Archrock Inc (AROC) 2016 Q3 法說會逐字稿

Good morning and welcome to the Archrock Incorporated and Archrock Partners, L.P. third-quarter 2016 conference call.

Yesterday, Archrock and Archrock Partners released their results for the third quarter of 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 non-consolidated in Archrock, any discussion of Archrock's financial results will include Archrock Partners unless otherwise noted.

I want to remind listeners that the newest releases issued yesterday by Archrock and Archrock Partners, the company's prepared remarks on the 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 could disclaim any intention or obligation to revise or update any forward-looking statements.

In addition, our discussion today will include non-GAAP financial measures including EBITDA and adjusted gross margin, gross margin percentage, cash available for dividend, and distributable cash flow. For reconciliations of our non-GAAP financial measures to our GAAP financial results, please see today's press releases and our Form 8-K furnished to the SEC.

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. Please go ahead sir.

Thank you operator. Good morning everyone. With me today is David Miller, CFO of Archrock and Archrock Partners. During our call I will review our recently announced drop-down transaction, the Archrock dividend increase, as well as third quarter operating results and our market outlook. David will review our third quarter financial results and provide fourth-quarter guidance.

I was pleased to announce yesterday the drop-down about 150,000 operating horsepower from Archrock to Archrock Partners for all equity consideration, valued at approximately $85 million. The drop-down is attractive for both entities. Archrock is able to build its ownership interest in Archrock Partners at a unit price we believe is attractive based on the current high distributable cash flow coverage at Archrock Partners. For Archrock Partners, the all-equity transaction will reduce its leverage profile and accelerate our efforts to resume distribution growth. This drop-down represents approximately 4% of the combined Archrock and Archrock Partners available horsepower September 30, and enhances Archrock Partners' leading position in the contract operations market.

Driven by our strategy of increasing returns to our stockholders by growing our dividends, and consistent with our approach of passing through the distributions received by Archrock from Archrock Partners, we are increasing the third quarter Archrock dividend by $0.025 cents per quarter, or approximately 25% to $0.12 per share payable later this month. This increase is approximately equal to the amount of incremental distributions that will be received from the general partner and limited partner units issued as consideration for the drop-down.

Now turning to our operating performance, third-quarter highlights included greater stability in our net operating horsepower, excellent execution in the field, and continued success in our cost and capital reduction programs. We generated EBITDA as adjusted of $80.4 million, which includes $2.5 million of other income on $196 million of revenue in the third quarter.

Operating horsepower declined by 34,000 horsepower in the quarter, and while still a reduction, it was significantly improved compared to the 168,000 and 138,000 horsepower declines we experienced in the first and second quarters.

SG&A was down 8% sequentially to $26 million in the third quarter. And we've reduced our outlook for maintenance capital expenditures in 2016 again to the $30 million to $35 million range versus approximately $75 million in 2016. Going forward, we will continue to maintain operating cost discipline, maximize our cash flow, maintain liquidity, and strengthen our financial position in order to set up Archrock well to capitalize on the strong secular growth in US natural gas production that we believe lies ahead.

On the cost management front, and building on the progress in the second quarter of 2016, we took the following actions in the third quarter. We reduced our headcount further by about 6%, which puts our headcount down by more than 25% since the beginning of 2016, and by more than 35% from the time we began restructuring our business in 2015. The executive team and the Board of Directors voluntarily reduced base salaries, and incentive compensation for members of the executive team, and retainer and meeting fees for the directors.

We reduced SG&A substantially on a run rate basis in both Q2 and Q3, delivering an SG&A expense in Q3 that is 25% lower than in the first quarter, which was Archrock's first quarter operating separately post our Q4 separation from Exterran. We maintained disciplined capital spending in both growth and maintenance CapEx. Year to date our total capital expenditures were $97 million compared to $206 million at this point in 2015. We expect to reduce our full-year 2016 total CapEx budget by approximately 50% to 60% compared to 2015.

And finally, in the third quarter we reduced Archrock's consolidated debt by $91 million, with $40 million of the reduction at Archrock Partners and $51.5 million of the reduction at Archrock. At the same time that we have removed significant cost from our operations, we continue to provide superior service and safety performance to our customers, and maintain excellent maintenance standards in the field.

