Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
(MARK ONE)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED March 31, 2016
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
Commission File No. 001-33666
ARCHROCK, INC.
(Exact name of registrant as specified in its charter)
|
| | |
Delaware | | 74-3204509 |
(State or Other Jurisdiction of | | (I.R.S. Employer |
Incorporation or Organization) | | Identification No.) |
| | |
16666 Northchase Drive | | |
Houston, Texas | | 77060 |
(Address of principal executive offices) | | (Zip Code) |
(281) 836-8000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
|
| | |
Large accelerated filer x | | Accelerated filer o |
| | |
Non-accelerated filer o | | Smaller reporting company o |
(Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
Number of shares of the common stock of the registrant outstanding as of February 2, 2017: 70,533,248 shares.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ARCHROCK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share amounts)
(unaudited)
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| | | As Restated |
| | | (Note 17) |
ASSETS | | | |
| | | |
Current assets: | | | |
Cash and cash equivalents | $ | 4,791 |
| | $ | 1,563 |
|
Accounts receivable, net of allowance of $1,870 and $3,343, respectively | 132,900 |
| | 147,786 |
|
Inventory | 123,494 |
| | 129,411 |
|
Other current assets | 4,141 |
| | 6,123 |
|
Current assets associated with discontinued operations | 376 |
| | 420 |
|
Total current assets | 265,702 |
| | 285,303 |
|
Property, plant and equipment, net | 2,264,098 |
| | 2,267,788 |
|
Intangible and other assets, net | 120,351 |
| | 120,889 |
|
Long-term assets associated with discontinued operations | 20,689 |
| | 21,200 |
|
Total assets | $ | 2,670,840 |
| | $ | 2,695,180 |
|
| | | |
LIABILITIES AND EQUITY | | | |
| | | |
Current liabilities: | | | |
Accounts payable, trade | $ | 41,196 |
| | $ | 52,430 |
|
Accrued liabilities | 79,924 |
| | 80,053 |
|
Deferred revenue | 1,826 |
| | 2,201 |
|
Current liabilities associated with discontinued operations | 212 |
| | 420 |
|
Total current liabilities | 123,158 |
| | 135,104 |
|
Long-term debt | 1,600,210 |
| | 1,576,882 |
|
Deferred income taxes | 174,752 |
| | 178,566 |
|
Other long-term liabilities | 16,086 |
| | 11,655 |
|
Long-term liabilities associated with discontinued operations | 5,714 |
| | 5,714 |
|
Total liabilities | 1,919,920 |
| | 1,907,921 |
|
Commitments and contingencies (Note 14) |
|
| |
|
|
Equity: | |
| | |
|
Preferred stock, $0.01 par value per share; 50,000,000 shares authorized; zero issued | — |
| | — |
|
Common stock, $0.01 par value per share; 250,000,000 shares authorized; 76,181,619 and 75,014,308 shares issued, respectively | 762 |
| | 750 |
|
Additional paid-in capital | 2,952,701 |
| | 2,944,897 |
|
Accumulated other comprehensive loss | (2,975 | ) | | (1,570 | ) |
Accumulated deficit | (2,152,609 | ) | | (2,137,738 | ) |
Treasury stock — 5,511,512 and 5,383,970 common shares, at cost, respectively | (73,168 | ) | | (72,429 | ) |
Total Archrock stockholders’ equity | 724,711 |
| | 733,910 |
|
Noncontrolling interest | 26,209 |
| | 53,349 |
|
Total equity | 750,920 |
| | 787,259 |
|
Total liabilities and equity | $ | 2,670,840 |
| | $ | 2,695,180 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ARCHROCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
| | | As Restated |
| | | (Note 17) |
Revenues: | | | |
Contract operations | $ | 176,239 |
| | $ | 202,261 |
|
Aftermarket services | 37,056 |
| | 50,612 |
|
| 213,295 |
| | 252,873 |
|
Costs and expenses: | | | |
Cost of sales (excluding depreciation and amortization expense): | | | |
Contract operations | 68,179 |
| | 82,679 |
|
Aftermarket services | 30,362 |
| | 40,777 |
|
Selling, general and administrative | 34,651 |
| | 32,568 |
|
Depreciation and amortization | 53,927 |
| | 57,013 |
|
Long-lived asset impairment | 9,860 |
| | 8,153 |
|
Restructuring and other charges | 8,065 |
| | — |
|
Interest expense | 20,300 |
| | 26,791 |
|
Other income, net | (1,989 | ) | | (550 | ) |
| 223,355 |
| | 247,431 |
|
Income (loss) before income taxes | (10,060 | ) | | 5,442 |
|
Benefit from income taxes | (3,334 | ) | | (740 | ) |
Income (loss) from continuing operations | (6,726 | ) | | 6,182 |
|
Income from discontinued operations, net of tax | — |
| | 33,788 |
|
Net income (loss) | (6,726 | ) | | 39,970 |
|
Less: Net (income) loss attributable to the noncontrolling interest | 4,907 |
| | (8,943 | ) |
Net income (loss) attributable to Archrock stockholders | $ | (1,819 | ) | | $ | 31,027 |
|
| | | |
Basic income (loss) per common share: | | | |
Loss from continuing operations attributable to Archrock common stockholders | $ | (0.03 | ) | | $ | (0.04 | ) |
Income from discontinued operations attributable to Archrock common stockholders | — |
| | 0.49 |
|
Net income (loss) attributable to Archrock common stockholders | $ | (0.03 | ) | | $ | 0.45 |
|
| | | |
Diluted income (loss) per common share: | | | |
Loss from continuing operations attributable to Archrock common stockholders | $ | (0.03 | ) | | $ | (0.04 | ) |
Income from discontinued operations attributable to Archrock common stockholders | — |
| | 0.49 |
|
Net income (loss) attributable to Archrock common stockholders | $ | (0.03 | ) | | $ | 0.45 |
|
| | | |
Weighted average common shares outstanding used in income (loss) per common share: | | | |
Basic | 68,833 |
| | 68,252 |
|
Diluted | 68,833 |
| | 68,252 |
|
| | | |
Dividends declared and paid per common share | $ | 0.1875 |
| | $ | 0.15 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ARCHROCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(unaudited)
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
| | | As Restated |
| | | (Note 17) |
Net income (loss) | $ | (6,726 | ) | | $ | 39,970 |
|
Other comprehensive loss, net of tax: | | | |
Derivative loss, net of reclassifications to earnings | (4,237 | ) | | (4,650 | ) |
Adjustments from changes in ownership of Partnership | (6 | ) | | — |
|
Amortization of terminated interest rate swaps | 52 |
| | 635 |
|
Foreign currency translation adjustment | — |
| | (7,745 | ) |
Total other comprehensive loss | (4,191 | ) | | (11,760 | ) |
Comprehensive income (loss) | (10,917 | ) | | 28,210 |
|
Less: Comprehensive (income) loss attributable to the noncontrolling interest | 7,693 |
| | (5,970 | ) |
Comprehensive income (loss) attributable to Archrock stockholders | $ | (3,224 | ) | | $ | 22,240 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ARCHROCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(In thousands)
(unaudited)
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Archrock, Inc. Stockholders | | | | |
| Common Stock | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Loss) | | Treasury Stock | | Accumulated Deficit | | Noncontrolling Interest | | Total |
Balance, January 1, 2015 (As Restated) (Note 17) | $ | 738 |
| | $ | 3,715,586 |
| | $ | 25,834 |
| | $ | (68,532 | ) | | $ | (1,963,605 | ) | | $ | 155,785 |
| | $ | 1,865,806 |
|
Treasury stock purchased |
|
| |
|
| |
|
| | (3,678 | ) | |
|
| |
|
| | (3,678 | ) |
Options exercised | 1 |
| | 571 |
| |
|
| |
|
| |
|
| |
|
| | 572 |
|
Cash dividends |
|
| |
|
| |
|
| |
|
| | (10,340 | ) | |
|
| | (10,340 | ) |
Shares issued in employee stock purchase plan |
|
| | 419 |
| |
|
| |
|
| |
|
| |
|
| | 419 |
|
Stock-based compensation, net of forfeitures | 6 |
| | 4,451 |
| |
|
| |
|
| |
|
| | 241 |
| | 4,698 |
|
Income tax benefit from stock-based compensation expense |
|
| | 302 |
| |
|
| |
|
| |
|
| |
|
| | 302 |
|
Cash distribution to noncontrolling unitholders of the Partnership |
|
| |
|
| |
|
| |
|
| |
|
| | (20,145 | ) | | (20,145 | ) |
Shares issued for exercise of warrants |
|
| | (88 | ) | |
|
| | 88 |
| |
|
| |
|
| | — |
|
Comprehensive income (loss) (As Restated) (Note 17) |
|
| |
|
| | (8,787 | ) | |
|
| | 31,027 |
| | 5,970 |
| | 28,210 |
|
Balance, March 31, 2015 (As Restated) (Note 17) | $ | 745 |
| | $ | 3,721,241 |
| | $ | 17,047 |
| | $ | (72,122 | ) | | $ | (1,942,918 | ) | | $ | 141,851 |
| | $ | 1,865,844 |
|
| | | | | | | | | | | | | |
Balance, January 1, 2016 (As Restated) (Note 17) | $ | 750 |
| | $ | 2,944,897 |
| | $ | (1,570 | ) | | $ | (72,429 | ) | | $ | (2,137,738 | ) | | $ | 53,349 |
| | $ | 787,259 |
|
Treasury stock purchased |
|
| |
|
| |
|
| | (739 | ) | |
|
| |
|
| | (739 | ) |
Cash dividends |
|
| |
|
| |
|
| |
|
| | (13,052 | ) | |
|
| | (13,052 | ) |
Stock-based compensation, net of forfeitures | 12 |
| | 3,113 |
| |
|
| |
|
| |
|
| | 406 |
| | 3,531 |
|
Income tax expense from stock-based compensation expense |
|
| | (1,062 | ) | |
|
| |
|
| |
|
| |
|
| | (1,062 | ) |
Contribution from Exterran Corporation |
|
| | 5,153 |
| |
|
| |
|
| |
|
| |
|
| | 5,153 |
|
Partnership units issued in March 2016 Acquisition |
|
| | 600 |
| |
|
| |
|
| |
|
| | 884 |
| | 1,484 |
|
Cash distribution to noncontrolling unitholders of the Partnership |
|
| |
|
| |
|
| |
|
| |
|
| | (20,737 | ) | | (20,737 | ) |
Comprehensive loss |
|
| |
|
| | (1,405 | ) | |
|
| | (1,819 | ) | | (7,693 | ) | | (10,917 | ) |
Balance, March 31, 2016 | $ | 762 |
| | $ | 2,952,701 |
| | $ | (2,975 | ) | | $ | (73,168 | ) | | $ | (2,152,609 | ) | | $ | 26,209 |
| | $ | 750,920 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ARCHROCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
| | | As Restated |
| | | (Note 17) |
Cash flows from operating activities: | | | |
Net income (loss) | $ | (6,726 | ) | | $ | 39,970 |
|
Adjustments to reconcile net income (loss) to cash provided by operating activities: | | | |
Depreciation and amortization | 53,927 |
| | 57,013 |
|
Long-lived asset impairment | 9,860 |
| | 8,153 |
|
Amortization of deferred financing costs | 1,105 |
| | 1,618 |
|
Income from discontinued operations, net of tax | — |
| | (33,788 | ) |
Amortization of debt discount | 304 |
| | 286 |
|
Provision for doubtful accounts | 1,378 |
| | 298 |
|
Gain on sale of property, plant and equipment | (443 | ) | | (357 | ) |
Loss on non-cash consideration in March 2016 Acquisition | 635 |
| | — |
|
Amortization of terminated interest rate swaps | 80 |
| | 977 |
|
Interest rate swaps | 323 |
| | (136 | ) |
Stock-based compensation expense | 3,288 |
| | 2,483 |
|
Non-cash restructuring charges | 3,181 |
| | — |
|
Deferred income tax provision | (3,801 | ) | | (2,578 | ) |
Changes in assets and liabilities, net of acquisitions: | | | |
Accounts receivable and notes | 13,508 |
| | 19,318 |
|
Inventory | 3,595 |
| | 1,198 |
|
Other current assets | 1,823 |
| | 466 |
|
Accounts payable and other liabilities | (10,110 | ) | | 393 |
|
Deferred revenue | (288 | ) | | 7,335 |
|
Other | (252 | ) | | 2,517 |
|
Net cash provided by continuing operations | 71,387 |
| | 105,166 |
|
Net cash provided by (used in) discontinued operations | (164 | ) | | 29,468 |
|
Net cash provided by operating activities | 71,223 |
| | 134,634 |
|
| | | |
Cash flows from investing activities: | | | |
Capital expenditures | (50,600 | ) | | (90,336 | ) |
Proceeds from sale of property, plant and equipment | 4,177 |
| | 5,310 |
|
Payment for March 2016 Acquisition | (13,779 | ) | | — |
|
