1. Organization and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements of Archrock included herein have been prepared in accordance with U.S. GAAP for interim financial information and the rules and regulations of the 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 adjustments, consisting only of normal recurring adjustments, which 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 our 2017 Form 10-K, which contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year. Certain prior year amounts have been reclassified to conform to the current year presentation.

Organization

We are a pure play U.S. natural gas contract operations services business and the leading provider of natural gas compression services to customers in the oil and natural gas industry throughout the U.S. and a leading supplier of aftermarket services to customers that own compression equipment in the U.S. We operate in two primary business segments: contract operations and aftermarket services. In our contract operations business, we use our owned fleet of natural gas compression equipment to provide operations services to our customers. In our aftermarket services business line, we sell parts and components and provide operations, maintenance, overhaul and reconfiguration services to customers who own compression equipment.

We have a significant equity interest in the Partnership, a master limited partnership that provides natural gas contract operations services to customers throughout the U.S. As of March 31, 2018, public unitholders held an approximate 57% ownership interest in the Partnership and we owned the remaining equity interest, including all of the general partner interest and incentive distribution rights.

Merger Transaction

On April 26, 2018, we completed the acquisition of all of the outstanding common units of the Partnership at a fixed exchange ratio of 1.40 shares of our common stock for each common unit of the Partnership not owned by us. In connection with the closing of the Merger, we issued an aggregate of 57.6 million shares of our common stock to unaffiliated holders of common units of the Partnership in exchange for all of the 41.2 million common units of the Partnership not owned by us. Additionally, the incentive distribution rights in the Partnership, which were previously owned indirectly by us, were canceled and ceased to exist. As a result of the Merger, common units of the Partnership are no longer publicly traded. See Note 18 (“Subsequent Events”) for further details of this transaction.

Significant Accounting Policies

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 (loss) 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 unvested restricted stock and 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 stock to be issued pursuant to our employee stock purchase plan unless their effect would be anti-dilutive.

The following table summarizes net loss attributable to Archrock common stockholders used in the calculation of basic and diluted loss per common share (in thousands):



	Three Months Ended March 31,
	2018			2017
Net loss attributable to Archrock stockholders	$	(3,816	)	$	(11,685	)
Less: Net income attributable to participating securities	(157		)	(154		)
Net loss attributable to Archrock common stockholders	$	(3,973	)	$	(11,839	)

The following table shows the potential shares of common stock that were included in computing diluted loss attributable to Archrock common stockholders per common share (in thousands):



	Three Months Ended March 31,
	2018		2017
Weighted average common shares outstanding including participating securities	71,299		70,763
Less: Weighted average participating securities outstanding	(1,383	)	(1,359	)
Weighted average common shares outstanding — used in basic income (loss) per common share	69,916		69,404
Net dilutive potential common shares issuable:
On exercise of options	*		*
On the settlement of employee stock purchase plan shares	*		—
Weighted average common shares outstanding — used in diluted income (loss) per common share	69,916		69,404

——————


*	Excluded from diluted 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 loss attributable to Archrock common stockholders per common share as their inclusion would have been anti-dilutive (in thousands):



	Three Months Ended March 31,
	2018	2017
Net dilutive potential common shares issuable:
On exercise of options where exercise price is greater than average market value for the period	223	311
On exercise of options	78	141
On the settlement of employee stock purchase plan shares	3	—
Net dilutive potential common shares issuable	304	452

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 changes in the fair value of derivative instruments, net of tax, that are designated as cash flow hedges, amortization of terminated interest rate swaps and adjustments related to changes in our ownership of 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, 2017 and 2018 (in thousands):



	Derivatives Cash Flow Hedges
Accumulated other comprehensive loss, January 1, 2017	$	(1,678	)
Gain recognized in other comprehensive income, net of tax⁽¹⁾	236
Loss reclassified from accumulated other comprehensive loss, net of tax⁽²⁾	313
Other comprehensive income attributable to Archrock stockholders	549
Accumulated other comprehensive loss, March 31, 2017	$	(1,129	)

Accumulated other comprehensive income, January 1, 2018	$	1,197
Gain recognized in other comprehensive income, net of tax⁽³⁾	1,572
Loss reclassified from accumulated other comprehensive loss, net of tax⁽⁴⁾	425
Other comprehensive income attributable to Archrock stockholders	1,997
Accumulated other comprehensive income, March 31, 2018	$	3,194

——————


⁽¹⁾	During the three months ended March 31, 2017, we recognized a gain of $0.3 million and a tax provision of $0.1 million, in other comprehensive income (loss) related to the change in the fair value of derivative instruments.


⁽²⁾	During the three months ended March 31, 2017, 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).


⁽³⁾	During the three months ended March 31, 2018, we recognized a gain of $2.0 million and a tax provision of $0.4 million other comprehensive income (loss) related to the change in the fair value of derivative instruments.

⁽⁴⁾

During the three months ended March 31, 2018, we reclassified a loss of $0.2 million to interest expense and an immaterial tax benefit to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss). Additionally, we reclassified stranded tax effects resulting from the TCJA of $0.3 million to accumulated deficit in our condensed consolidated balance sheets. See Note 2 (“Recent Accounting Developments”) for further detail.