Turning to our operations, Archrock's operations teams continue to drive excellent gross margin performance, posting a 62% gross margin for the quarter. Gross margin percentage was down about 200 basis points from the second quarter level, primarily due to lower pricing as we work through a competitive environment, and higher costs in the Permian as we deploy resources in this growing basin.

The horsepower decline that we experienced in the quarter is about 1% of our operating horsepower, and was a significant improvement compared to the declines in the first half of 2016. Revenues fell by 4% sequentially due primarily to second quarter horsepower declines and competitive pricing on new horsepower going to work.

From a play perspective, we grew our operating horsepower in the Permian, in the Marcellus Utica, and the Eagle Ford, as activity in those plays picked up in the quarter. The remainder of the other basins in which we operate experienced modest declines, with about 50% of our operating horsepower reduction coming from conventional dry gas plays. From an application perspective, we saw an incrementally higher level of horsepower declines in our wellhead group compared to our gathering applications, and we experienced modest growth in our gas lift applications.

In our aftermarket services business, revenues continued to be under pressure as customers are delaying maintenance activity on their equipment, and in some cases using internal resources to perform work they have historically outsourced. Pressure on gross margins continues as fewer opportunities have led to more competitive pricing. For our current opportunity set, we believe that we have right sized our business and will continue to focus on maintaining gross margin levels through this period. And as we have noted before, maintenance cannot be deferred indefinitely and we do expect an uptick in this business as the environment improves.

Turning to the partnership, in the third quarter Archrock Partners experienced a decline of 16,000 operating horsepower and 3% of revenue. Gross margin percentage was a strong 62%. SG&A at the partnership was down 9% sequentially to just under $18 million as Archrock Partners benefited from the cost management activities at Archrock.

Archrock Partners' strong cash flow produced a distributable cash flow coverage ratio of 2.5 times, and once again enabled us to reduce debt in the quarter. Leverage of the partnership increased to 5 times debt to EBITDA; however, we expect to benefit from the pro forma effect of the drop-down in Q4 2016. Leverage at the partnership continues to be a primary focus of Archrock and Archrock Partners.

I'd like to turn to the market and outlook for our businesses. We believe overall energy market conditions improved during the last few months. Compared to the first half of 2016, both natural gas and oil prices were at higher levels throughout the third quarter. The rig count is up substantially from its second quarter 2016 low, and some of our customers are now beginning to discuss new development opportunities. We believe the improved market sentiment contributed to both the higher levels of new orders that we experienced in Q2 and that continued into Q3, as well as the lower level of operating horsepower decline in the third quarter compared to the first half of the year.

Looking ahead, many of our customers are in the process of developing their 2017 capital plans and wrapping up their 2016 budgets. Although we believe the market is strengthened, we do not expect customer behavior to change meaningfully in the near term compared to the third quarter of 2016, and new orders tend to be seasonally lower during the holidays.

Further into 2017, based on the expected increase in natural gas production and the solidifying opportunity set we see from our customers, we believe we will continue to see a good level of new orders in our contract operations business compared to the first half of 2016. Building on and beyond 2017, we believe our business is in an excellent position to participate in and capitalize on the secular growth drivers that are expected to increase natural gas production by between 15% and 20% through 2020, and likely more beyond that.

In the coming years, we believe the significantly improved quantities, accessibility, and price stability of natural gas in the US will continue to drive higher levels of demand for LNG export, pipeline exports to Mexico, power generation, and use as a petrochemical feedstock. With the operational and financial benefits from the structural improvements we have made to our company, we intend to leverage our strong operating presence and solid customer relationships, and our excellent service capability to continue to be the compression services provider of choice, and maximize opportunities to grow our business.

Finally, let me turn to our financial strategy. As I have outlined in the past, we are focused on positioning our companies to be able to grow their respective dividends and distribution. In order to do so we believe we need to see a path to achieving certain financial targets. Those targets are first, a debt-to-EBITDA ratio at Archrock Partners trending toward 4 times or lower; second, sustainable distributable cash flow coverage at Archrock Partners; and finally, adequate liquidity at Archrock Partners to support the growth opportunities ahead of us in the market.