Net cash used in continuing operations | (60,202 | ) | | (85,026 | ) |
Net cash used in discontinued operations | — |
| | (24,311 | ) |
Net cash used in investing activities | (60,202 | ) | | (109,337 | ) |
| | | |
Cash flows from financing activities: | | | |
Proceeds from borrowings of long-term debt | 103,500 |
| | 417,000 |
|
Repayments of long-term debt | (81,000 | ) | | (396,500 | ) |
Payments for debt issuance costs | (222 | ) | | (1,311 | ) |
Payments for settlement of interest rate swaps that include financing elements | (812 | ) | | (942 | ) |
Proceeds from stock options exercised | — |
| | 572 |
|
Proceeds from stock issued pursuant to our employee stock purchase plan | — |
| | 419 |
|
Purchases of treasury stock | (739 | ) | | (3,678 | ) |
Dividends to Archrock stockholders | (13,052 | ) | | (10,340 | ) |
Stock-based compensation excess tax benefit | 116 |
| | 1,367 |
|
Distributions to noncontrolling partners in the Partnership | (20,737 | ) | | (20,145 | ) |
Contribution from Exterran Corporation | 5,153 |
| | — |
|
Net cash used in continuing operations | (7,793 | ) | | (13,558 | ) |
Net cash provided by discontinued operations | — |
| | 764 |
|
Net cash used in financing activities | (7,793 | ) | | (12,794 | ) |
| | | |
Effect of exchange rate changes on cash and cash equivalents | — |
| | (231 | ) |
Net increase in cash and cash equivalents - total operations | 3,228 |
| | 12,272 |
|
Less: Net increase in cash and cash equivalents - discontinued operations | — |
| | 12,089 |
|
Cash and cash equivalents at beginning of period | 1,563 |
| | 378 |
|
Cash and cash equivalents at end of period | $ | 4,791 |
| | $ | 561 |
|
| | | |
Supplemental disclosure of non-cash transactions: | | | |
Non-cash consideration in March 2016 Acquisition | $ | 3,165 |
| | $ | — |
|
Partnership units issued in March 2016 Acquisition | $ | 1,799 |
| | $ | — |
|
Treasury shares issued for exercise of warrants | $ | — |
| | $ | 88 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
ARCHROCK, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
The accompanying unaudited condensed consolidated financial statements of Archrock, Inc. (“Archrock,” “our,” “we” or “us”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP are not required in these interim financial statements and have been condensed or omitted. Management believes that the information furnished includes all normal recurring adjustments, and adjustments related to the matters described in Note 17 (“Restatement of Previously Reported Consolidated Financial Statements”), that are necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods indicated. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements presented in Amendment No. 1 to our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K/A”). That report contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year.
Income (Loss) Attributable to Archrock Common Stockholders Per Common Share
Basic income (loss) attributable to Archrock common stockholders per common share is computed using the two-class method, which is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Under the two-class method, basic income (loss) attributable to Archrock common stockholders per common share is determined by dividing income (loss) attributable to Archrock common stockholders after deducting amounts allocated to participating securities, by the weighted average number of common shares outstanding for the period. Participating securities include our unvested restricted stock and certain stock settled restricted stock units that have nonforfeitable rights to receive dividends or dividend equivalents, whether paid or unpaid. During periods of net loss, no effect is given to participating securities because they do not have a contractual obligation to participate in our losses.
Diluted income (loss) attributable to Archrock common stockholders per common share is computed using the weighted average number of shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options and warrants to purchase common stock, restricted stock units, stock to be issued pursuant to our employee stock purchase plan and convertible senior notes, unless their effect would be anti-dilutive.
The following table summarizes net income (loss) attributable to Archrock common stockholders used in the calculation of basic and diluted income (loss) per common share (in thousands):
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Loss from continuing operations attributable to Archrock stockholders | $ | (1,819 | ) | | $ | (2,761 | ) |
Income from discontinued operations, net of tax | — |
| | 33,788 |
|
Net income (loss) attributable to Archrock stockholders | (1,819 | ) | | 31,027 |
|
Less: Net income attributable to participating securities | (184 | ) | | (117 | ) |
Net income (loss) attributable to Archrock common stockholders | $ | (2,003 | ) | | $ | 30,910 |
|
The following table shows the potential shares of common stock that were included in computing diluted income (loss) attributable to Archrock common stockholders per common share (in thousands):
|
| | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Weighted average common shares outstanding including participating securities | 70,162 |
| | 69,179 |
|
Less: Weighted average participating securities outstanding | (1,329 | ) | | (927 | ) |
Weighted average common shares outstanding — used in basic income (loss) per common share | 68,833 |
| | 68,252 |
|
Net dilutive potential common shares issuable: | | | |
On exercise of options and vesting of restricted stock units | — |
| | * |
|
Weighted average common shares outstanding — used in diluted income (loss) per common share | 68,833 |
| | 68,252 |
|
| |
* | Excluded from diluted income (loss) per common share as their inclusion would have been anti-dilutive. |
The following table shows the potential shares of common stock issuable that were excluded from computing diluted income (loss) attributable to Archrock common stockholders per common share as their inclusion would have been anti-dilutive (in thousands):
|
| | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Net dilutive potential common shares issuable: | | | |
On exercise of options where exercise price is greater than average market value for the period | 916 |
| | 568 |
|
On exercise of options and vesting of restricted stock units | — |
| | 282 |
|
Net dilutive potential common shares issuable | 916 |
| | 850 |
|
Comprehensive Income (Loss)
Components of comprehensive income (loss) are net income (loss) and all changes in equity during a period except those resulting from transactions with owners. Our accumulated other comprehensive income (loss) consists of foreign currency translation adjustments, changes in the fair value of derivative financial instruments, net of tax, that are designated as cash flow hedges to the extent the hedge is effective, amortization of terminated interest rate swaps and adjustments related to changes in our ownership of Archrock Partners, L.P. (along with its subsidiaries, the “Partnership”).
The following table presents the changes in accumulated other comprehensive income (loss) by component, net of tax, and excluding noncontrolling interest, during the three months ended March 31, 2015 and 2016 (in thousands):
|
| | | | | | | | | | | |
| Derivatives Cash Flow Hedges | | Foreign Currency Translation Adjustment | | Total |
Accumulated other comprehensive income, January 1, 2015 | $ | (911 | ) | | $ | 26,745 |
| | $ | 25,834 |
|
Loss recognized in other comprehensive loss, net of tax | (1,502 | ) | (1) | (7,745 | ) |
| (9,247 | ) |
Loss reclassified from accumulated other comprehensive income, net of tax | 460 |
| (2) | — |
| | 460 |
|
Other comprehensive loss attributable to Archrock stockholders | (1,042 | ) | | (7,745 | ) | | (8,787 | ) |
Accumulated other comprehensive income, March 31, 2015 | $ | (1,953 | ) | | $ | 19,000 |
| | $ | 17,047 |
|
| | | | | |
Accumulated other comprehensive loss, January 1, 2016 | $ | (1,570 | ) | | $ | — |
| | $ | (1,570 | ) |
Loss recognized in other comprehensive loss, net of tax | (1,730 | ) | (3) | — |
|
| (1,730 | ) |
Loss reclassified from accumulated other comprehensive loss, net of tax | 325 |
| (4) | — |
| | 325 |
|
Other comprehensive loss attributable to Archrock stockholders | (1,405 | ) | | — |
| | (1,405 | ) |
Accumulated other comprehensive loss, March 31, 2016 | $ | (2,975 | ) | | $ | — |
| | $ | (2,975 | ) |
| |
(1) | During the three months ended March 31, 2015, we recognized a loss of $2.3 million and a tax benefit of $0.8 million, in other comprehensive income (loss) related to changes in the fair value of derivative financial instruments. |
| |
(2) | During the three months ended March 31, 2015, we reclassified a loss of $0.7 million to interest expense and a tax benefit of $0.2 million to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss). |
| |
(3) | During the three months ended March 31, 2016, we recognized a loss of $2.5 million and a tax benefit of $0.8 million in other comprehensive income (loss) related to the change in the fair value of derivative financial instruments. |
| |
(4) | During the three months ended March 31, 2016, we reclassified a loss of $0.5 million to interest expense and a tax benefit of $0.2 million to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss). |
Financial Instruments
Our financial instruments consist of cash, receivables, payables, interest rate swaps and debt. At March 31, 2016 and December 31, 2015, the estimated fair values of these financial instruments approximated their carrying amounts as reflected in our condensed consolidated balance sheets. The fair value of our fixed rate debt was estimated based on quoted market yields in inactive markets, which are Level 2 inputs. The fair value of our floating rate debt was estimated using a discounted cash flow analysis based on interest rates offered on loans with similar terms to borrowers of similar credit quality, which are Level 3 inputs. See Note 9 (“Fair Value Measurements”) for additional information regarding the fair value hierarchy.
The following table summarizes the carrying amount and fair value of our debt as of March 31, 2016 and December 31, 2015 (in thousands):
|
| | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| Carrying Amount(1) | | Fair Value | | Carrying Amount(1) | | Fair Value |
Fixed rate debt | $ | 681,250 |
| | $ | 518,000 |
| | $ | 680,484 |
| | $ | 524,000 |
|
Floating rate debt | 918,960 |
| | 920,000 |
| | 896,398 |
| | 897,000 |
|
Total debt | $ | 1,600,210 |
| | $ | 1,438,000 |
| | $ | 1,576,882 |
| | $ | 1,421,000 |
|
| |
(1) | Carrying values are shown net of unamortized debt discounts and unamortized deferred financing costs. See Note 7 (“Long-Term Debt”) for further details. |
GAAP requires that all derivative instruments (including certain derivative instruments embedded in other contracts) be recognized in the balance sheet at fair value and that changes in such fair values be recognized in income (loss) unless specific hedging criteria are met. Changes in the values of derivatives that meet these hedging criteria will ultimately offset related income effects of the hedged item pending recognition in income.
