Brad Childers - President & CEO David Miller - CFO.

Bhavesh Lodaya - Credit Suisse Andrew Burd - JPMorgan Praveen Narra - Raymond James Blake Hutchinson - Howard Weil Jerren Holder - Goldman Sachs Daniel Burke - Johnson Rice TJ Shultz - RBC Capital Markets Sharon Lui - Wells Fargo Securities.

Welcome to the Archrock, Incorporated and Archrock Partners LP First Quarter 2016 Earnings Conference Call. Yesterday, Archrock and Archrock Partners released their results for the first quarter 2016. If you have not received a copy, you can find the information on the Company's website at www.archrock.com.

During today's call, Archrock, Incorporated may be referred to as Archrock or AROC and Archrock Partners as either Archrock Partners or APLP. Because APLP's financial results and position are consolidated into Archrock, any discussion of Archrock's financial results will include Archrock Partners unless otherwise noted.

I want to remind listeners that the news releases issued yesterday by Archrock and Archrock Partners, the Company's prepared remarks on this conference call and the related question-and-answer session include forward-looking statements.

These forward-looking statements include projections and expectations of the Company's performance and represent the Company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements.

Information concerning the risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found in the Company's press releases as well as in the Archrock annual report on form 10-K for the year ended December 31, 2015 and Archrock Partners annual report on form 10-K for the year ended December 31, 2015 and those set forth from time to time in Archrock and Archrock Partners filings with the Securities and Exchange Commission which are currently available at www.archrock.com.

Except as required by law, the Companies expressly disclaims any intention or obligation to revise or update any forward-looking statements. Your host for this morning's call is Brad Childers, President and CEO of Archrock. I would now like to turn the call over to Mr. Childers. You may begin..

Thank you, operator. Good morning, everyone. With me today is David Miller, CFO of Archrock and Archrock Partners. Let me start our call with a discussion of the recent action taken at Archrock and Archrock Partners to strengthen the financial position of both Companies.

After that I will review our first quarter highlights and share our market outlook before turning the call over to David for review of our results and financial position.

Although our business execution in the first quarter continued to demonstrate the strength of our operations at the gross margin level, the impact of this challenging market on our business and the uncertain timing of an eventual recovery have caused us to take further steps to solidify the financial positions of Archrock and Archrock Partners.

In order to set up both Companies to navigate this current market from a position of financial strength and position them well to participate in the eventual recovery when it occurs, we have implemented a plan to address leverage metric concerns at Archrock Partners, maximize free cash flow and increase the amount of retained cash we can use to repay debt.

These actions include reducing the distributions at APLP and the dividend at Archrock, in each case by about 50%, as announced in our releases yesterday; amending APLP's credit facility to increase our covenant leverage from 5.25 times to 5.95 times; and executing sharp cost and CapEx reductions which I will discuss more detail later in the call.

Let me share that the decision to reduce that APLP distribution and Archrock dividend was a difficult one.

As we discussed in the past, we recognize that our unit holders and shareholders have invested in us with the expectation that we will return capital to them in the form of distributions and dividends and we remain committed to maximizing distributions and dividends to our investors from available cash flow.

However, the cumulative impact of horsepower and revenue declines from the last half of 2015 and so for this year, the increase in APLP's leverage to 4.7 times and our expectation that the remainder of 2016 will be challenging, with uncertainty on the timing of an eventual recovery.

All of these factors taken together, have caused us to prioritize our need to retain more of our available cash at this time. By taking these steps we believe we have addressed leverage concerns at APLP and strengthened APLP's financial position without issuing equity at the dilutive prices availing in the market currently.

We expect to maintain strong coverage on the distribution at APLP and on the dividend at Archrock at the new distribution levels.

We have ample liquidity at both companies and we have positioned our businesses not just to navigate and emerge from this downturn, but to do so in a strong financial position that will allow us to take advantage of growth opportunities. A final comments on the actions we have taken.

We took these steps following a disciplined analysis of our options with our financial advisors and the Boards at both Archrock and Archrock Partners.

Among the advantages of these actions, we have preserved the current GP MLP structure which offers optionality for financing future investments and has reserved the potential value of this GP MLP structure which has been demonstrated during market growth cycles.

In addition we also evaluated other options for Archrock to provide direct support to Archrock Partners.