We believe the drop-down transaction announced yesterday is an important step toward achieving these targets. Additionally, in the third quarter we maintained our focus on reducing costs and capital expenditures across the board, including operating expenses, SG&A, and maintenance and growth capital expenditures. We will continue to evaluate alternatives to strengthen the financial position of Archrock Partners. We remain committed to maximizing our cash flow, protecting our liquidity, and solidifying our financial position. These actions have helped us to navigate the current cycle, and position Archrock and Archrock Partners to capitalize on growth opportunities that we expect will result from increasing demand for natural gas in the US.

Now I would like to turn the call over to David for a review of both companies' financial results.

Thanks Brad. Let's look at a summary of third-quarter results, and then cover guidance for fourth quarter.

Starting with our operating segments and contract operations, revenue came in at $157 million in the third quarter, down from $163 million in the second quarter. In the third quarter, much like the second quarter, roughly two thirds the decline in revenue is related to the decline in operating horsepower, and about one third related to declines in pricing. Gross margin decreased modestly to 62%, but continued to be solid as we maintained disciplined cost management. Gross margin percentage was down sequentially about 200 basis points, mostly due to competitive pricing and increased spending on equipment make-ready expense, parts, and labor in growth plays including the Permian.

In aftermarket services, revenues of $39 million for the third quarter decreased 5% compared to second-quarter revenues of $41 million, as customers continue to defer maintenance activities, or perform typically outsourced work with internal resources. Gross margins remained unchanged at 17%.

SG&A expenses were $26 million in the third quarter, down 8% from the second quarter, including about $1.3 million of benefits related to insurance and compensation accrual reversals. We're continuing to see the benefits of right-sizing activities and savings initiatives implemented during 2016.

During the third quarter on a consolidated basis, we determined that approximately 60 idle compressor units totaling around 25,000 horsepower would be retired from the active fleet. As a result of the retirement of these units, we recorded a $9.1 million long-lived asset impairment charge. 45 of these units were owned by the partnership, and an impairment charge of $4.7 million was recorded at Archrock Partners. Additionally during the quarter, we reviewed the carrying value of units which had been culled from our fleet in previous years and are available for sale. Based on that review, we took an additional impairment of $7.6 million at Archrock on a consolidated basis. Approximately $3.2 million of this amount was recorded at Archrock Partners.

In the third quarter, we incurred $4.7 million in restructuring charges. This cost primarily related to severance benefits and consulting fees incurred to reduce our cost structure. Of this amount, approximately $1.9 million was allocated to Archrock Partners.

In the third quarter, Archrock's growth capital expenditures were $19.5 million, up from second-quarter levels of $9.3 million as we purchased new equipment in highly-utilized categories to meet customer demands. Maintenance CapEx for the quarter was $5 million, down from second-quarter levels, as we continue to focus on tight capital management in all areas of the business.

As noted on our second-quarter earnings release, pursuant to the separation agreement entered into in connection with the spinoff, Exterran Corporation intends to contribute to us an amount equal to the remaining proceeds it receives from PDVSA, relating to its previously nationalized Venezuelan assets. In July 2016, Exterran Corporation received payments of $19.5 million from PDVSA, and transferred cash to us equal to that amount. This is the same payment we disclosed in our second quarter earnings release. As of September 30, 2016, PDVSA owed the remaining principal amount of approximately $37.5 million. We can not predict when PDVSA will pay the remaining amount.

Third quarter ending debt on a consolidated basis was $1.47 billion, down $91 million from second quarter 2016 levels. On a deconsolidated basis, Archrock's third quarter 2016 debt balance was $101 million, down $51.5 million versus second-quarter levels. Available but undrawn capacity on Archrock's revolving credit facility was around $240 million at September 30, 2016.

Cash distributions to be received by Archrock based on its limited partner and general partner interest in Archrock Partners are approximately $7.1 million for the third quarter 2016. Compared to the same level for second quarter 2016. In the event that the drop-down closes prior to Archrock Partners third-quarter distribution record date, Archrock has agreed to waive third-quarter distributions on the incremental LP and GP units received as consideration for drop-downs, since partners will not have owned the assets in Q3.