Goodwill
Beginning in late 2014 and extending throughout 2015, the energy markets experienced a significant reduction in oil and natural gas prices which has had a significant impact on the financial performance and operating results of many oil and natural gas companies. Such declines accelerated in the fourth quarter of 2015, resulting in higher borrowing costs for companies and a substantial reduction in forecasted capital spending across the energy industry leading to lower projected growth rates over the short-term. Such declines impacted our future cash flow forecasts, our market capitalization, and the market capitalization of peer companies. We identified these conditions as a triggering event, which required us to perform a two-step goodwill impairment test as of December 31, 2015. Accordingly, we recorded a preliminary full impairment of our goodwill in the fourth quarter of 2015 of $3.7 million. During the first quarter of 2016, we finalized the impairment analysis, which did not result in an adjustment to the preliminary impairment booked in the fourth quarter of 2015.
2. Recent Accounting Developments
Accounting Standards Updates Implemented
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2015-03 (“Update 2015-03”) that addresses the presentation of debt issuance costs. Update 2015-03 requires an entity to present such costs in the balance sheet as a direct deduction from the carrying amount of the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. In August 2015, the FASB issued Accounting Standards Update 2015-15 (“Update 2015-15”) which clarifies that the guidance in Update 2015-03 does not apply to line-of-credit arrangements. Per Update 2015-15, line-of-credit arrangements will continue to defer and present debt issuance costs as an asset and subsequently amortize the deferred debt costs ratably over the term of the arrangement. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle. Update 2015-03 was effective for reporting periods beginning after December 15, 2015 on a retrospective basis. We adopted Update 2015-03 in the first quarter of 2016, which resulted in the reclassification of an $11.6 million asset previously presented in intangibles and other assets, net on the condensed consolidated balance sheet to a contra-liability presented in long-term debt on the condensed consolidated balance sheet as of December 31, 2015. See Note 7 (“Long-Term Debt”) for further details.
In February 2015, the FASB issued Accounting Standards Update 2015-02 (“Update 2015-02”) that revises the consolidation model. Update 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. Update 2015-02 was effective for reporting periods beginning after December 15, 2015. We adopted Update 2015-02 in the first quarter of 2016 and determined that the Partnership is a variable interest entity, for which we are the primary beneficiary, to be consolidated by us based upon its general partners’ role and rights as afforded by the partnership agreement and the limited rights afforded to the limited partners. The adoption of Update 2015-02 had no impact on our consolidated financial statements.
Accounting Standards Updates Not Yet Implemented
In March 2016, the FASB issued Accounting Standards Update No. 2016-09 (“Update 2016-09”) that simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either debt or equity liabilities, and classification on the statement of cash flows. For public entities, Update 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of Update 2016-09 on our consolidated financial statements.
In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (“Update 2016-02”) that establishes a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Under the new guidance, lessor accounting is largely unchanged. Update 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of Update 2016-02 on our consolidated financial statements.
In July 2015, the FASB issued Accounting Standards Update No. 2015-11 (“Update 2015-11”) that will require an entity to measure inventory at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. For public business entities, Update 2015-11 is effective on a prospective basis for interim and annual periods beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of Update 2015-11 on our financial statements.
In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“Update 2014-09”) that outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes the most current revenue recognition guidance, including industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Update 2014-09 also requires disclosures enabling users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Update 2014-09 will be effective for reporting periods beginning after December 15, 2017, including interim periods within the reporting period. Early adoption is permitted for reporting periods beginning after December 15, 2016. Companies may use either a full retrospective or a modified retrospective approach. In March 2016, the FASB issued Accounting Standards Update No. 2016-08 (“Update 2016-08”), which clarifies the guidance in Update 2014-09 by providing guidance on recording revenue on a gross basis versus a net basis based on the determination of whether an entity is a principal or an agent when another party is involved in providing goods or services to a customer. Update 2016-08 has the same effective date as the original standard. We are currently evaluating the potential impact of Update 2014-09 and Update 2016-08 on our consolidated financial statements.
3. Discontinued Operations
Spin-off of Exterran Corporation
On November 3, 2015 (the “Distribution Date”), we completed the spin-off (the “Spin-off”) of our international contract operations, international aftermarket services and global fabrication businesses into a standalone public company operating as Exterran Corporation. To effect the Spin-off, we distributed on the Distribution Date, on a pro rata basis, all of the shares of Exterran Corporation common stock to our stockholders as of October 27, 2015 (the “Record Date”). Archrock stockholders received one share of Exterran Corporation common stock for every two shares of our common stock held at the close of business on the Record Date. Upon the completion of the Spin-off, we were renamed “Archrock, Inc.” and, on November 4, 2015, the ticker symbol for our common stock on the New York Stock Exchange was changed to “AROC.” Following the completion of the Spin-off, we and Exterran Corporation are independent, publicly traded companies with separate public ownership, boards of directors and management, and we continue to own and operate the U.S. contract operations and U.S. aftermarket services businesses that we previously owned. Additionally, we continue to hold our interests in the Partnership, which include the sole general partner interest and certain limited partner interests, as well as all of the incentive distribution rights in the Partnership. Effective on the Distribution Date, the Partnership was renamed “Archrock Partners, L.P.,” and, on November 4, 2015, the ticker symbol for its common units on the Nasdaq Global Select Market was changed to “APLP.” Exterran Corporation’s business following the Spin-off has been reported as discontinued operations, net of tax, in our condensed consolidated statement of operations for all periods presented and was previously included in the international contract operations segment, fabrication segment and aftermarket services segment. Following the Spin-off, we no longer operate in the international contract operations or fabrication segments and our operations in the aftermarket services segment are now limited to domestic operations.
In order to effect the Spin-off and govern our relationship with Exterran Corporation after the Spin-off, we entered into several agreements with Exterran Corporation on the Distribution Date:
| |
• | The separation and distribution agreement contains the key provisions relating to the separation of our business from Exterran Corporation’s business. The separation and distribution agreement identifies the assets and rights that were transferred, liabilities that were assumed or retained and contracts and related matters that were assigned to us or Exterran Corporation in the Spin-off and describes how these transfers, assumptions and assignments occurred. Pursuant to the separation and distribution agreement, on the Distribution Date, a subsidiary of Exterran Corporation transferred net proceeds of $532.6 million from borrowings under the Exterran Corporation credit facility to us to allow for the repayment of a portion of our indebtedness. On the Distribution Date, we terminated our former credit facility and repaid all borrowings and accrued and unpaid interest outstanding on the repayment date totaling $326.5 million. Our new capital structure includes a $350.0 million revolving credit facility that became available on the Distribution Date. On December 4, 2015, we redeemed for cash the $350.0 million aggregate principal amount of our 7.25% senior notes due December 2018 at a redemption price equal to 101.813% of the principal amount thereof plus accrued but unpaid interest to the redemption date for $369.2 million. In addition, the separation and distribution agreement contains certain noncompetition provisions addressing restrictions for three years after the Spin-off on Exterran Corporation’s ability to provide contract operations and aftermarket services in the United States and on our ability to provide contract operations and aftermarket services outside of the United States and to provide products for sale worldwide that compete with Exterran Corporation’s current product sales business, subject to certain exceptions. The separation and distribution agreement also governs the treatment of aspects relating to indemnification, insurance, confidentiality and cooperation. Additionally, the separation and distribution agreement specifies our right to receive payments from a subsidiary of Exterran Corporation based on a notional amount corresponding to payments received by Exterran Corporation’s subsidiaries from PDVSA Gas, S.A. (“PDVSA Gas”) in respect of the sale of Exterran Corporation’s subsidiaries’ and joint ventures’ previously nationalized assets promptly after such amounts are collected by Exterran Corporation’s subsidiaries. As of March 31, 2016, we have received payments, including annual charges, of approximately $498.2 million ($50.0 million of which was used to repay insurance proceeds previously collected under the policy we maintained for the risk of expropriation), $5.2 million of which was received during the three months ended March 31, 2016. Pursuant to the separation and distribution agreement, Exterran Corporation or its subsidiary was due to receive the remaining principal amount as of March 31, 2016 of approximately $74.9 million in installments. As these remaining proceeds are received, Exterran Corporation intends to contribute to us an amount equal to such proceeds pursuant to the terms of the separation and distribution agreement. The separation and distribution agreement also specifies our right to receive a $25.0 million cash payment from a subsidiary of Exterran Corporation promptly following the occurrence of a qualified capital raise as defined in the Exterran Corporation credit agreement. |
| |
• | The tax matters agreement governs the respective rights, responsibilities and obligations of Exterran Corporation and us with respect to tax liabilities and benefits, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings and certain other matters regarding taxes. Subject to the provisions of this agreement Exterran Corporation and us agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. As of March 31, 2016, we classified $5.7 million of unrecognized tax benefits (including interest and penalties) as long-term liability associated with discontinued operations since it relates to operations of Exterran Corporation prior to the Spin-off. We have also recorded an offsetting $5.7 million indemnification asset related to this reserve as long-term assets associated with discontinued operations. |
| |
• | The employee matters agreement governs the allocation of liabilities and responsibilities between us and Exterran Corporation relating to employee compensation and benefit plans and programs, including the treatment of retirement, health and welfare plans and equity and other incentive plans and awards. The agreement contains provisions regarding stock-based compensation. See Note 12 (“Stock-Based Compensation”) for additional information relating to the Archrock Stock Incentive Plan. |
| |
• | The transition services agreement sets forth the terms on which Exterran Corporation will provide to us, and we will provide to Exterran Corporation, on a temporary basis, certain services or functions that the companies historically have shared. Transition services provided to us by Exterran Corporation and to Exterran Corporation by us include accounting, administrative, payroll, human resources, environmental health and safety, real estate, fleet, financial audit support, legal, tax, treasury and other support and corporate services, and each service is provided at a predetermined rate set forth in the transition services agreement. Each service provided under the agreement has its own duration, which is generally less than one year and not more than two years, extension terms and monthly cost, and the transition services agreement will terminate upon cessation of all services provided thereunder. For the three months ended March 31, 2016, we recorded other income of $0.3 million and selling, general and administrative expense of $0.6 million associated with the services under the transition services agreement. |
| |
• | The supply agreement sets forth the terms under which Exterran Corporation will provide manufactured equipment, including the design, engineering, manufacturing and sale of natural gas compression equipment, on an exclusive basis to us and the Partnership. This supply agreement has an initial term of two years, subject to certain cancellation conditions, and is extendible for additional one-year terms by mutual agreement of the parties. Pursuant to the supply agreement, we and the Partnership each will be required to purchase our respective requirements of newly-manufactured compression equipment from Exterran Corporation, subject to certain exceptions. For the three months ended March 31, 2016, we purchased $19.9 million of newly-manufactured compression equipment from Exterran Corporation. |
| |
• | The storage agreements set forth the terms under which Exterran Corporation will provide each of us and the Partnership with storage space for equipment purchased under the supply agreement, as well as the terms under which we will provide storage space to Exterran Corporation for certain of its equipment. |
| |
• | The services agreements set forth the terms under which Exterran Corporation will provide us (or our customers on our behalf) with engineering, preservation and installation and commissioning services and we will provide Exterran Corporation (or its customers on its behalf) with make-ready, parts sales, preservation and installation and commissioning services. These services agreements will continue in effect until terminated by either party on 30 days’ written notice. |
Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Exterran Corporation’s business with Exterran Corporation. Pursuant to the separation and distribution agreement, we and Exterran Corporation generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business.