Ultimately, we determined that the overall distribution reduction, coupled with covenant relief at APLP, was the right move in the right level of support from Archrock at this time as the amount of retained cash at APLP included the full amount of the prior IDR payments.

Now turning to our operations, despite the difficult market, Archrock's operations teams continued to execute well on our cost management priorities, producing improved gross margin percentages in both contract operations and after-market services.

Contract operation gross margin percentage increased 200 basis points sequentially to 61% and after-market services gross margin percentage increased 100 basis points sequentially to 18%.

Our solid gross margin performance is one result of the success of our field service management teams which have worked diligently to ensure we scale our operations with declining business levels, reduce costs even further and enhance efficiencies.

In contract operations, we experienced our largest operating horsepower loss since the downturn began, with a decline of about 5% of our operating horsepower in the quarter and revenues declined 7% sequentially.

The decline in our operating horsepower was driven primarily by the continued efforts of our customers through reduced cost by optimizing their compression equipment, shutting in uneconomic wells and discontinuing service at locations where they've scale back drilling activities.

As in the prior quarter, our horsepower declines were generally spread evenly across our operating horsepower sized and were mostly balanced across our three primary service applications which are wellhead, gathering and gas lift, though we did a small uptick in the amount of wellhead in gas lift horsepower that stopped during the quarter.

A little more than 40% of our operating horsepower reduction came from conventional dry gas plays, with the remainder being distributed fairly evenly across the balance of the basins in which we operate. Our after-market services business got off to a slower start in 2016 than we anticipated. For the first quarter, revenues were down 29% sequentially.

While this business can have volatile top line quarter over quarter, I believe we saw a pronounced change in customer behavior during the quarter as customers elected to defer maintenance or use internal resources rather than outsource to providers like Archrock.

I believe there is risk this behavior continues in the near term, but given this sharp revenue production was really pleased with our AMS team's work to maintain and even improve, margin performance in the quarter. Now I would like to turn the market and outlook for our businesses.

Longer term, we remain optimistic that the growth and the demand for natural gas with a strong supply response and with it increased demand for our compression services, as I have discussed last quarter and at other times in the past.

However, as our actions this quarter make apparent, we believe near term, industry conditions, likely at least through the remainder of 2016, will remain challenging. Despite the very recent improvements in oil prices, bookings and bid activity levels continue to be low and an industry focused on CapEx rationalization and cost reduction continues.

With these near term challenges we continue to remain keenly focused on two things, providing excellent customer service and maximizing our cash flow by executing on our cost and capital reduction program. On our cost reduction initiative, here is what we accomplished so far. We have reduced our headcount by about 15% year to date.

Combining this with the reductions we made in 2015, our headcount down by 25%, a level of production that's significantly ahead of the decline in our business levels. We have made changes to our field maintenance practices and have and will continue to reduce operating expenses and maintenance CapEx.

These changes were contributors to our gross margin and maintenance capital performance in the quarter. Our supply chain team has been working with our vendors to drive further savings and efficiencies into our parts and material costs.

Through our first quarter growth capital spend, though it was higher in the first quarter than at fourth quarter levels, we remain committed to reducing our full-year 2016 new capital build budget by 60% to 70% and our total CapEx budget by 50% to 60% compared to 2015.

We're committed to continuing our program of maximizing our cash flow by ensuring we take further actions as required to right size our operations, reduce our cost structure, rein in capital spending and simplify and streamline our Company.

Now turning to the partnership, Archrock Partnerships also experienced declines in operating horsepower revenue during the first quarter, but gross margin came in at a solid 62%. Our distributable cash flow coverage ratio was also a strong 2.51 times due to the reduced distribution and effective execution in the field and on cost management.

Before I turn the call over to David, I want to touch briefly on Exterran Corporation's recent 8-K filing.

Exterran Corporation which was spun off from our Archrock in November of 2015, is conducting an investigation into possible errors relating to the application of percentage of completion accounting principles to specific engineering procurement and construction projects in the Middle East by its Belleli subsidiary.

Additionally, Exterran Corporation has announced that it will be restating its 2015 financial statements. Exterran Corporation's results have been reported as income from discontinued operations net of tax in Archrock's consolidated statement of operations for historical periods presented in Archrock's 2015 annual report on form 10-K.

As we noted in our release yesterday, with our audit committee we're in the process of determining the impact of this matter on Archrock's pre-spin historical financial statements.