In connection with the drop-down, Archrock announced that it will increase its quarterly dividend by $0.025 per share to $0.12 beginning with the third-quarter dividend. Archrock's $8.5 million quarterly dividend will be paid on November 17. Archrock's second quarter 2016 dividend was $6.7 million. With this increase, Archrock's cash available for dividend coverage was approximately 2 times for the third quarter.

Turning to the financial results for the partnership, Archrock Partners' third-quarter EBITDA as adjusted was $68 million, down 5% as compared to $71 million in the second quarter of 2016, primarily driven by lower revenue partially offset by lower SG&A expense. Net loss was $600,000 in the third quarter compared to net income of $3.3 million in the second quarter.

Revenue for the third quarter was $135 million as compared to $140 million in the second quarter. The decline in revenue was primarily attributable to the full impact of Q2 operating horsepower declines and competitive pricing, as already noted. Revenue per average operating horsepower was $49.25 for the third quarter, down 1% compared to $49.75 in the second quarter. Cost of sales per average operating horsepower was $18.49 in the third quarter, up 6% compared to $17.52 in the second quarter 2016 as we deployed additional resources into growth plays, including the Permian.

Gross margins were solid at 62% in the third quarter, but down from 65% in the second quarter 2016 for reasons noted previously. SG&A expenses for the third quarter were $18 million, a reduction of approximately 9% or $2 million compared to the second quarter 2016. Distributable cash flow was $44 million in the third quarter of 2016, down from $47 million in the second quarter. Our distributable cash flow coverage remains very strong at 2.5 times in the third quarter compared to 2.7 times in the second quarter 2016.

Archrock Partners' capital expenditures for the third quarter were approximately $18 million, consisting of $13 million for fleet growth capital, and $5 million for maintenance activities. On the balance sheet, Archrock Partners' total debt decreased $40 million sequentially and stood at $1.37 billion as of September 30, 2016. Available but undrawn debt capacity under Archrock Partners' debt facilities at September 30 was approximately $274 million.

As of September 30, 2016, Archrock Partners had a total leverage ratio, which is covenant debt to EBITDA as adjusted, as defined in the credit agreement, of 5 times, up slightly from 4.9 times at the end of the second quarter. As a reminder, our covenant maximum debt to EBITDA is 5.95 times through the end of 2017.

Archrock Partners' senior secured leverage ratio, which is senior secured debt to EBITDA as adjusted as defined in the credit agreement, was 2.5 times at September 30, 2016 as compared to 2.5 times at the end of the second quarter. Leverage at the partnership continues to be a primary focus for Archrock and Archrock Partners, as evidenced by our equity finance drop-down transactions.

Now let's discuss Archrock guidance for the fourth quarter of 2016, which includes the consolidation of Archrock Partners' results. In contract operations, we expect revenue of $150 million to $155 million with gross margins in the 61% to 63% range. As Brad mentioned, we do not expect customer activity to change meaningfully in the fourth quarter. For AMS we expect revenue of $37 million to $42 million with gross margins between 16% and 18%. We believe our aftermarket services business will generally be in line with the third-quarter performance.

On SG&A expenses we are targeting $26 million to $27 million for the fourth quarter as we continue to focus on cost management. Depreciation and amortization expense is expected to be in the low to mid-$50 million range with interest expense of approximately $20 million. For 2016, total CapEx is expected to be in the range of $110 million to $120 million, which lowers the top end of guidance provided on the second-quarter call by $10 million. Within our total CapEx outlook we have increased our growth CapEx guidance for the year, but that increase is offset by a decrease in expected total maintenance CapEx.

Maintenance capital spending for the year is expected to be $30 million to $35 million, roughly 55% lower than 2015 levels and $10 million lower than our guidance on the second-quarter call. New build capital expenditures are expected to be in the $75 million to $85 million range for the full year 2016, which represents a 40% to 50% reduction from 2015 levels. This is moderately higher than guidance in the prior quarter, driven primarily by the award of projects from customers requiring equipment that is in tight supply both in the market and in our fleet. At Archrock Partners we expect new build capital expenditures to be in the $45 million to $55 million range, and maintenance capital expenditures in the $20 million to $25 million range.

