tax benefit in the first nine months of 2017 and $73.4 million cumulatively since 2012. Of the cumulative amount, $57.4 million was disputed and in litigation. If unsuccessful, the company could owe taxes, penalties and interest; future quarterly costs could also rise if the favorable tax treatment is lost. The Texas Supreme Court heard oral argument in a related case in October 2017.
  • Tax uncertainty: Unrecognized tax benefits were $21.1 million at September 30, up from $9.7 million at year-end 2016; $16.0 million would affect the effective tax rate if recognized. Recent appellate decisions prompted remeasurement of certain uncertain positions.
  • Restatement and regulatory matters: The company incurred $3.3 million of restatement and other charges in the first nine months. The SEC was investigating previously disclosed errors and possible irregularities at a former international operation; Archrock and Exterran were cooperating, and related information was also provided to the Department of Justice at its request.
  • Asset impairment and office move: Nine-month impairment charges were $20.9 million, including $19.7 million on 190 idle compressor units totaling 71,000 horsepower. The corporate office relocation generated $2.1 million of charges in Q3; the company said it expected no further relocation costs.
  • Debt and rate exposure: The Partnership’s facility has leverage and coverage covenants, borrowing-base limitations and cross-default provisions. After swaps, $207 million of debt was effectively floating-rate; a 1 percentage-point increase would add approximately $2.1 million to annual interest expense.
  • Revenue accounting: Archrock planned to adopt the new revenue standard on January 1, 2018 using the modified retrospective method. Management expected certain aftermarket services to be recognized over time and some contract costs to be deferred and amortized; the overall impact was still being assessed.

Most important facts for investors to verify

  • Whether contract operations pricing and margins stabilize as new orders and operating horsepower translate into revenue.
  • Actual 2017 capital spending and operating cash flow compared with management’s outlook, and the resulting borrowing needs and covenant headroom.
  • Developments in the Texas compressor-tax litigation, including potential repayment, penalties and the sustainability of recorded tax benefits.
  • Resolution and costs of the SEC/DOJ inquiry and any further restatement-related matters.
  • The impact of the 2018 revenue-accounting change on reported revenue, margins, contract costs and opening equity.
  • Whether Archrock and the Partnership can sustain their dividends and distributions given losses, low cash balances, capital requirements and credit-agreement restrictions.