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 adjustments, consisting only of normal recurring adjustments, 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 our Annual Report on Form 10-K for the year ended December 31, 2016, which contains a more comprehensive summary of our accounting policies. The interim results reported herein are not necessarily indicative of results for a full year. Certain prior year amounts have been reclassified to conform to the current year presentation.

Organization

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

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 unless their effect would be anti-dilutive.

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



	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
Loss from continuing operations attributable to Archrock stockholders	$	(6,687	)	$	(4,451	)	$	(18,372	)	$	(6,270	)
Loss from discontinued operations, net of tax	—			(26		)	—			(26		)
Net Loss attributable to Archrock stockholders	(6,687		)	(4,477		)	(18,372		)	(6,296		)
Less: Net income attributable to participating securities	(180		)	(151		)	(334		)	(335		)
Net loss attributable to Archrock common stockholders	$	(6,867	)	$	(4,628	)	$	(18,706	)	$	(6,631	)

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,
	2017		2016		2017		2016
Weighted average common shares outstanding including participating securities	70,908		70,627		70,833		70,390
Less: Weighted average participating securities outstanding	(1,320	)	(1,606	)	(1,337	)	(1,468	)
Weighted average common shares outstanding — used in basic income (loss) per common share	69,588		69,021		69,496		68,922
Net dilutive potential common shares issuable:
On exercise of options	*		*		*		*
Weighted average common shares outstanding — used in diluted income (loss) per common share	69,588		69,021		69,496		68,922


*	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,
	2017	2016	2017	2016
Net dilutive potential common shares issuable:
On exercise of options where exercise price is greater than average market value for the period	282	534	297	725
On exercise of options	108	45	125	23
Net dilutive potential common shares issuable	390	579	422	748

Comprehensive Income (Loss)

Components of comprehensive income (loss) are net income (loss) and all changes in equity during a period except those resulting from transactions with owners. Our accumulated other comprehensive income (loss) consists of changes in the fair value of derivative 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, 2016 and 2017 (in thousands):



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

Accumulated other comprehensive loss, January 1, 2017	$	(1,678	)
Gain recognized in other comprehensive income, net of tax⁽³⁾	173
Loss reclassified from accumulated other comprehensive loss, net of tax⁽⁴⁾	569
Other comprehensive income attributable to Archrock stockholders	742
Accumulated other comprehensive loss, June 30, 2017	$	(936	)

⁽¹⁾

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.

⁽²⁾

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).

⁽³⁾

During the three months ended June 30, 2017, we recognized a loss of $0.1 million and tax benefit of $0.1 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, 2017, we recognized a gain of $0.2 million and immaterial tax expense in other comprehensive income (loss) related to the change in the fair value of derivative financial instruments.

⁽⁴⁾

During the three months ended June 30, 2017, we reclassified a loss of $0.4 million to interest expense and a tax benefit of $0.1 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, 2017, we reclassified a loss of $0.9 million to interest expense and a tax benefit of $0.3 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, 2017 and December 31, 2016, 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 prices 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, 2017 and December 31, 2016 (in thousands):



	June 30, 2017				December 31, 2016
	Carrying Amount⁽¹⁾		Fair Value		Carrying Amount⁽¹⁾		Fair Value
Fixed rate debt	$	685,152	$	699,000	$	683,577	$	686,000
Floating rate debt	757,500		759,000		758,147		759,000
Total debt	$	1,442,652	$	1,458,000	$	1,441,724	$	1,445,000


⁽¹⁾	Carrying amounts 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 value 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.