As a result of this ongoing process, for Archrock we provided an operational update yesterday in lieu of our typical earnings release, because we're not at this time able to provide financial information that would require a reconciliation to historical information that could be impacted by this process and, as you can understand, because of the uncertainties while the investigation is ongoing.

Our discussion of Archrock's financial results on this call today will also take this limitation into account and we will not be filing Archrock's 10-Q today as we have traditionally done, pending the outcome of this process.

Archrock Partners is not expected to be impacted by this process and we do expect to file APLP's 10-Q later today, consistent with past practices. Since this processes in an early stage it is ongoing, we really cannot really comment further at this time.

I would like to assure you, however, that we and our counterparts at Exterran are working as diligently as possible to resolve this matter for both Archrock and Exterran. Now I would like to turn the call over to David for review of both Companies' financial results..

Thanks, Brad. I will start with a summary of first quarter results for Archrock and Archrock Partners and then cover guidance for the second quarter. Archrock generated revenues of $213 million for the first quarter 2016 compared to $241 million fourth quarter of 2015.

By operating segment, in contract operations revenue came in at $176 million in the first quarter, down from $189 million in the fourth quarter due to lower operating horsepower and continued pricing pressure. About two-thirds of the decline in revenues related to declines in operating horsepower and about one-third related to declines in pricing.

Gross margin improved 61%, up from 59% in the fourth quarter, as noted by Brad, due to mostly solid course management.

In after-market services revenues of $37 million for the first quarter were down 29% compared to the fourth quarter revenues of $52 million as more customers elected to defer maintenance activities or use internal resources to complete work that was previously outsourced.

First quarter gross margins of 18% were up compared to 17% in the fourth quarter. The increased margins are attributable to efforts to tightly managed labor and other costs. SG&A expenses were $35 million in the first quarter, essentially flat to the fourth quarter levels.

We experienced higher-than-anticipated legal and consulting expenses and the bulk of our cost reduction activities were not implemented until very late in the quarter. Depreciation and amortization expense was $54 million for the first quarter. Interest expense was $20 million compared to fourth quarter interest expense of $25 million.

As a reminder, results in the fourth quarter included interest expense associated with our pre-spin capital structure for a portion of the quarter. During the first quarter, on a consolidated basis we determined that approximately 80 idle compressor units totaling approximately 33,000 horsepower would be retired from the fleet.

As a result of the retirement of these units, we recorded a $9.9 million long-lived asset impairment charge. 60 of these units were owned by the partnership and an impairment charge of $6.3 million was recorded at Archrock Partners. As mentioned, in the first quarter we took aggressive action to reduce our cost.

These actions resulted in a $7 million restructuring charge, primarily related to severance benefits and consulting fees. Of this amount, $4.1 million was allocated to Archrock Partners.

Turning to CapEx, in the first quarter Archrock's gross capital expenditures were $37 million which included purchases of new equipment from Exterran related to our separation agreement that spilled over into the first quarter as well as equipment ordered in the fourth quarter before we were hit harder by the downturn.

We indicated growth capital would be front-end loaded at 2016 and we expect lower quarterly growth capital expenditures for the remainder of the year. Maintenance CapEx for the quarter was $11 million, down approximately 40% from the fourth quarter levels of $19 million.

We plan to scale back new fleet additions during the last three quarters of the year and expect to recognize meaningful reductions in maintenance capital expenditures relative to 2015 levels and prior guidance. Looking at the balance sheet, first quarter ending debt on consolidated basis was $1.6 billion, up slightly from December 31, 2015 levels.

On a deconsolidated basis, Archrock's Q1 2016 debt balance was $171.5 million versus $166.5 million in Q4 2015, up slightly due to higher-than-expected growth CapEx in Q1.

As previously disclosed, pursuant to the separation agreement entered into in connection with the spinoff, Exterran Corporation intends to transfer to us an amount of cash equal to the remaining proceeds its subsidiary receives from PDVSA relating to its previously nationalized Venezuela assets.

In January 2016, a subsidiary of Exterran Corporation received an installment payment including an annual charge of $5.2 million from PDVSA and transferred cash to us equal to that amount.

As of March 31, 2016 and currently, PDVSA owes the remaining principal amount of approximately $75 million and is currently in default on its payment obligations to Exterran Corporation's subsidiary. Exterran Corporation and its affiliate intend to exercise their rights and remedies under all applicable agreements.