Other discontinued operations activity
In December 2013, we abandoned our contract water treatment business as part of our continued emphasis on simplification and focus on our core businesses. The abandonment of this business meets the criteria established for recognition as discontinued operations under GAAP. Therefore, our contract water treatment business has been reported as discontinued operations, net of tax, in our condensed consolidated statement of operations. This business was previously included in our contract operations segment.
The following table summarizes the operating results of discontinued operations (in thousands):
|
| | | | | | | | | | | |
| Three Months Ended March 31, 2015 |
| Exterran Corporation (1) | | Contract Water Treatment Business | | Total |
Revenue | $ | 469,277 |
| | $ | — |
| | $ | 469,277 |
|
Cost of sales (excluding depreciation and amortization expense) | 330,527 |
| | 72 |
| | 330,599 |
|
Selling, general and administrative | 54,118 |
| | — |
| | 54,118 |
|
Depreciation and amortization | 38,892 |
| | — |
| | 38,892 |
|
Long-lived asset impairment | 4,579 |
| | — |
| | 4,579 |
|
Restructuring charges | 4,790 |
| | — |
| | 4,790 |
|
Interest expense | 507 |
| | — |
| | 507 |
|
Equity in income of non-consolidated affiliates | (5,006 | ) | | — |
| | (5,006 | ) |
Other income, net (2) | (11,250 | ) | | — |
| | (11,250 | ) |
Income (loss) from discontinued operations before income taxes | 52,120 |
| | (72 | ) | | 52,048 |
|
Provision for (benefit from) income taxes | 18,302 |
| | (42 | ) | | 18,260 |
|
Income (loss) from discontinued operations, net of tax | $ | 33,818 |
| | $ | (30 | ) | | $ | 33,788 |
|
| |
(1) | Includes the results of operations of Exterran Corporation and costs directly attributable to the Spin-off. |
| |
(2) | Includes income from discontinued operations, net of tax, related to previously discontinued Venezuela operations of $18.7 million for the three months ended March 31, 2015. |
The following tables summarize the balance sheet data for discontinued operations (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| Exterran Corporation | | Contract Water Treatment Business | | Total | | Exterran Corporation | | Contract Water Treatment Business | | Total |
Other current assets | $ | 376 |
| | $ | — |
| | $ | 376 |
| | $ | 420 |
| | $ | — |
| | $ | 420 |
|
Total current assets associated with discontinued operations | 376 |
| | — |
| | 376 |
| | 420 |
| | — |
| | 420 |
|
Intangibles and other assets, net | 5,714 |
| | — |
| | 5,714 |
| | 5,714 |
| | — |
| | 5,714 |
|
Deferred income taxes | — |
| | 14,975 |
| | 14,975 |
| | — |
| | 15,486 |
| | 15,486 |
|
Total assets associated with discontinued operations | $ | 6,090 |
| | $ | 14,975 |
| | $ | 21,065 |
| | $ | 6,134 |
| | $ | 15,486 |
| | $ | 21,620 |
|
Deferred income taxes | $ | 212 |
| | $ | — |
| | $ | 212 |
| | $ | 420 |
| | $ | — |
| | $ | 420 |
|
Total current liabilities associated with discontinued operations | 212 |
| | — |
| | 212 |
| | 420 |
| | — |
| | 420 |
|
Deferred income taxes | 5,714 |
| | — |
| | 5,714 |
| | 5,714 |
| | — |
| | 5,714 |
|
Total liabilities associated with discontinued operations | $ | 5,926 |
| | $ | — |
| | $ | 5,926 |
| | $ | 6,134 |
| | $ | — |
| | $ | 6,134 |
|
4. Business Acquisitions
On March 1, 2016, the Partnership completed an acquisition of contract operations customer service agreements with four customers and a fleet of 19 compressor units used to provide compression services under those agreements comprising approximately 23,000 horsepower. The $18.8 million purchase price was funded with $13.8 million in borrowings under the Partnership’s revolving credit facility, a non-cash exchange of approximately 24 Partnership compressor units for $3.2 million, and the issuance of 257,000 of the Partnership’s common units for $1.8 million. In connection with this acquisition, the Partnership issued and sold to Archrock General Partner, L.P. (“GP”), our wholly-owned subsidiary and the Partnership’s general partner, 5,205 general partner units to maintain GP’s approximate 2% general partner interest in the Partnership. This acquisition by the Partnership is referred to as the “March 2016 Acquisition.” During the three months ended March 31, 2016, the Partnership incurred transaction costs of approximately $0.2 million related to the March 2016 Acquisition, which is reflected in other income, net, in our condensed consolidated statement of operations.
We accounted for the March 2016 Acquisition using the acquisition method, which requires, among other things, assets acquired to be recorded at their fair value on the acquisition date. The following table summarized the purchase price allocation based on estimated fair values of the acquired assets as of the acquisition date (in thousands):
|
| | | |
| Fair Value |
Property, plant and equipment | $ | 14,929 |
|
Intangible assets | 3,839 |
|
Purchase price | $ | 18,768 |
|
Property, Plant and Equipment and Intangible Assets Acquired
Property, plant and equipment is primarily comprised of compressor units that will be depreciated on a straight-line basis over an estimated average remaining useful life of 15 years.
The amount of finite life intangible assets, and their associated average useful lives, was determined based on the period which the assets are expected to contribute directly or indirectly to our future cash flows, and consisted of the following:
|
| | | | | |
| Amount (in thousands) | | Average Useful Life |
Customer related | $ | 3,839 |
| | 2.3 years |
The results of operations attributable to the assets acquired in the March 2016 Acquisition have been included in our condensed consolidated financial statements as part of our contract operations segment since the date of acquisition.
Pro forma financial information is not presented for the March 2016 Acquisition as it is immaterial to our reported results.
5. Inventory
Inventory consisted of the following amounts (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Parts and supplies | $ | 106,280 |
| | $ | 109,634 |
|
Work in progress | 17,214 |
| | 19,777 |
|
Inventory | $ | 123,494 |
| | $ | 129,411 |
|
As of March 31, 2016 and December 31, 2015, we had inventory reserves of $6.8 million and $9.8 million, respectively.
6. Property, Plant and Equipment, net
Property, plant and equipment, net, consisted of the following (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Compression equipment, facilities and other fleet assets | $ | 3,318,140 |
| | $ | 3,292,364 |
|
Land and buildings | 53,745 |
| | 53,175 |
|
Transportation and shop equipment | 108,751 |
| | 108,998 |
|
Other | 108,406 |
| | 109,291 |
|
Property, plant and equipment | 3,589,042 |
| | 3,563,828 |
|
Accumulated depreciation | (1,324,944 | ) | | (1,296,040 | ) |
Property, plant and equipment, net | $ | 2,264,098 |
| | $ | 2,267,788 |
|
7. Long-Term Debt
Long-term debt consisted of the following (in thousands):
|
| | | | | | | |
| March 31, 2016 | | December 31, 2015 |
Revolving credit facility due November 2020 | $ | 171,500 |
| | $ | 166,500 |
|
| | | |
Partnership’s revolving credit facility due May 2018 | 598,000 |
| | 580,500 |
|
| | | |
Partnership’s term loan facility due May 2018 | 150,000 |
| | 150,000 |
|
Less: Deferred financing costs, net of amortization | (540 | ) | | (602 | ) |
| 149,460 |
| | 149,398 |
|
| | | |
Partnership’s 6% senior notes due April 2021 | 350,000 |
| | 350,000 |
|
Less: Debt discount, net of amortization | (3,704 | ) | | (3,862 | ) |
Less: Deferred financing costs, net of amortization | (5,139 | ) | | (5,396 | ) |
| 341,157 |
| | 340,742 |
|
| | | |
Partnership’s 6% senior notes due October 2022 | 350,000 |
| | 350,000 |
|
Less: Debt discount, net of amortization | (4,526 | ) | | (4,673 | ) |
Less: Deferred financing costs, net of amortization | (5,381 | ) | | (5,585 | ) |
| 340,093 |
| | 339,742 |
|
| | | |
Long-term debt | $ | 1,600,210 |
| | $ | 1,576,882 |
|
Archrock Revolving Credit Facility
In October 2015, in connection with the Spin-off, we entered into a five-year, $350.0 million revolving credit facility (the “Credit Facility”). Our ability to borrow under the Credit Facility was subject to the satisfaction of certain conditions precedent, including (i) the payoff and termination of our former credit facility and (ii) the consummation of the Spin-off on or before January 4, 2016 (the date on which those conditions are satisfied is referred to as the “Archrock Initial Availability Date”). On November 3, 2015, we terminated our former credit facility, repaid $326.5 million in borrowings and accrued and unpaid interest outstanding on the repayment date and completed the Spin-off. Accordingly, the Archrock Initial Availability Date was November 3, 2015, and the Credit Facility will mature in November 2020. As of March 31, 2016, we had $171.5 million in outstanding borrowings and $10.0 million in outstanding letters of credit under the Credit Facility. At March 31, 2016, taking into account guarantees through letters of credit, we had undrawn and available capacity of $168.5 million under the Credit Facility.
The Partnership Revolving Credit Facility and Term Loan
In February 2015, the Partnership amended its senior secured credit agreement (the “Partnership Credit Agreement”), which among other things, increased the borrowing capacity under its revolving credit facility by $250.0 million to $900.0 million. The Partnership Credit Agreement, which matures in May 2018, also includes a $150.0 million term loan facility. During the three months ended March 31, 2015, the Partnership incurred transaction costs of $1.3 million related to the amendment of the Partnership Credit Agreement. These costs were included in intangible and other assets, net, and are being amortized to interest expense over the term of the facility. As of March 31, 2016, the Partnership had undrawn and available capacity of $302.0 million under its revolving credit facility.
Effective May 2, 2016, the Partnership amended its Partnership Credit Agreement to, among other things, decrease the borrowing capacity under its revolving credit facility by $75.0 million to $825.0 million. Prior to this amendment, the Partnership was able to increase the aggregate commitments under the Partnership Credit Agreement by up to an additional $50 million subject to certain conditions, including the approval of the lenders. As a result of this amendment and subject to certain conditions, including the approval of the lenders, the Partnership is able to increase the aggregate commitments under the Partnership Credit Agreement by up to an additional $125 million.