As a final note before I open the call for questions, I want to mention that we are continuing, with our audit committee, the process of determining the impact on our pre-spin historical financial statements of the previously disclosed investigation at Exterran Corporation into certain accounting items related to its Belleli subsidiary. As discussed last quarter, Exterran Corporation's results have been reported as income from discontinued operations net of tax, and Archrock's consolidated statement of operations for historical periods presented in Archrock's 2015 annual report on Form 10-K.

As a result of the ongoing process, we are again providing an operational update only, in lieu of our typical earnings release for Archrock, because we are not able at this time to provide financial information that would require a reconciliation to historical information that could be impacted by this process.

Our discussion of Archrock's financial results on this call took 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. As previously stated, Archrock Partners is not expected to be impacted by this process, and we expect to file Archrock Partners' 10-Q later today consistent with past practices.

Since this process is ongoing, we can not 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. I will now turn the call back to the operator and open it up for questions.

(Operator Instructions)

Blake Hutchinson, Scotia Howard Weil.

Good morning.

Good morning.

I guess first of all, Brad, I wanted to make sure we're not mischaracterizing your outlook in the business, although it was kind of sideways for 4Q. It sounded like, as you look into the first half of the year, unlike recent years where we've had customers go out and reconfigure fleets to the negative, you might actually see the reconfiguration trend be a net positive to you? Is that characterizing your first half outlook correctly?

Blake, the reconfiguration thought is not the way I would characterize it. I want to say I'm not sure what to do with the reconfiguration characterization. But I can expand on what I'm trying to put into our outlook. That is, while for the near-term, and that means Q4, could be beyond Q4, because the market is just stabilizing, and showing us signs of secular growth in the future. Picking the point at which we see that actual turn is too hard to do. Where we were at in providing the guidance for the market outlook that we provided, is that while it does look like we had good activity in Q3, we expect that to continue into Q4, and beyond, what we're not seeing is yet that turn in the market, or the timing of the turn, with the great clarity that we would all like to see.

Another way of saying it, is that while we believe the market is stabilizing, and nicely, we see an uptick in order discussions with our customers, which is good. And looking out, we certainly see increases in production in natural gas ahead. We're not out of the woods yet. I don't think the sector is out of the woods. We saw some of the choppiness in the market even this week. That is the way I would characterize what we're looking at in the future.

Okay. That's fair and exactly what I was looking for. And then I guess, as we look at the opportunity set on the new build side clearly has gone up, and you talked a little bit about the incremental adds, mix shift towards gathering applications, as we think about potential turn and all of these adds, you mentioned several times that obviously pricing is quite competitive. At some point, I guess stepping back, given the mix predilection, I guess, for lack of a better term, would you expect that the impact on margin from the incremental capacity you are putting back would be relatively seamless, or at some point do we need to consider that as dilutive just because of a new kind of pricing regime.

When we move to a stronger growth mode, we will incur mobilization expense both in the form of make ready as well as mobilization into the field. We will incur those expenses ahead of revenue starting. And we believe that you will see that investment show up in incremental gross margin deterioration.

Right but -- sorry.

When we get to that point, however, we will be pretty happy to see that investment level of equipment going to work, and going back into the field.

Okay. And then just finally, you noted the lower number of maintenance CapEx. Is that just a function of lower average working horsepower throughout the year, or have you post-separation kind of identified higher level efficiency, in just your maintenance CapEx spending? I would just like to hear about that.

There are three contributors to that lower level of maintenance CapEx. The first really is the one you cited, and that is lower average working horsepower in the field. We don't spend money maintaining that equipment. Although we do button it up and get it ready to wait until it can go to work on the next job.

The second is that we actually have made structural improvements to the way that we manage our maintenance CapEx through a combination of both a centralization process for decision-making, as well as better decision-making in how we approach the units. In essence we look at on a condition base, hours, runtime approach with more discipline than we have been able to in the past, whether and when that equipment is required to incur a major maintenance event.