Cash distributions to be received by Archrock based on this limited partner and general partner interest in Archrock Partners are approximately $7.1 million for the first quarter compared to $18.9 million for the fourth quarter 2015.

This distribution will be used to fund Archrock's $6.7 million quarterly dividend that will be paid on May 18, 2016, compared to Archrock's fourth quarter 2015 dividend of $12.9 million. As announced, Archrock reduced its quarterly dividend to $0.095 per share in the first quarter, approximately 50% below its fourth quarter level.

Archrock's cash available for dividend coverage was 2.05 times for the first quarter. Turning to the financial results for the partnership, Archrock Partners' first quarter EBITDA as adjusted was $69 million, down 8% as compared to $75 million in the fourth quarter of 2015.

Revenue for the first quarter was $151 million as compared to $161 million in the fourth quarter. Revenue per average operating horsepower was $51.14 for the first quarter, down 3% compared to $52.67 in the fourth quarter.

The decline in revenue and revenue per average operating horsepower was primarily attributable to the operating horsepower declines and pricing pressure as already discussed. Cost of sales per average operating horsepower was $19.54 in the first quarter, down compared to $20.73 in the fourth quarter 2015 due to solid cost management in the quarter.

Gross margins grew to 62% in the first quarter, up 100 basis points from 61% in the fourth quarter. SG&A expenses for the first quarter were $23 million, relatively flat compared to the fourth quarter of 2015. Distributable cash flow was $44 million in the first quarter of 2016, down from $46 million in the fourth quarter of 2015.

Our distributable cash flow coverage was 2.51 times in the first quarter, compared to 1.17 times coverage in the fourth quarter 2015, up primarily as a result of our reduction in APLP's quarterly distribution by approximately 50% to $0.285 per limited partner unit.

Turning to CapEx, APLP's gross capital expenditures in the first quarter were approximately $22 million, consisting of $14 million for fleet growth capital and $8 million for maintenance activities.

Turning to the balance sheet, we were very pleased with the amendment to the Archrock Partners credit facility which provides covenant relief at 5.95 total debt to EBITDA through 2017 with no change to our pricing grid.

Other terms of the amendment include a reduction of aggregate revolving commitments of $75 million and a reduction in our senior secured leverage ratio to 3.5 times from 4 times through 2017.

In 2018, our covenant maximum total debt to EBITDA steps down to 5.75 times in Q1 and then the 5.25 times in Q2 while our senior leverage increases to 3.7 times and 4 times, respectively, in the same periods in 2018. There was no change to the maturity of our facility in May of 2018.

On the balance sheet, Archrock Partners total debt remained relatively flat sequentially at $1.4 billion as of March 31, 2016.

Available but undrawn debt capacity at Archrock Partners debt facilities at March 31 was approximately $302 million or $227 million pro forma for the reduction in aggregate revolving commitment as part of our amendment to the revolving credit facility.

As of March 31, 2016, Archrock Partners had a total leverage ratio which is covenant debt to EBITDA as adjusted as defined in the credit agreement, of 4.7 times as compared to 4.5 times at the end of the fourth quarter.

Archrock senior secure leverage ratio which is senior secured debt to EBITDA as adjusted and defined in the credit agreement, was 2.5 times as of March 1 as of March 31, 2016 as compared to 2.3 times at the end of the fourth quarter.

Now let me review Archrock guidance for the second quarter of 2016 which includes the consolidation of Archrock Partners results. In contract operations, we expect revenue of $165 million to $175 million, with gross margins in the 59% to 61% range. For AMS, we expect revenue of $37 million to $42 million, with gross margins between 16% and 18%.

We believe our after-market services business will follow the trends we saw in the first quarter. On SG&A expenses, we're targeting $31 million to $33 million for the second quarter as we're expecting to see our savings initiatives start to pay off.

Depreciation and amortization expense is expected to be in the $50 million range, with interest expense of approximately $20 million. For 2016, total CapEx is expected to be in the $110 million to $130 million range, a modest reduction from the guidance provided in the fourth quarter call.

Maintenance capital spending for the year is expected to be $55 million to $60 million, roughly 25% lower than 2015 levels and $10 million to $15 million lower than our guidance on the fourth quarter call.

New-build capital expenditures are expected to be in the $45 million to $65 million range for the full year 2016 which represents a 60% to 70% reduction from 2015 levels. This is a slight increase from guidance in the prior quarter due to higher growth capital expenditures in the first quarter.