The Partnership Credit Agreement contains various covenants with which the Partnership must comply, including, but not limited to, restrictions on the use of proceeds from borrowings and limitations on the Partnership’s ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay dividends and distributions. The Partnership Credit Agreement also contains various covenants, which have been amended effective March 31, 2016, requiring mandatory prepayments from the net cash proceeds of certain asset transfers. In addition, if as of any date the Partnership has cash and cash equivalents (other than proceeds from a debt or equity issuance in the 30 days prior to such date reasonably expected to be used to fund an acquisition permitted under the Partnership Credit Agreement) in excess of $50.0 million, then such excess amount will be used to pay down outstanding borrowings of a corresponding amount under the revolving credit facility. The Partnership must maintain various consolidated financial ratios, including a ratio of EBITDA (as defined in the Partnership Credit Agreement) to Total Interest Expense (as defined in the Partnership Credit Agreement) of not less than 2.75 to 1.0, a ratio of Total Debt (as defined in the Partnership Credit Agreement) to EBITDA of not greater than 5.95 to 1.0 though the fourth quarter of 2017, 5.75 to 1.0 in the first quarter of 2018, and 5.25 to 1.0 (subject to a temporary increase to 5.5 to 1.0 for any quarter during which an acquisition meeting certain thresholds is completed and for the following two quarters after the acquisition closes) thereafter and a ratio of Senior Secured Debt (as defined in the Partnership Credit Agreement) to EBITDA of not greater than 3.50 to 1.0 through the fourth quarter of 2017, 3.75 to 1.0 in the first quarter of 2018 and 4.0 to 1.0 thereafter. A material adverse effect with respect to the Partnership’s assets, liabilities, financial condition, business or operations that, taken as a whole, impacts the Partnership’s ability to perform its obligations under the Partnership Credit Agreement, could lead to a default under that agreement. As of March 31, 2016, the Partnership was in compliance with all financial covenants under the Partnership Credit Agreement.
8. Accounting for Derivatives
We are exposed to market risks associated with changes in interest rates. We use derivative financial instruments to minimize the risks and/or costs associated with financial activities by managing our exposure to interest rate fluctuations on a portion of our debt obligations. We do not use derivative financial instruments for trading or other speculative purposes.
Interest Rate Risk
At March 31, 2016, the Partnership was a party to the following interest rate swaps, which were entered into to offset changes in expected cash flows due to fluctuations in the associated variable interest rates:
|
| | | | |
Expiration Date | | Notional Value (in millions) |
May 2018 | | $ | 300 |
|
May 2019 | | 100 |
|
May 2020 | | 100 |
|
| | $ | 500 |
|
As of March 31, 2016, the weighted average effective fixed interest rate on the interest rate swaps was 1.6%. We have designated these interest rate swaps as cash flow hedging instruments so that any change in their fair values is recognized as a component of comprehensive income (loss) and is included in accumulated other comprehensive income (loss) to the extent the hedge is effective. As the swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate, we currently do not expect a significant amount of ineffectiveness on these hedges. We perform quarterly calculations to determine whether the swap agreements are still effective and to calculate any ineffectiveness. We recorded an immaterial amount of interest expense during the three months ended March 31, 2016 as compared to $0.3 million of interest income during the three months ended March 31, 2015 due to ineffectiveness related to interest rate swaps. We estimate that $4.2 million of deferred pre-tax losses attributable to interest rate swaps and included in our accumulated other comprehensive income (loss) at March 31, 2016, will be reclassified into earnings as interest expense at then current values during the next twelve months as the underlying hedged transactions occur. Cash flows from derivatives designated as hedges are classified in our condensed consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions, unless the derivative contract contains a significant financing element; in this case, the cash settlements for these derivatives are classified as cash flows from financing activities in our condensed consolidated statements of cash flows.
The following tables present the effect of derivative instruments on our consolidated financial position and results of operations (in thousands):
|
| | | | | | | | |
| | March 31, 2016 | | December 31, 2015 |
| Balance Sheet Location | Fair Value Asset (Liability) | | Fair Value Asset (Liability) |
Derivatives designated as hedging instruments: | | |
| | |
Interest rate swaps | Intangible and other assets, net | $ | — |
| | $ | 45 |
|
Interest rate swaps | Accrued liabilities | (4,949 | ) | | (4,608 | ) |
Interest rate swaps | Other long-term liabilities | (5,470 | ) | | (1,421 | ) |
Total derivatives | | $ | (10,419 | ) | | $ | (5,984 | ) |
|
| | | | | | | | | |
| Pre-tax Loss Recognized in Other Comprehensive Income (Loss) on Derivatives | | Location of Pre-tax Loss Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss) | | Pre-tax Loss Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss) |
Derivatives designated as cash flow hedges: | |
| | | | |
|
Interest rate swaps | |
| | | | |
|
Three months ended March 31, 2016 | $ | (5,932 | ) | | Interest expense | | $ | (1,116 | ) |
Three months ended March 31, 2015 | (6,253 | ) | | Interest expense | | (1,675 | ) |
The counterparties to the derivative agreements are major international financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us. The Partnership has no specific collateral posted for its derivative instruments. The counterparties to the interest rate swaps are also lenders under the Partnership’s senior secured credit facility and, in that capacity, share proportionally in the collateral pledged under the related facility.
9. Fair Value Measurements
The accounting standard for fair value measurements and disclosures establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three broad categories:
| |
• | Level 1 — Quoted unadjusted prices for identical instruments in active markets to which we have access at the date of measurement. |
| |
• | Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 inputs are those in markets for which there are few transactions, the prices are not current, little public information exists or prices vary substantially over time or among brokered market makers. |
| |
• | Level 3 — Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are those inputs that reflect our own assumptions regarding how market participants would price the asset or liability based on the best available information. |
The following table presents our assets and liabilities measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015, with pricing levels as of the date of valuation (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 |
Interest rate swaps asset | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 45 |
| | $ | — |
|
Interest rate swaps liability | — |
| | (10,419 | ) | | — |
| | — |
| | (6,029 | ) | | — |
|
Our interest rate swaps are recorded at fair value utilizing a combination of the market approach and income approach to estimate fair value based on forward LIBOR curves.
The following table presents our assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2016 and December 31, 2015, with pricing levels as of the date of valuation (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2016 | | December 31, 2015 |
| Level 1 | | Level 2 | | Level 3 | | Level 1 | | Level 2 | | Level 3 |
Impaired long-lived assets | $ | — |
| | $ | — |
| | $ | 487 |
| | $ | — |
| | $ | — |
| | $ | 12,565 |
|
Our estimate of the impaired long-lived assets’ fair value was primarily based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. We discounted the expected proceeds, net of selling and other carrying costs, using a weighted average disposal period of four years.
10. Long-Lived Asset Impairment
We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances, including the removal of compressor units from our active fleet, indicate that the carrying amount of an asset may not be recoverable.
During the three months ended March 31, 2016, we reviewed the future deployment of our idle compression assets used in our contract operations segment for units that were not of the type, configuration, condition, make or model that are cost-efficient to maintain and operate. Based on this review, we determined that approximately 80 idle compressor units totaling approximately 33,000 horsepower would be retired from the active fleet during the three months ended March 31, 2016. The retirement of these units from the active fleet triggered a review of these assets for impairment. As a result, we recorded a $9.9 million asset impairment to reduce the book value of each unit to its estimated fair value during the three months ended March 31, 2016. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use.
During the three months ended March 31, 2015, we reviewed the future deployment of our idle compression assets used in our contract operations segment for units that were not of the type, configuration, condition, make or model that are cost-efficient to maintain and operate. Based on this review, we determined that approximately 70 idle compressor units representing approximately 23,000 horsepower would be retired from the active fleet during the three months ended March 31, 2015. The retirement of these units from the active fleet triggered a review of these assets for impairment. As a result, we recorded an $8.2 million asset impairment to reduce the book value of each unit to its estimated fair value during the three months ended March 31, 2015. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use.
11. Restructuring and Other Charges
In the first quarter of 2016, we determined to undertake a cost reduction program to reduce our on-going operating expenses, including workforce reductions and closure of certain make-ready shops. These actions are a result of our review of our businesses and efforts to efficiently manage cost and maintain our businesses in line with current and expected activity levels and anticipated make-ready demand in the U.S. market. During the three months ended March 31, 2016, we incurred $7.0 million of restructuring and other charges as a result of this plan primarily related to severance benefits and consulting fees.
The following table presents the expense incurred under this plan by reportable segment (in thousands):
|
| | | | | | | | | | | | | | | |
| Contract Operations | | Aftermarket Services | | Other (1) | | Total |
Three months ended March 31, 2016 | $ | 2,241 |
| | $ | 369 |
| | $ | 4,391 |
| | $ | 7,001 |
|
Estimated additional charges | 1,183 |
| | 744 |
| | 4,400 |
| | 6,327 |
|
| |
(1) | Represents expense incurred under this plan that is not directly attributable to our reportable segments because it represents severance benefits and consulting fees incurred within the corporate function. |
These charges are reflected as restructuring and other charges in our condensed consolidated statement of operations. As of March 31, 2016, we had an accrued liability of $2.5 million primarily related to severance benefits incurred. We expect to incur an additional $6.3 million through the remainder of 2016 related to consulting fees and severance benefits related to our corporate function.
As discussed in Note 3 (“Discontinued Operations”), we completed the Spin-off of Exterran Corporation on November 3, 2015. During the three months ended March 31, 2016, we incurred $1.1 million of costs associated with the Spin-off that were directly attributable to Archrock and are summarized below. The restructuring charges associated with the Spin-off are not directly attributable to our reportable segments because they primarily represent costs incurred within the corporate function. As of March 31, 2016, we had an accrued liability of $0.6 million primarily related to retention benefits incurred. We expect to incur an additional $2.1 million for the remainder of 2016 and $1.5 million in 2017 related to retention payments.
The following table summarizes the changes to our accrued liability balance related to restructuring and other charges for the three months ended March 31, 2016 (in thousands):
|
| | | | | | | | | | | |
| Spin-off | | Cost Reduction Plan | | Total |
Beginning balance at January 1, 2016 | $ | 855 |
| | $ | — |
| | $ | 855 |
|
Additions for costs expensed | 1,064 |
| | 7,001 |
| | 8,065 |
|
Less non-cash expense (1) | (330 | ) | | — |
| | (330 | ) |
Reductions for payments | (1,005 | ) | | (4,496 | ) | | (5,501 | ) |
Ending balance at March 31, 2016 | $ | 584 |
| | $ | 2,505 |
| | $ | 3,089 |
|
| |
(1) | Represents non-cash retention benefits associated with the Spin-off to be settled in Archrock stock. |
The following table summarizes the components of charges included in restructuring and other charges in our condensed consolidated statements of operations for the three months ended March 31, 2016 and 2015 (in thousands):
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Retention and severance benefits | $ | 5,324 |
| | $ | — |
|
Consulting services | 2,741 |
| | — |
|
Total restructuring and other charges | $ | 8,065 |
| | $ | — |
|
12. Stock-Based Compensation
Stock Incentive Plan
In April 2013, we adopted the Archrock, Inc. 2013 Stock Incentive Plan (the “2013 Plan”) to provide for the granting of stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, other stock-based awards and dividend equivalent rights to employees, directors and consultants of Archrock. Under the 2013 Plan, the maximum number of shares of common stock available for issuance pursuant to awards is 10,100,000. Each option and stock appreciation right granted counts as one share against the aggregate share limit, and any share subject to a stock settled award other than a stock option, stock appreciation right or other award for which the recipient pays intrinsic value counts as 1.75 shares against the aggregate share limit. Shares subject to awards granted under the 2013 Plan that are subsequently canceled, terminated, settled in cash or forfeited (excluding shares withheld to satisfy tax withholding obligations to or pay the exercise price of an option) are, to the extent of such cancelation, termination, settlement or forfeiture, available for future grant under the 2013 Plan. Cash settled awards are not counted against the aggregate share limit. No additional grants may be made under the Archrock, Inc. 2007 Amended and Restated Stock Incentive Plan (the “2007 Plan”). Previous grants made under the 2007 Plan will continue to be governed by that plan.