And third, it is the case that when you're reducing cost, we absolutely have tried to ensure that every dollar we spend is a dollar that needed to be spent at that point. There is a small amounts -- there is an amount of deferred maintenance that we believe is acceptable and warranted that in no way has impaired our performance in the field, or the operation of the equipment. So it is those three categories.

A great. Thanks for your time guys. I appreciate it.

Thank you.

Mike Urban, Deutsche Bank

Thanks, good morning. Wanted to follow up on the cost question as well. You've done a great job reducing costs overall, you just addressed the maintenance cost. I know there is always more that you can do, have we seen the big decrements to your cost structure at this point, kind of the big structural changes, you've obviously made some cyclical changes, and maybe some of that would hopefully be temporary in terms of salary reduction and things like that, hopefully you have better times ahead. But, are we most of the way through that process, and they will be more incremental going forward, or are there still some big structural chunks that you can take out?

I think that running in the 60%, low and mid-60% gross margin for this business and like businesses is a very good run rate. There are natural limitations on what you can achieve from a gross margin percent in the marketplace. Among them is the competition. The competition both within our customer base as well as externally. This is a very good run rate. While I am definitely in agreement that we never feel done with improving the operation, I do believe that the amount of profitability that we have achieved is a testament to both maintaining revenue with customer pressure as well as reducing cost through great operations.

So we are at a level where I do believe is going to be incremental gains that will allow us to maintain margin, and will improve margin going forward knowing that there will be headwinds in the form of both pricing, potential increases in commodity pricing, because we've seen an uplift in commodity pricing that will obviously impact parts of our business going forward, as well as in the labor category. So I do believe that we're not throwing up the flag, not calling it quits, we believe there is more ahead, but they are going to be incremental.

Got you. And historically I think there's been a little bit of seasonality in your cost structure, I think kind of peaking in the warmer months, longer daylight hours, that kind of stuff. Is that going to be the case this year, or are you starting to see some of those headwinds creep in, in Q4, Q1?

We have a couple of [seed] times of the year where operating activities are driven by environmental and ambient conditions more than at other times of the year. We experience that primarily in some of the peaky hot summer months in the South, in particular. And we experience it in some of the very cold months primarily in the North. That does generate incremental operating activity around how we maintain the equipment. So we will experience some of that. But for the fourth quarter we did take that into account in our guidance.

Okay. Got you. And then the last one for me, it looks like you did experience a little bit of additional pricing pressure in the quarter. What are you seeing I guess, at the leading edge? On average presumably if it continued to come down, are you seeing any stabilization on the pricing front, or is that still continuing to come down at the leading edge?

Mike, we always approach the pricing discussion, especially any forward-pricing talk with a bit of caution. So it's not the kind of area that we go to specifically. Generally what I would share with you, is when we look at the industry across the board, there's definitely excess capacity in the market. Our utilization, which is at 79% right now on the total fleet, reflects incremental capacity that needs to go back to work. As long as we see utilization and below the low to mid-80s I believe, we and the industry, will continue to experience price pressure in those categories that are underutilized, and we will continue to see some pricing aggressiveness to put that equipment back to work until utilization ticks back up.

Got it. Okay. That's all from me. Thank you.

Thanks.

Andrew Burd, JPMorgan.

Hello, good morning. Perhaps you could just walk us through a little bit more the drop-down decision. Was it purely because you view APLP units as so cheap, or is there something else, either offensive or defensive that might have driven the timing decision on that?

No. Let me take a cut at this question. The real issue that we wanted to focus on, and we have been focused on, is primarily bolstering APLP's combination of leverage and liquidity at this time. As well as the execution of our longer-term strategy of transferring horsepower from Archrock to our Archrock Partners over time. The timing of this is really driven by those two factors, and that is what we sought to do. I do think that we were encouraged by some of the increasing in the price that we've seen, and the valuation and yield on APLP over the last several months.

That was a factor that allowed us to want to proceed at this time and at the same time, it was a supportive transaction from AROC to APLP from a value perspective, and for the benefit of Archrock we also though get the benefit of what we think are well-priced APLP units, especially given the robust distribution coverage that we have at our Archrock Partners.