At Archrock Partners, we now expect new-build capital expenditures to be in the $25 million to $45 million range and maintenance capital expenditures in the $45 million to $50 million range. This concludes the financial portion of our discussion and at this point I'd like to turn the call back over to the operator and open it up for questions..

[Operator Instructions]. And our first question online comes from Bhavesh Lodaya from Credit Suisse. Please go ahead..

First question on the timing for the distribution card, specifically deciding to hold distributions and the previous quarter and cutting this quarter.

I guess my question is, what was the tipping point during the quarter? How worse is outlook for the future especially since APLP's distribution coverage is still about one times currently?.

Sure. When we looked at this and assessed our position in the prior quarter, what we really wanted was to understand and see more of how the business would behave through this downturn.

What we experienced in Q4 was a horsepower reduction that really ramped up in Q1 as leverage tipped up, so it was those two moves that really put us in the position to say okay, this is the right time. We felt like, while we were watching it carefully, an earlier cut was not warranted.

We really felt like those factors, those macro drivers really lined up to make this quarter the quarter when it made sense. Look, we did not do this, though, based on just a quarter or two of performance.

We really did it based upon trying to solidify our position so that not only do we make it through this, but we make it through with solid leverage, capital liquidity so we can take advantage of opportunities. We just did not want to not have financial strength, both through the process and at the end of this process over this market cycle..

And then it seems the first priority was deleveraging and with coverage expected to be around 2.5 times, would you be willing to share some longer term plans in terms of how you plan to use the excess cash for maybe funding drop downs or some longer term distribution policy guidance?.

As you point, out the first priority of this was definitely leverage so the priority immediately for excess cash is going to be to reduce debt, so we like that. But also in this market environment, when looking ahead, we do think there will be opportunities when and as this market stabilizes.

We want to make sure we're in a good position to take advantage of those..

You did mention the HP, the horsepower utilization, is turning lower. It's been at 90% in the first time in many years.

Is there some sense of guidance in terms of we're we should think it goes throughout this year?.

Yes.

Look, I wish I had that insight as to where it goes, but it is natural for the overall business to be below 90% and Archrock Partners has grown, because your question on utilization looked at the numbers from Archrock Partners, as Archrock Partners grows its utilization will resolve and settle more in a natural market rate that in the past we've always said 90% feels like full employment.

Longer term, that is the type of number that allows us to have units starting, stopping, available to put back to work through our sales efforts as well as those getting ready to go back on the jobs. It is moved into a level which is not an unusual position from a longer term perspective.

The issue, I think, is going to be how well we can generate cash from a horsepower utilization that's going to be more at that level going forward and longer term..

Okay. A final one, we have seen some very impressive success on the cost saving initiatives.

Are there more in the works? How should we think about the gross margins going ahead?.

We gave guidance that we expect to continue to maintain margin, but I will share with you that we're really pleased with where our margins came out and what I also I shared with you in our headcount numbers is that to the certain extent, we have reduced cost really hard in the face of this market and hopefully gotten ahead of it.

We think we're in a good spot to be able to hopefully fight and hold and maintain margin within the ranges that we were guiding but that is going to be success is maintaining margin within that guidance range given the pressure that we have on horsepower pricing and then what we can gain on cost management over all.

I am really pleased with how far we have gotten but I do expect that with horsepower and price erosion, it is a fight to maintain it within the guidance range..

Our next question online comes from Andrew Burd from JPMorgan. Please go ahead..

A quick follow up on the SG&A question. Appreciate the color on the headcount. The team's consolidated SG&A was flatish sequentially in year over year and that in the second quarter guidance is also roughly flat.

Is a lot of the impact of the cost-cutting to date in the current run rate or is there somewhat of a lag that we can expect in upcoming quarters to really realize that full potential in the numbers?.

As I mentioned Andrew, some of the major cost-cutting activity came at the end of the first quarter so that would not have shown up yet and in our guidance, we guided SG&A to $31 million to $33 million for Q2 versus $35 million in Q1 and Q4 2015.

We're hoping to start to see some of the benefits of our cost-cutting efforts show up in the second quarter. But just given the magnitude of the cost and outside of SG&A versus the cost within SG&A, the bulk of the savings would come outside of SG&A but we're hoping to make significant progress on SG&A..