Exterran Corporation Spin-off Adjustments
In connection with the Spin-off of Exterran Corporation, stock options, restricted stock, restricted stock units and performance unit awards were adjusted in accordance with anti-dilution provisions under the existing plans. As such, we did not record any additional compensation expense related to the adjustment of the awards. The awards were generally adjusted as follows:
| |
• | Pre-2015 Awards. Immediately prior to the Spin-off, each outstanding Exterran Holdings, Inc. (“Exterran Holdings”) stock option, restricted stock, restricted stock unit and performance unit granted prior to January 1, 2015, whether vested or unvested, was split into two awards, consisting of an Archrock award and an Exterran Corporation award. However, Exterran Holdings “incentive stock options” (within the meaning of Section 422 of the Code) were converted solely, into options denominated in shares of common stock of the applicable holder’s post-spin employer if the holder of the award elected, prior to the Spin-off, to preserve the tax treatment of such option. |
| |
• | 2015 Awards. Each Exterran Holdings stock option, restricted stock award, restricted stock unit award and performance unit award that was (i) granted in calendar year 2015 and (ii) held by an individual who became our employee or is engaged to provide service to us following the Spin-off was converted solely into an Archrock award. We did not grant any stock options in the calendar year 2015 prior to the Spin-off. |
Equity awards that were adjusted as described above generally remain subject to the same vesting, expiration, performance conditions and other terms and conditions as applied to the awards immediately prior to the Spin-off.
Stock Options
Stock options are granted at fair market value at the grant date, are exercisable according to the vesting schedule established by the compensation committee of our board of directors in its sole discretion and expire no later than seven years after the grant date. Stock options generally vest one-third per year on each of the first three anniversaries of the grant date, subject to continued services through the applicable vesting date.
The following table presents stock option activity during the three months ended March 31, 2016:
|
| | | | | | | | | | | | |
| Stock Options (in thousands) | | Weighted Average Exercise Price Per Share | | Weighted Average Remaining Life (in years) | | Aggregate Intrinsic Value (in thousands) |
Options outstanding, January 1, 2016 | 1,247 |
| | $ | 18.28 |
| | | | |
|
Granted | — |
| | — |
| | | | |
|
Cancelled | (331 | ) | | 22.89 |
| | | | |
|
Options outstanding, March 31, 2016 | 916 |
| | 16.61 |
| | 2.3 | | $ | 384 |
|
Options exercisable, March 31, 2016 | 884 |
| | 16.30 |
| | 2.2 | | 384 |
|
Intrinsic value is the difference between the market value of our stock and the exercise price of each stock option multiplied by the number of stock options outstanding for those stock options where the market value exceeds their exercise price. As of March 31, 2016, we expect $0.3 million of unrecognized compensation cost related to unvested stock options to be recognized over the weighted-average period of 0.9 years.
Restricted Stock, Stock-Settled Restricted Stock Units, Performance Units, Cash-Settled Restricted Stock Units and Cash Settled Performance Units
For grants of restricted stock, restricted stock units and performance units, we recognize compensation expense over the vesting period equal to the fair value of our common stock at the grant date. Our restricted stock and certain of our stock-settled restricted stock units and performance units include rights to receive dividends or dividend equivalents. We remeasure the fair value of cash-settled restricted stock units and cash-settled performance units and record a cumulative adjustment of the expense previously recognized. Our obligation related to the cash-settled restricted stock units and cash settled performance units is reflected as a liability in our condensed consolidated balance sheets. Restricted stock, stock-settled restricted stock units, performance units, cash-settled restricted stock units and performance units generally vest one-third per year on each of the first three anniversaries of the grant date, subject to continued services through the applicable vesting date.
The following table presents restricted stock, restricted stock unit, performance unit, cash settled restricted stock unit and cash settled performance unit activity during the three months ended March 31, 2016:
|
| | | | | | |
| Shares (in thousands) | | Weighted Average Grant-Date Fair Value Per Share |
Non-vested awards, January 1, 2016 | 1,155 |
| | $ | 18.50 |
|
Granted | 1,357 |
| | 6.09 |
|
Vested | (596 | ) | | 16.39 |
|
Cancelled | (11 | ) | | 21.48 |
|
Non-vested awards, March 31, 2016 (1) | 1,905 |
| | 10.30 |
|
| |
(1) | Non-vested awards as of March 31, 2016 are comprised of 270,000 cash-settled restricted stock units and cash-settled performance units and 1,635,000 restricted shares and stock-settled restricted stock units. |
As of March 31, 2016, we expect $16.5 million of unrecognized compensation cost related to unvested restricted stock, stock-settled restricted stock units, performance units, cash-settled restricted stock units and cash-settled performance units to be recognized over the weighted-average period of 2.2 years.
Partnership Long-Term Incentive Plan
The Partnership’s Long-Term Incentive Plan (the “Partnership Plan”) was adopted in October 2006 for the benefit of the employees, directors and consultants of the Partnership, us and our respective affiliates. A maximum of 1,035,378 common units, common unit options, restricted units and phantom units are available under the Partnership Plan. The Partnership Plan is administered by the board of directors of Archrock GP LLC, the general partner of the Partnership’s general partner, or a committee thereof (the “Partnership Plan Administrator”).
Phantom units are notional units that entitle the grantee to receive common units upon the vesting of such phantom units or, at the discretion of the Partnership Plan Administrator, cash equal to the fair market value of such common units. Phantom units granted under the Partnership Plan may include nonforfeitable tandem distribution equivalent rights to receive cash distributions on unvested phantom units in the quarter in which distributions are paid on common units. Phantom units generally vest one-third per year on each of the first three anniversaries of the grant date, subject to continued service through the applicable vesting date.
Partnership Phantom Units
The following table presents phantom unit activity during the three months ended March 31, 2016:
|
| | | | | | |
| Phantom Units (in thousands) | | Weighted Average Grant-Date Fair Value per Unit |
Phantom units outstanding, January 1, 2016 | 77 |
| | $ | 27.01 |
|
Granted | 190 |
| | 7.84 |
|
Vested | (68 | ) | | 18.59 |
|
Phantom units outstanding, March 31, 2016 | 199 |
| | 11.58 |
|
As of March 31, 2016, we expect $2.2 million of unrecognized compensation cost related to unvested phantom units to be recognized over the weighted-average period of 2.3 years.
13. Cash Dividends
The following table summarizes our dividends per common share:
|
| | | | | | | | | | |
Declaration Date | | Payment Date | | Dividends per Common Share | | Total Dividends |
January 30, 2015 | | February 17, 2015 | | $ | 0.1500 |
| | $ | 10.3 | million |
April 28, 2015 | | May 18, 2015 | | 0.1500 |
| | 10.4 | million |
July 30, 2015 | | August 17, 2015 | | 0.1500 |
| | 10.5 | million |
October 18, 2015 | | October 30, 2015 | | 0.1500 |
| | 10.4 | million |
January 26, 2016 | | February 16, 2016 | | 0.1875 |
| | 13.1 | million |
On May 2, 2016, our board of directors declared a quarterly dividend of $0.095 per share of common stock, paid on May 18, 2016 to stockholders of record at the close of business on May 12, 2016. Any future determinations to pay cash dividends to our stockholders will be at the discretion of our board of directors and will be dependent upon our financial condition and results of operations, credit and loan agreements in effect at that time and other factors deemed relevant by our board of directors.
14. Commitments and Contingencies
We have issued the following guarantees that are not recorded on our condensed consolidated balance sheet (dollars in thousands):
|
| | | | | |
| Term | | Maximum Potential Undiscounted Payments as of March 31, 2016 |
Standby letters of credit | 2016 | | $ | 9,969 |
|
Performance bonds (1) | 2016 | | 1,230 |
|
Maximum potential undiscounted payments | | | $ | 11,199 |
|
| |
(1) | We have issued guarantees to third parties to ensure performance of our obligations, some of which may be fulfilled by third parties. |
We are subject to a number of state and local taxes that are not income-based. As many of these taxes are subject to audit by the taxing authorities, it is possible that an audit could result in additional taxes due. We accrue for such additional taxes when we determine that it is probable that we have incurred a liability and we can reasonably estimate the amount of the liability. As of March 31, 2016 and December 31, 2015, we had accrued $2.5 million and $2.7 million, respectively, for the outcomes of non-income based tax audits. We do not expect that the ultimate resolutions of these audits will result in a material variance from the amounts accrued. We do not accrue for unasserted claims for tax audits unless we believe the assertion of a claim is probable, it is probable that it will be determined that the claim is owed and we can reasonably estimate the claim or range of the claim. We also believe the likelihood is remote that the impact of potential unasserted claims from non-income based tax audits could be material to our consolidated financial position, but it is possible that the resolution of future audits could be material to our consolidated results of operations or cash flows for the period in which the resolution occurs.
Subject to the provisions of the tax matters agreement between Exterran Corporation and us, both parties agreed to indemnify the primary obligor of any return for tax periods beginning before and ending before or after the Spin-off (including any ongoing or future amendments and audits for these returns) for the portion of the tax liability (including interest and penalties) that relates to their respective operations reported in the filing. As of March 31, 2016 and December 31, 2015, we recorded a $1.5 million indemnification liability (including penalties and interest) related to non-income based tax audits.
Our business can be hazardous, involving unforeseen circumstances such as uncontrollable flows of natural gas or well fluids and fires or explosions. As is customary in our industry, we review our safety equipment and procedures and carry insurance against some, but not all, risks of our business. Our insurance coverage includes property damage, general liability and commercial automobile liability and other coverage we believe is appropriate. In addition, we have a minimal amount of insurance on our offshore assets. We believe that our insurance coverage is customary for the industry and adequate for our business; however, losses and liabilities not covered by insurance would increase our costs.
Additionally, we are substantially self-insured for workers’ compensation and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to the deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages.
Indemnification Obligations
On November 3, 2015, we completed the Spin-off of our international contract operations, international aftermarket services and global fabrication businesses into a separate, publicly traded company operating as Exterran Corporation. In connection with the Spin-off, we entered into a separation and distribution agreement, which provides for cross-indemnities between Exterran Corporation’s operating subsidiary and us and established procedures for handling claims subject to indemnification and related matters. Generally, the separation and distribution agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of Exterran Corporation’s business with Exterran Corporation. Pursuant to the separation and distribution agreement, we and Exterran Corporation will generally release the other party from all claims arising prior to the Spin-off that relate to the other party’s business.
