1. Organization and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements of Archrock, Inc. (“Archrock,” “our,” “we” or “us”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP are not required in these interim financial statements and have been condensed or omitted. Management believes that the information furnished includes all normal recurring adjustments, and adjustments related to the matters described in Note 17 (“Restatement of Previously Reported Consolidated Financial Statements”), that are necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods indicated. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements presented in Amendment No. 1 to our Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K/A”). That report contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year.

Income (Loss) Attributable to Archrock Common Stockholders Per Common Share

Basic income (loss) attributable to Archrock common stockholders per common share is computed using the two-class method, which is an earnings allocation formula that determines net income per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Under the two-class method, basic income (loss) attributable to Archrock common stockholders per common share is determined by dividing income (loss) attributable to Archrock common stockholders after deducting amounts allocated to participating securities, by the weighted average number of common shares outstanding for the period. Participating securities include our unvested restricted stock and certain stock settled restricted stock units that have nonforfeitable rights to receive dividends or dividend equivalents, whether paid or unpaid. During periods of net loss, no effect is given to participating securities because they do not have a contractual obligation to participate in our losses.

Diluted income (loss) attributable to Archrock common stockholders per common share is computed using the weighted average number of shares outstanding adjusted for the incremental common stock equivalents attributed to outstanding options and warrants to purchase common stock, restricted stock units, stock to be issued pursuant to our employee stock purchase plan and convertible senior notes, unless their effect would be anti-dilutive.

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



	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Loss from continuing operations attributable to Archrock stockholders	$	(4,451	)	$	(4,848	)	$	(6,270	)	$	(7,609	)
Income (loss) from discontinued operations, net of tax	(26		)	(19,328		)	(26		)	14,460
Net income (loss) attributable to Archrock stockholders	(4,477		)	(24,176		)	(6,296		)	6,851
Less: Net income attributable to participating securities	(151		)	(126		)	(335		)	(243		)
Net income (loss) attributable to Archrock common stockholders	$	(4,628	)	$	(24,302	)	$	(6,631	)	$	6,608

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



	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
Weighted average common shares outstanding including participating securities	70,627		69,503		70,390		69,339
Less: Weighted average participating securities outstanding	(1,606	)	(989	)	(1,468	)	(958	)
Weighted average common shares outstanding — used in basic income (loss) per common share	69,021		68,514		68,922		68,381
Net dilutive potential common shares issuable:
On exercise of options and vesting of restricted stock units	*		*		*		*
On settlement of employee stock purchase plan shares	—		*		—		*
Weighted average common shares outstanding — used in diluted income (loss) per common share	69,021		68,514		68,922		68,381


*	Excluded from diluted income (loss) per common share as their inclusion would have been anti-dilutive.

The following table shows the potential shares of common stock issuable that were excluded from computing diluted income (loss) attributable to Archrock common stockholders per common share as their inclusion would have been anti-dilutive (in thousands):



	Three Months Ended June 30,		Six Months Ended June 30,
	2016	2015	2016	2015
Net dilutive potential common shares issuable:
On exercise of options where exercise price is greater than average market value for the period	534	374	725	471
On exercise of options and vesting of restricted stock units	45	290	23	286
On settlement of employee stock purchase plan shares	—	1	—	—
Net dilutive potential common shares issuable	579	665	748	757

Comprehensive Income (Loss)

Components of comprehensive income (loss) are net income (loss) and all changes in equity during a period except those resulting from transactions with owners. Our accumulated other comprehensive income (loss) consists of foreign currency translation adjustments, changes in the fair value of derivative financial instruments, net of tax, that are designated as cash flow hedges to the extent the hedge is effective, amortization of terminated interest rate swaps and adjustments related to changes in our ownership of Archrock Partners, L.P. (along with its subsidiaries, the “Partnership”).

The following table presents the changes in accumulated other comprehensive income (loss) by component, net of tax, and excluding noncontrolling interest, during the six months ended June 30, 2015 and 2016 (in thousands):



	Derivatives Cash Flow Hedges				Foreign Currency Translation Adjustment				Total
Accumulated other comprehensive income, January 1, 2015	$	(911	)		$	26,745			$	25,834
Loss recognized in other comprehensive loss, net of tax	(1,943		)	⁽¹⁾	(4,420		)	⁽³⁾	(6,363		)
Loss reclassified from accumulated other comprehensive income, net of tax	1,030			⁽²⁾	—				1,030
Other comprehensive loss attributable to Archrock stockholders	(913		)		(4,420		)		(5,333		)
Accumulated other comprehensive income, June 30, 2015	$	(1,824	)		$	22,325			$	20,501