Switching gears, has your calculus changed in terms of where growth capital is deployed at APLP versus AROC? A secondary question is how should we think about potential for drop downs near or long term?.

On the CapEx the question first, I don't think a longer term picture as to where capital gets deployed has changed.

APLP remains the primary vehicle through which we want to grow the contract operations business and it is where we expect to, over the long term, achieve a better cost of capital or a good cost of capital and target growth investments, that has not changed over the long term.

In the short run, however, especially as we completed the separation with Exterran, one benefit of the current structure is we have the choices to where we deploy CapEx on eight short term basis and so we did see a blip or an increase in the amount of CapEx that was spent at Archrock compared to Archrock Partners but that is not a change in direction or a change in plan for the allocation of that.

Look, we don't comment on the timing of drop down activity. What we have always said is that you can look to our past practices which in a normalized market, when we don't have competing priorities. We have executed about one a year and so that is the type of pace that again, absent of other activities, I think people should look to..

Brad, you had also mentioned that utilization or the utilization decline has accelerated into the first quarter and obviously that was in the numbers.

As we sit here two months into the second quarter, how has pace or acceleration of declines lightened up a bit? Or is it the same type of empty-handed returns?.

Yes. I did try to clarify in my comments that our actions now which we did not take lightly, are driven by our analysis of what is going in the market year to date and so into the current period we see a continuation of the type of return activity that we saw in the combination of Q4 and Q1.

It is at that level, we have not seen a drastic change or abatement in our order activity or in our opportunities compared to Q1 in the current period..

Our next question online comes from Praveen Narra from Raymond James. Please go ahead..

In following up with that question, I know you mentioned that the utilization with any kind of hit on all three levels at the LP level. Can you give us a sense on the gathering lines or some color around when you were getting that utilization? Was it contracts rolling over and customers giving back? Any more call you can add would be helpful..

I want to make sure I understand the question.

Is the question where from an activity in the oil field we're seeing the declines?.

Yes..

Yes. The sharpest declines are primarily shut-ins or consolidations due to poor economics and we're seeing those in the conventional dry gas plays as the sharpest. These are typically longer-lived operations for both the producers as well as for us, so that is the bulk of the activity.

The second area where we're seeing it is that there are few of the shell plays where investments really got -- were they were in full on growth mode and where some of our customers invested quite a bit in both infrastructure operations and were looking to lean on us for outsourcing of their compression needs.

They're just curtailing their drilling activities. As they turn those down, they rationalizing their overall operation and that includes our horsepower.

We see those activities, too, as some of the producers are putting us on hold some of their prior drilling plans, completion plans and deferring in the current environment and so that is impacting it, too. I think those are the two biggest drivers that we see in the field overall..

If we could just go through the same idea on the pricing side.

I would assume that the gas lift levered horsepower is really where you are seeing more of the price in declines but could you give us more clarity on what you are seeing across on the pricing side?.

Sure. I think you are right, by the way. Where we see the most aggressive competitive marketplace right now is on the smaller horsepower and that includes, of course, gas left.

As customers have multiple options on how to enhance their oil recovery, whether it is through ESPs or pumps or compression and while compression can be one of the most efficient, it is not necessarily the least cost option and so we see customers using multiple options to enhance oil recovery.

That is where I think we see the sharpest pricing competition overall. That's true..

Okay. And then just kind of bigger picture going back to the distribution policy going forward.

Has there been any change in where you think you guys are comfortable from a leverage standpoint on a more normalized basis when we come to the recovery?.

Right. Look, a couple things on distribution strategy.

Distribution strategy overall remains intact and that is that we consider Archrock to be primarily a pass through of the APLP distributions received and we were, in prior distribution scenario, basically leverage to that and in the current distribution scenario, dividend scenario were leverage to that.

That overall philosophy has not changed from a leveling perspective. I think that, that is the main strategy to think of. On the leveraging side for APLP, we said in the past that in a normalized market we were targeting a leverage ratio that was in the 3.5 to 4 range.

That is still the range we would like to get to, to operate on a more normalized basis..

Our next question online comes from Blake Hutchinson from Howard Weil. Please go ahead..

I know we have spent some time here talking about the kind of dual stresses on the system in North American compression and contract compression, but it is somewhat, I guess, inconsistent with what looks like a pretty strong guide for Q2.