Litigation and Claims
In 2011, the Texas Legislature enacted changes related to the appraisal of natural gas compressors for ad valorem tax purposes by expanding the definitions of “Heavy Equipment Dealer” and “Heavy Equipment” effective from the beginning of 2012 (the “Heavy Equipment Statutes”). Under the revised statutes, we believe we are a Heavy Equipment Dealer, that our natural gas compressors are Heavy Equipment and that we, therefore, are required to file our ad valorem taxes under this new methodology. We further believe that our natural gas compressors are taxable under the Heavy Equipment Statutes in the counties where we maintain a business location and keep natural gas compressors instead of where the compressors may be located on January 1 of a tax year. As a result of this new methodology, our ad valorem tax expense (which is reflected in our condensed consolidated statements of operations as a component of cost of sales (excluding depreciation and amortization expense)) includes a benefit of $4.3 million during the three months ended March 31, 2016. Since the change in methodology became effective in 2012, we have recorded an aggregate benefit of $48.3 million as of March 31, 2016, of which approximately $10.2 million has been agreed to by a number of appraisal review boards and county appraisal districts and $38.1 million has been disputed and is currently in litigation. A large number of appraisal review boards denied our position, although some accepted it, and our wholly-owned subsidiary, Archrock Services Leasing LLC, formerly known as EES Leasing LLC (“EES Leasing”), and Archrock Partners’ subsidiary, Archrock Partners Leasing LLC, formerly known as EXLP Leasing LLC (“EXLP Leasing”) filed 176 petitions for review in the appropriate district courts with respect to the 2012 tax year, 109 petitions for review in the appropriate district courts with respect to the 2013 tax year, 115 petitions for review in the appropriate district courts with respect to the 2014 tax year and 119 petitions for review in the appropriate district courts with respect to the 2015 tax year.
As of March 31, 2016, only five cases have advanced to the point of trial or submission of summary judgment motions on the merits, and only three cases have been decided, with two of the decisions having been rendered by the same presiding judge. All three of those decisions were appealed, and all three of the appeals have been decided by intermediate appellate courts.
On October 17, 2013, the 143rd Judicial District Court of Loving County, Texas ruled in EXLP Leasing LLC & EES Leasing LLC v. Loving County Appraisal District that EES Leasing and EXLP Leasing are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment, but the district court further held that the Heavy Equipment Statutes were unconstitutional as applied to EES Leasing’s and EXLP Leasing’s compressors. EES Leasing and EXLP Leasing appealed the district court’s constitutionality holding to the Eighth Court of Appeals in El Paso, Texas. On September 23, 2015, the Eighth Court of Appeals ruled in EES Leasing’s and EXLP Leasing’s favor by overruling the 143rd District Court’s constitutionality ruling. The Eighth Court of Appeals also ruled, however, that EES Leasing’s and EXLP Leasing’s natural gas compressors are taxable in the counties where they were located on January 1 of the tax year at issue.
On October 28, 2013, the 143rd Judicial District Court of Ward County, Texas ruled in EES Leasing LLC & EXLP Leasing LLC v. Ward County Appraisal District that EES Leasing and EXLP Leasing are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment, but the court held that the Heavy Equipment Statutes were unconstitutional as applied to their compressors. EES Leasing and EXLP Leasing appealed the district court’s constitutionality holding to the Eighth Court of Appeals in El Paso, Texas, and the Ward County Appraisal District cross-appealed the district court’s rulings that EES Leasing’s and EXLP Leasing’s compressors qualify as Heavy Equipment. On September 23, 2015, the Eighth Court of Appeals ruled in EES Leasing’s and EXLP Leasing’s favor by overruling the 143rd District Court’s constitutionality ruling and affirming its ruling that EES Leasing’s and EXLP Leasing’s compressors qualify as Heavy Equipment. The Eighth Court of Appeals also ruled, however, that EES Leasing’s and EXLP Leasing’s natural gas compressors are taxable in the counties where they were located on January 1 of the tax year at issue. The Ward County Appraisal District and Loving County Appraisal District each filed (on January 27, 2016 and February 10, 2016, respectively) a petition asking the Texas Supreme Court to review its respective Eighth Court of Appeals decision. On March 11, 2016, EES Leasing and EXLP Leasing filed responses to the appraisal districts’ petitions and cross-petitions for review in each case asking the Texas Supreme Court to also review the Eighth Court of Appeals’ determination that natural gas compressors are taxable in the counties where they were located on January 1 of the tax year at issue.
On March 18, 2014, the 10th Judicial District Court of Galveston, Texas ruled in EXLP Leasing LLC & EES Leasing LLC v. Galveston Central Appraisal District that EES Leasing and EXLP Leasing are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment, but the court held the Heavy Equipment Statutes unconstitutional as applied to their compressors. EES Leasing and EXLP Leasing appealed the district court’s constitutionality holding to the Fourteenth Court of Appeals in Houston, Texas. On August 25, 2015, the Fourteenth Court of Appeals issued a ruling stating that EES Leasing’s and EXLP Leasing’s compressors are taxable in the counties where they were located on January 1 of the tax year at issue, and it remanded the case to the district court for further evidence on the issue of whether the Heavy Equipment Statutes are constitutional as applied to EES Leasing’s and EXLP Leasing’s compressors. On November 24, 2015, EES Leasing and EXLP Leasing filed a petition asking the Texas Supreme Court to review this decision. On March 21, 2016, the Galveston Central Appraisal District filed a response to EES Leasing’s and EXLP Leasing’s petition for review, and EES Leasing and EXLP Leasing filed their reply on April 26, 2016.
In EES Leasing v. Irion County Appraisal District, EES Leasing and the appraisal district each filed motions for summary judgment in the 51st Judicial District Court of Irion County, Texas concerning the applicability and constitutionality of the Heavy Equipment Statutes. On May 20, 2014, the district court entered an order denying both motions for summary judgment, holding that a fact issue existed as to the applicability of the Heavy Equipment Statutes to the one compressor at issue. The presiding judge for the 51st District Court has since consolidated the 2012 tax year case with EES Leasing’s 2013 tax year case, which also included EXLP Leasing as a party. On August 27, 2015, the presiding judge abated the combined case, EES Leasing LLC and EXLP Leasing LLC v. Irion County Appraisal District, until the final resolution of the appellate cases considering the constitutionality of the Heavy Equipment Statutes, or further order of the court.
EES Leasing and EXLP Leasing also filed a motion for summary judgment in EES Leasing LLC & EXLP Leasing LLC v. Harris County Appraisal District, pending in the 189th Judicial District Court of Harris County, Texas. The court heard arguments on the motion on December 6, 2013 but has yet to rule. No trial date has been set.
On June 3, 2015, the Fourth Court of Appeals in San Antonio, Texas issued a decision reversing the 406th District Court’s dismissal of EES Leasing’s and EXLP Leasing’s tax appeals for want of jurisdiction. In EXLP Leasing LLC et. al v. Webb County Appraisal District, United Independent School District (“United ISD”) intervened as a party in interest and sought to dismiss the lawsuit arguing that the district court was without jurisdiction to hear the appeal. Under Section 42.08(b) of the Texas Tax Code, a property owner must pay before the delinquency date the lesser of (1) the amount of taxes due on the portion
of the taxable value of the property that is not in dispute or (2) the amount of taxes due on the property under the order from which the appeal is taken. EES Leasing and EXLP Leasing paid zero taxes to Webb County because the entire amount of tax assessed by Webb County was in dispute. Instead, as required by the Heavy Equipment Statutes and Texas Comptroller forms, EES Leasing and EXLP Leasing paid taxes on the compressors at issue to Victoria County, where they maintain their place of business and keep natural gas compressors. The Webb County Appraisal District and United ISD contested EES Leasing’s and EXLP Leasing’s position that the Heavy Equipment Statutes contain situs provisions requiring that taxes be paid where the dealer has a business location and keeps its natural gas compressors, instead arguing that taxes are payable to the county where each compressor is located as of January 1 of the tax year at issue. The district court granted United ISD’s motion to dismiss on April 1, 2014 and declined EES Leasing’s and EXLP Leasing’s motion to reconsider. The Fourth Court of Appeals reversed, holding that, based on the plain meaning of Section 42.08(b)(1), and because the entire amount was in dispute, ESS Leasing and EXLP Leasing were not required to prepay disputed taxes to invoke the trial court’s jurisdiction. The Fourth Court of Appeals denied United ISD’s request for a rehearing. On September 29, 2015, United ISD filed a petition for review in the Texas Supreme Court. On December 4, 2015, the Texas Supreme Court denied United ISD’s petition for review.
United ISD has four delinquency lawsuits pending against EES Leasing and EXLP Leasing in the 49th District Court of Webb County, Texas. The cases have been abated pending the resolution of EES Leasing’s and EXLP Leasing’s 2012 tax year case pending in the 406th Judicial District Court of Webb County, Texas.
We continue to believe that the revised statutes are constitutional as applied to natural gas compressors and that under the revised statutes our natural gas compressors are taxable in the counties where we maintain a business location and keep natural gas compressors. Recognizing the similarity of the issues and that these cases will ultimately be resolved by the Texas appellate courts, most of the remaining 2012-2016 district court cases have been formally or effectively abated pending a decision from the Texas Supreme Court.
If our appeals are ultimately unsuccessful, or if the Texas Supreme Court determines to review the matter and rules against us, we would be required to pay ad valorem taxes up to the aggregate benefit we have recorded, and the additional ad valorem tax payments may also be subject to substantial penalties and interest. In addition, while we do not expect the ultimate determination of the issue of where the natural gas compressors are taxable under the Heavy Equipment Statutes would have an impact on the amount of taxes due, we could be subject to substantial penalties if we are unsuccessful on this issue. Also, if we are unsuccessful in our litigation with the appraisal districts, or if legislation is enacted in Texas that repeals or alters the Heavy Equipment Statutes such that in the future we do not qualify as a Heavy Equipment Dealer or our compressors do not qualify as Heavy Equipment, then we would likely be required to pay these ad valorem taxes under the old methodology going forward, which would increase our quarterly cost of sales expense up to approximately the amount of our then most recent quarterly benefit recorded. If this litigation is resolved against us in whole or in part, or if in the future we do not qualify as a Heavy Equipment Dealer or our compressors do not qualify as Heavy Equipment because of new or revised Texas statutes, we will incur additional taxes and could be subject to substantial penalties and interest, which would impact our future results of operations, financial condition and cash flows and also our ability to pay dividends in the future.
In the ordinary course of business, we are also involved in various other pending or threatened legal actions. While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from any of these other actions will not have a material adverse effect on our condensed consolidated financial position, results of operations or cash flows. However, because of the inherent uncertainty of litigation and arbitration proceedings, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
In addition, Exterran Corporation’s Form 10-K/A discloses that it has been cooperating with the SEC in an investigation, including responding to a subpoena for documents related to its restatement described in Note 17 (“Restatement of Previously Reported Consolidated Financial Statements”) and compliance with the U.S. Foreign Corrupt Practices Act, which are also being provided to the Department of Justice at its request. Archrock has been assisting Exterran Corporation in responding to this investigation, including providing information regarding periods prior to the Spin-off that is not otherwise in Exterran Corporation’s possession.