That is helpful. And just a follow-up on kind of the characterization of the assets being dropped down. I appreciate the color that was provided in the press release. But anything that you can offer in terms of utilization of those assets, contractual coverage, any region or anything would be helpful there.

The assets are basically like a cross section of our overall asset base. As far as utilization, we only drop down 100% utilized assets. So the assets of [130,000] horsepower is all utilized. It's slightly larger than the average size -- than the overall average of our fleet, but only slightly larger. And so I think when you're trying to model it out, I think you could just use Archrock Partners' financial metrics and apply them to that horsepower and you get pretty close to where we are.

Okay. And kind of taking that, or also using the words from the press release of the kind of immediate accretion that is expected, is it fair to say that the drop-down multiple is probably below where APLP is trading right now?

Yes.

Okay. Great, thanks for taking my questions.

Sure.

John Watson, Simmons & Company.

Good morning.

Good morning.

As a follow up to one of Mike's questions, Brad, once utilization does reach maybe a high-80s percentage, what units and in which basin do expect pricing to improve the most quickly, or maybe said another way, on what types of units and in which basins is there the most excess capacity at the moment?

Let me address the basins first. We have seen and we believe we'll continue to see customer capital funding growth and expanding production capacity more aggressively in the Permian, in the SCOOP and STACK in the Mid-Continent, in the Niobrara, in the Marcellus Utica, ahead of other plays. Although other plays will also have some potential for growth. So that is where think the capital goes back to work first and puts the most -- the largest opportunities for growth ahead in our business.

From an equipment type perspective, we still see, even though utilization is in the 79% for us, and I think that's somewhat reflective of the overall market, in that range from an equipment perspective, there's still a fair amount of tightness in certain categories, especially larger horsepower units. So that would be the 1400 horsepower size and above. And there are some mid-range in the 600 horsepower and 800 horsepower range of units, we also see a little bit of tightness. We see, still, excess capacity at smaller horsepower ranges and in some categories of equipment that is slightly larger, but coming out of the dry gas plays, so that is an older model, for example, of the 1200 horsepower-type units.

That's where we expect to see the tightness first in the market, that's where we are seeing some of the tightness now from a play perspective, and it's in the larger horsepower where we expect to see the tightness in the equipment type.

Okay. Great. And then an unrelated one, also a follow-up to one of Mike's questions, are there cost that have been made over the past few quarters that you think might not be sticky when the market does turn? I know we don't know when that [up fluction] point is, but any thoughts there?

Overall, the thought is, we have made reductions that have permanently improved our structure, operationally and financially, that we absolutely intend to leverage going forward. So a lot of what we have done, we intend to make sure and govern tightly to make it permanent. And that said, when you are in a decline market of course you take out costs ahead of the decline, and you reduce costs that you would otherwise need to invest and incur, whether they are at the CapEx level, or the SG&A level, or OpEx, when the market returns to growth going forward. The main point is, good structural improvement that we're going to leverage going forward, but of course there are some costs in investment that we will need to incur in a growth market that you don't have to incur in a decline market.

Right. And the last one for me on the aftermarket side, what are some catalysts that you think might cause customers to stop deferring maintenance?

The primary drivers around, I think, their decision making on AMS -- and it is a complicated market -- relate to maintaining their own workforces, and the demands on their equipment. So any downturn, everybody wants to maintain their workforce as best they can. And that means they'll turn their attention on more maintenance activities, at the expense of outsource providers. When they get busy thinking about growth, those same resources focus elsewhere and they need the outsource provider more.

Second, like all businesses they rationalize hard their decision making around maintenance expense. Once the upturn comes, they are going to have to get back to maintaining the equipment at a different spend level than they have. So I believe that as we see the industry picking up that, that naturally will occur. That's what we experienced in the past.

Great. I will turn it back. Thanks.

Thank you.

We have no further questions at this time. I would like to turn the call over, back to Mr. Childers.

Great. Thank you everyone for joining our third-quarter conference call, and we look forward to talking to you again with our fourth-quarter results next year. Thank you.