Is there some portion of what you saw in first quarter from either a utilization or pricing standpoint that is still more in step with other years where it was somewhat one-time in nature so that the impact into the coming quarters is lessened somewhat? Or is you guidance for 2Q, maybe we're missing an element of this somewhat supported by equipment entering the market that was on a contract that was built into late last year?.

Blake, I am a little confused. We've guided revenue to $165 million to $170 million for Q2 in contract operations which is down quite a bit from our Q1 levels..

Sure, I guess. You are also, however, suggesting that the pace of decline is somewhat similar sequentially in both or at least in utilization.

I guess that would suggest that either you have more contracted horsepower entering as an offset in Q2 or perhaps the pricing reset that we saw in first quarter is more a function of the fact that we revisit that at every year end and it may tend to be a bit more stable here as we proceed through the year or at least a quarter out.

Again, just trying to piece that together.

Is that what this suggests? Or are you suggesting you we will still probably see a two-third, one-third type progression?.

We did not really guide as to the mix but something along that order is probably still expected.

As we saw the decline from Q4 to Q1 and then the continued decline from Q1 to Q2 and then couple that with limited visibility, we got to the point where we felt like we needed to take the steps that we took in order to shore up our leverage situation at APLP..

Is there a number in terms of growth CapEx that is actually falls under the currently committed figure, meaning it is stuff that you are still on the hook for, so to speak, from last year?.

Most of what we're committed for from last year has been wrapped up in Q1. We're now pretty much in a position to order as we see demand that makes sense for us to deploy our precious capital into..

Okay. So flexible there.

Finally, I know there has been some talk about G&A levels and obviously very sensitive and meaningful from personal standpoint, I guess as you assess, the business as a standalone at this point, is there any thought, more theoretically than practically, about what type of support you may need ultimately or on a long term on a kind of percentage basis from a G&A perspective or are we getting probably much closer to that level?.

Yes. Look, I appreciated your intro to that question, because it is a tough question. It does have far-reaching implications. In a declining market, it is really hard to get your percentage, your SG&A percentage of revenue, moving in the right direction.

It is just really tough and it is compounded a bit by the fact that we just stepped off -- we have a platform that we just stepped off a major piece off with the Exterran separation back in Q4.

That means that it is both a harder go on a -- to do it fast, but it also means I do think there is an opportunity there, but it is going to take a combination of getting back to a more normalized market to see that percentage move in the right direction and we're absolutely committed to undertaking the changes to the foundation and to the structure that we sit on to some finally reduced SG&A that should show up on a percentage of sales basis, percentage basis also.

I do think that the other side is there is opportunity there. It is just harder to chip at and get at because a lot of it is very foundational, structural, systematic and process oriented. It takes time to change those, but we're in the process of doing exactly that..

Our next question comes from Jerren Holder from Goldman Sachs. Please go ahead..

I understand the point about not issuing equity at these prices, but we've obviously seen a lot of MLPs issue preferred equity.

Is that something that you guys explored, too?.

We did. We looked at a number of different things, levers within our control and then third-party levers.

As we thought about issuing equity through private placements, either convertible preferreds or preferreds, the answer was still the same that it is pretty darn dilutive to our existing equity base and so we felt like that the actions that we took today with the bank covenant relief and the cost reduction activities that we're undergoing and the distribution reduction was the best course of action to retain cash and improve our leverage situation right now and preserve longer term upside in our equity..

Our next question comes from Daniel Burke from Johnson Rice. Please go ahead..

I guess I heard a lot of discussion on the call about the rationale, the APLP level in terms of retaining more funds for debt pay down and understand that, that payout level, sort of instructed the payout level at Archrock, but could you articulate a little more clearly the coverage level you all feel is appropriate at Archrock? I assume retained fund will be devoted to debt pay down at the parent level, but wanted to touch on that little more closely here..

Sure. We've said from the beginning that AROC would be a pass-through entity of the distributions that it receives from APLP and we're now, with the revised distribution and dividend levels, we're now passing about one to one based on what AROC receives from APLP.

In addition, in this market with the limited visibility, we think it is important to retain cash and preserve flexibility, whether for an acquisition or a drop down at AROC that would change the cash flow picture at AROC.

We wanted to make sure that we have the ability to maintain flexibility, retain cash and preserve our optionality at both entities, not just at APLP..