Accumulated other comprehensive loss, January 1, 2016	$	(1,570	)		$	—			$	(1,570	)
Loss recognized in other comprehensive loss, net of tax	(2,666		)	⁽⁴⁾	—				(2,666		)
Loss reclassified from accumulated other comprehensive loss, net of tax	655			⁽⁵⁾	—				655
Other comprehensive loss attributable to Archrock stockholders	(2,011		)		—				(2,011		)
Accumulated other comprehensive loss, June 30, 2016	$	(3,581	)		$	—			$	(3,581	)

⁽¹⁾

During the three months ended June 30, 2015, we recognized a loss of $0.6 million and a tax benefit of $0.2 million, in other comprehensive income (loss) related to changes in the fair value of derivative financial instruments. During the six months ended June 30, 2015, we recognized a loss of $2.9 million and a tax benefit of $1.0 million, in other comprehensive income (loss) related to changes in the fair value of derivative financial instruments.

⁽²⁾

During the three months ended June 30, 2015, we reclassified a loss of $0.9 million to interest expense and a tax benefit of $0.4 million to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss). During the six months ended June 30, 2015, we reclassified a loss of $1.6 million to interest expense and a tax benefit of $0.6 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 and six months ended June 30, 2015, we recognized a gain of $3.3 million and a loss of $4.4 million, respectively, in other comprehensive income (loss) related to changes in foreign currency translation adjustment.

⁽⁴⁾

During the three months ended June 30, 2016, we recognized a loss of $1.5 million and a tax benefit of $0.5 million in other comprehensive income (loss) related to the change in the fair value of derivative financial instruments. During the six months ended June 30, 2016, we recognized a loss of $4.0 million and a tax benefit of $1.3 million in other comprehensive income (loss) related to the change in the fair value of derivative financial instruments.

⁽⁵⁾

During the three months ended June 30, 2016, we reclassified a loss of $0.5 million to interest expense and a tax benefit of $0.2 million to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss). During the six months ended June 30, 2016, we reclassified a loss of $1.0 million to interest expense and a tax benefit of $0.4 million to provision for (benefit from) income taxes in our condensed consolidated statements of operations from accumulated other comprehensive income (loss).

Financial Instruments

Our financial instruments consist of cash, receivables, payables, interest rate swaps and debt. At June 30, 2016 and December 31, 2015, the estimated fair values of these financial instruments approximated their carrying amounts as reflected in our condensed consolidated balance sheets. The fair value of our fixed rate debt was estimated based on quoted market yields in inactive markets, which are Level 2 inputs. The fair value of our floating rate debt was estimated using a discounted cash flow analysis based on interest rates offered on loans with similar terms to borrowers of similar credit quality, which are Level 3 inputs. See Note 9 (“Fair Value Measurements”) for additional information regarding the fair value hierarchy.

The following table summarizes the carrying amount and fair value of our debt as of June 30, 2016 and December 31, 2015 (in thousands):



	June 30, 2016				December 31, 2015
	Carrying Amount⁽¹⁾		Fair Value		Carrying Amount⁽¹⁾		Fair Value
Fixed rate debt	$	682,019	$	626,000	$	680,484	$	524,000
Floating rate debt	880,523		881,000		896,398		897,000
Total debt	$	1,562,542	$	1,507,000	$	1,576,882	$	1,421,000


⁽¹⁾	Carrying values are shown net of unamortized debt discounts and unamortized deferred financing costs. See Note 7 (“Long-Term Debt”) for further details.

GAAP requires that all derivative instruments (including certain derivative instruments embedded in other contracts) be recognized in the balance sheet at fair value and that changes in such fair values be recognized in income (loss) unless specific hedging criteria are met. Changes in the values of derivatives that meet these hedging criteria will ultimately offset related income effects of the hedged item pending recognition in income.

Goodwill

Beginning in late 2014 and extending throughout 2015, the energy markets experienced a significant reduction in oil and natural gas prices which has had a significant impact on the financial performance and operating results of many oil and natural gas companies. Such declines accelerated in the fourth quarter of 2015, resulting in higher borrowing costs for companies and a substantial reduction in forecasted capital spending across the energy industry leading to lower projected growth rates over the short-term. Such declines impacted our future cash flow forecasts, our market capitalization, and the market capitalization of peer companies. We identified these conditions as a triggering event, which required us to perform a two-step goodwill impairment test as of December 31, 2015. Accordingly, we recorded a preliminary full impairment of our goodwill in the fourth quarter of 2015 of $3.7 million. During the first quarter of 2016, we finalized the impairment analysis, which did not result in an adjustment to the preliminary impairment booked in the fourth quarter of 2015.