15. Reportable Segments
We manage our business segments primarily based upon the type of product or service provided. We have two reportable segments which we operate within the U.S.: contract operations and aftermarket services. The contract operations segment primarily provides natural gas compression services to meet specific customer requirements. The aftermarket services segment provides a full range of services to support the compression needs of customers, from part sales and normal maintenance services to full operation of a customer’s owned assets.
We evaluate the performance of our segments based on gross margin for each segment. Revenue includes only sales to external customers.
The following table presents revenue and other financial information by reportable segment during the three months ended March 31, 2016 and 2015 (in thousands):
|
| | | | | | | | | | | |
Three Months Ended | Contract Operations | | Aftermarket Services | | Reportable Segments Total |
March 31, 2016: | |
| | |
| | |
|
Revenue from external customers | $ | 176,239 |
| | $ | 37,056 |
| | $ | 213,295 |
|
Gross margin | 108,060 |
| | 6,694 |
| | 114,754 |
|
March 31, 2015: | |
| | |
| | |
|
Revenue from external customers | $ | 202,261 |
| | $ | 50,612 |
| | $ | 252,873 |
|
Gross margin | 119,582 |
| | 9,835 |
| | 129,417 |
|
The following table reconciles total gross margin to income (loss) before income taxes (in thousands):
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Total gross margin | $ | 114,754 |
| | $ | 129,417 |
|
Less: | | | |
Selling, general and administrative | 34,651 |
| | 32,568 |
|
Depreciation and amortization | 53,927 |
| | 57,013 |
|
Long-lived asset impairment | 9,860 |
| | 8,153 |
|
Restructuring and other charges | 8,065 |
| | — |
|
Interest expense | 20,300 |
| | 26,791 |
|
Other income, net | (1,989 | ) | | (550 | ) |
Income (loss) before income taxes | $ | (10,060 | ) | | $ | 5,442 |
|
16. Transactions Related to the Partnership
At March 31, 2016, Archrock owned an approximately 40% interest in the Partnership. As of March 31, 2016, the Partnership’s fleet included 6,393 compressor units comprising approximately 3.3 million horsepower, or 82% of our and the Partnership’s combined total U.S. horsepower.
The liabilities recognized as a result of consolidating the Partnership do not necessarily represent additional claims on the general assets of Archrock outside of the Partnership; rather, they represent claims against the specific assets of the consolidated Partnership. Conversely, assets recognized as a result of consolidating the Partnership do not necessarily represent additional assets that could be used to satisfy claims against Archrock’s general assets. There are no restrictions on the Partnership’s assets that are reported in Archrock’s general assets.
On March 1, 2016, the Partnership completed the March 2016 Acquisition. A portion of the $18.8 million purchase price was funded through the issuance of 257,000 of the Partnership’s common units for $1.8 million. In connection with this acquisition, the Partnership issued and sold to Archrock General Partner, L.P. (“GP”), our wholly-owned subsidiary and the Partnership’s general partner, 5,205 general partner units to maintain GP’s approximate 2% general partner interest in the Partnership. See Note 4 (“Business Acquisitions”) for additional information. As a result, adjustments were made to noncontrolling interest, accumulated other comprehensive income (loss), deferred income taxes and additional paid-in capital to reflect our new ownership percentage in the Partnership.
The following table presents the effects of changes from net income attributable to Archrock stockholders and changes in our equity interest of the Partnership on our equity attributable to Archrock stockholders (in thousands):
|
| | | | | | | |
| Three Months Ended March 31, |
| 2016 | | 2015 |
Net income (loss) attributable to Archrock stockholders | $ | (1,819 | ) | | $ | 31,027 |
|
Increase in Archrock stockholders’ additional paid-in capital for change in ownership of Partnership units | 600 |
| | — |
|
Change from net income (loss) attributable to Archrock stockholders and transfers to/from the noncontrolling interest | $ | (1,219 | ) | | $ | 31,027 |
|
17. Restatement of Previously Reported Consolidated Financial Statements
On November 3, 2015, we completed the Spin-off of our international contract operations, international aftermarket services and global fabrication businesses into a standalone public company operating as Exterran Corporation. Since the completion of the Spin-off, Archrock and Exterran Corporation have been independent, publicly traded companies.
Subsequent to the filing of our Annual Report on Form 10-K for the year ended December 31, 2015, originally filed with the SEC on February 29, 2016, we were notified that senior management of Exterran Corporation identified errors relating to the application of percentage-of-completion accounting principles to certain engineering, procurement and construction (“EPC”) projects in the Middle East by its Belleli subsidiary. As a result of an internal investigation, Exterran Corporation’s management identified inaccuracies related to Belleli EPC projects in estimating the total costs required to complete projects, estimating penalties for liquidated damages and cost of sales amounts charged to projects impacting the years ended December 31, 2015, 2014 and 2013 (including the unaudited quarterly periods within 2015 and 2014). Additionally, prior period errors were separately identified related to the miscalculation and recovery of non-income-based tax receivables owed to Exterran Corporation from the Brazilian government as of December 31, 2011.
Along with restating its financial statements to correct the errors discussed above, Exterran Corporation recorded adjustments for certain immaterial accounting errors related to the periods covered in its Form 10-K/A amending its Annual Report on Form 10-K for the year ended December 31, 2015.
Our management and the Audit Committee of our Board of Directors conducted a review of the errors and inaccuracies that were identified by Exterran Corporation in order to determine the impacts of such matters on our pre-Spin-off historical financial statements. None of the errors and inaccuracies identified relate to our ongoing operations. The international contract operations, international aftermarket services and global fabrication results of operations have been reported as discontinued operations, net of tax, in our consolidated statement of operations for all periods presented and were previously included in the international contract operations segment, aftermarket services segment and fabrication segment prior to the Spin-off. Subsequent to the Spin-off, we no longer operate in the international contract operations, international aftermarket services or fabrication businesses.
Our consolidated financial statements as of and for the year ended December 31, 2015 and related financial information have been restated to reflect the adjustments described above. The restatement has been set forth in its entirety in our 2015 Form 10-K/A which we have filed with the SEC concurrently with this Form 10-Q. As a result of the errors and inaccuracies related to Belleli EPC projects, as described above, our net income was overstated by $1.1 million during the three months ended March 31, 2015.
We delayed the filing of this Quarterly Report on Form 10-Q pending the completion of our review of the errors and inaccuracies described above, including the completion of the restatement, and after considering conclusions reached by Exterran Corporation described above.
The tables below summarize the effects of the restatement on our (i) balance sheet at December 31, 2015 and January 1, 2016, (ii) statement of operations for the three months ended March 31, 2015, (iii) statement of comprehensive income for the three months ended March 31, 2015, (iv) statement of equity at March 31, 2015 and (v) statement of cash flows for the three months ended March 31, 2015.
The effects of the restatement on our condensed consolidated balance sheet as of December 31, 2015 and January 1, 2016 are set forth in the following table (in thousands):
|
| | | | | | | | | | |
| December 31, 2015 and January 1, 2016 |
| As Previously Reported | | Restatement Adjustments | | As Restated |
Additional paid-in capital | $ | 2,820,958 |
| | 123,939 |
| | $ | 2,944,897 |
|
Accumulated deficit | (2,013,799 | ) | | (123,939 | ) | | (2,137,738 | ) |
The effects of the restatement on our condensed consolidated statements of operations for the three months ended March 31, 2015 are set forth in the following table (in thousands, except per share amounts):
|
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2015 |
| As Previously Reported | | Restatement Adjustments | | Reclassification Adjustments(1) | | As Restated and Reclassified |
Revenues: | | | | | | | |
North America contract operations | $ | 202,261 |
| | $ | — |
| | $ | — |
| | $ | 202,261 |
|
International contract operations | 120,691 |
| | — |
| | (120,691 | ) | | — |
|
Aftermarket services | 86,856 |
| | — |
| | (36,244 | ) | | 50,612 |
|
Fabrication | 319,274 |
| | (6,932 | ) | | (312,342 | ) | | — |
|
| 729,082 |
| | (6,932 | ) | | (469,277 | ) | | 252,873 |
|
Costs and expenses: | | | | | | | |
Cost of sales (excluding depreciation and amortization expense): | | | | | | | |
North America contract operations | 82,679 |
| | — |
| | — |
| | 82,679 |
|
International contract operations | 44,339 |
| | — |
| | (44,339 | ) | | — |
|
Aftermarket services | 65,934 |
| | — |
| | (25,157 | ) | | 40,777 |
|
Fabrication | 267,118 |
| | (6,087 | ) | | (261,031 | ) | | — |
|
Selling, general and administrative | 86,686 |
| | — |
| | (54,118 | ) | | 32,568 |
|
Depreciation and amortization | 95,808 |
| | 97 |
| | (38,892 | ) | | 57,013 |
|
Long-lived asset impairment | 12,732 |
| | — |
| | (4,579 | ) | | 8,153 |
|
Restructuring and other charges | 4,790 |
| | — |
| | (4,790 | ) | | — |
|
Interest expense | 27,298 |
| | — |
| | (507 | ) | | 26,791 |
|
Equity in income of non-consolidated affiliates | (5,006 | ) | | — |
| | 5,006 |
| | — |
|
Other (income) expense, net | 7,841 |
| | (898 | ) | | (7,493 | ) | | (550 | ) |
| 690,219 |
| | (6,888 | ) | | (435,900 | ) | | 247,431 |
|
Income before income taxes | 38,863 |
| | (44 | ) | | (33,377 | ) | | 5,442 |
|
Provision for (benefit from) income taxes | 16,491 |
| | 1,071 |
| | (18,302 | ) | | (740 | ) |
Income from continuing operations | 22,372 |
| | (1,115 | ) | | (15,075 | ) | | 6,182 |
|
Income from discontinued operations, net of tax | 18,713 |
| | — |
| | 15,075 |
| | 33,788 |
|
Net income | 41,085 |
| | (1,115 | ) | | — |
| | 39,970 |
|
Less: Net income attributable to the noncontrolling interest | (8,943 | ) | | — |
| | — |
| | (8,943 | ) |
Net income attributable to Archrock stockholders | $ | 32,142 |
| | $ | (1,115 | ) | | $ | — |
| | $ | 31,027 |
|
| | | | | | | |
Basic income (loss) per common share: | | | | | | | |
Income (loss) from continuing operations attributable to Archrock common stockholders | $ | 0.19 |
| | $ | (0.02 | ) | | $ | (0.21 | ) | | $ | (0.04 | ) |
Income from discontinued operations attributable to Archrock common stockholders | 0.27 |
| | — |
| | 0.22 |
| | 0.49 |
|
Net income attributable to Archrock common stockholders | $ | 0.46 |
| | $ | (0.02 | ) | | $ | 0.01 |
| | $ | 0.45 |
|
| | | | | | | |
Diluted income (loss) per common share: | | | | | | | |
Income (loss) from continuing operations attributable to Archrock common stockholders | $ | 0.19 |
| | $ | (0.02 | ) | | $ | (0.21 | ) | | $ | (0.04 | ) |
Income from discontinued operations attributable to Archrock common stockholders | 0.27 |
| | — |
| | |