The only other one for me and certainly a much smaller question, but in terms of that little nudge up in growth CapEx in Q1, is there a need in market you can point to that you were addressing in terms of that budget figure looking a little larger than it did in February?.

Yes. Couple things. What we expected to be Q4 2015 spend that moved into 2016, so dollars for dollars for the two quarters it just moved from one quarter to the other. That drove it up a little. The other opportunity that we see is we do have customers that are core customers in growth areas that are looking for equipment that we're tight on.

So notwithstanding the overall move in utilization and horsepower, there are still categories that we need to invest in to make sure we can provide the customers with the services that they need in this growth area.

We're going to be very disciplined on when and for whom we do that, with which customers and to what markets we deploy, but those are the two drivers behind that number ticking up a bit..

To cram a last one in maybe, on the Venezuela, I know that Exterran's receivable, but do you contemplate spending any dollars at the Archrock level in pursuit of that receivable that I guess would rise to a magnitude were would notice or need to remark on?.

I think my answer on that right now is, I don't think so. I don't think it would become a material number and we still have decisions to make on how best to go about working with the collection of the final amounts on that receivable, but I really don't think so..

Our next question online comes from TJ Schultz from RBC Capital Markets. Please go ahead..

Just on the debt covenant amendment at 5.95 times, how much headroom under that do you want to have? Just given a headroom you have now I'm just trying to square that covenant with how you view the degree of cash flow degradation possibly over the next couple years..

Well we would like to not to use it at all, but given, as I have said, as we said a few times here, given the current market conditions and the limited visibility we thought it was very prudent to be proactive in seeking an amendment like this one before we absolutely had to have it. We went out and got the amendment done.

We're really pleased with it going through 2017. We think it gives us ample headroom to last through for a long period of time and hopefully throughout this downturn, however long it takes and into the recovery. I can't give you a specific number but I think you get the sense of where we were heading with this..

Okay.

Just to clarify, when we think about the MLP distribution policy going forward and you say you want to get to 3.5 to 4 times leverage range, is that the range we should be thinking about before you can -- is the way I'm reading it you want to get there before you consider growth on distributions at the MLP again? Essentially, for the foreseeable future, excess cash flow is allocated to debt repayment?.

I don't think it is going to be that formulaic, that's fairly tight. If we see that we have the means of achieving the right leverage range and we feel good about it, I think that will be taken into account in how we think about the distribution policy going forward.

The distribution policy, it is revisited quarterly, it's the prerogative of the Board and I think that, that will be taken into account. I just don't want to lead anybody to believe that for the Board that decision has to see leverage in a range at a point in time that would be too tight..

And our final question comes from Sharon Lui from Wells Fargo. Please go ahead..

Following up on the questions on the distribution at the MLP, maybe if you can just provide some color on how you actually arrived at the 50% reduction versus a deeper cut and whether, I guess there is a risk for further reduction if market conditions continue to deteriorate?.

As we thought through it, when you get to the 50% reduction level, you have eliminated all of the IDR payments made to AROC and you have cut the LP distribution by 50%, obviously. We feel like that was the right place to get to.

If for some reason there is -- the market conditions are worse than we even anticipated or anticipate or than we worked with in coming up with the 50% reduction, we think there are other mechanisms we can employ that would be more additive than another distribution reduction.

We feel pretty comfortable that this 50% reduction should see us through the downturn..

Okay.

In terms of housekeeping, is there a requirement to accrue any minimum quarterly distributions during this period?.

There is not..

Okay.

With the credit agreement changes, does your cost financing increase in all?.

No. Our pricing remains the same..

At this time I see we have no further questions. I would like to turn the call back over to Mr. Childers for any closing remarks..

Thanks, Operator. I want to thank everyone for participating in our first quarter call. As we discussed on last quarter's call, market trends in the first quarter followed those that we saw late in 2015 and we believe we have demonstrated Archrock's ability to quickly right size the business and maintain our margins.

We expect the next few quarters to be challenging but we've taken the measures that we discussed on this call to position Archrock to navigate this downturn and participate in the recovery. We now believe we have a solid balance sheet, ample liquidity, strong coverage.

We will continue to maximize that performance that this relatively stable compression business delivers and as we do so, we will remain focused on providing exceptional coverage and service to our customers, protecting our balance sheet and leverage positions and maximizing our free cash flow.

I look forward to updating you all on our second quarter call later in the year. Thanks again..

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect..