Archrock's (AROC) CEO Bradley Childers on Q2 2016 Results - Earnings Call Transcript

| About: Archrock Inc. (AROC)

Archrock, Inc. (NYSE:AROC)

Q2 2016 Earnings Conference Call

August 4, 2016 10:00 am ET

Executives

Bradley Childers - President and CEO

David S. Miller - SVP and CFO

Analysts

Bhavesh Lodaya - Credit Suisse

Michael Urban - Deutsche Bank Securities

Blake Hutchinson - Scotia Howard Weil

TJ Schultz - RBC Capital Markets

Operator

Good morning and welcome to the Archrock, Inc. and Archrock Partners, L.P. Second Quarter 2016 Conference Call. Today, Archrock and Archrock Partners released their results for the second quarter of 2016. If you have not received a copy, you can find the information on the Company's Web-site at www.archrock.com.

During today's call, Archrock, Inc. 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 this morning 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 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 as 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. [Operator Instructions]

Your host for this morning's call is Brad Childers, President and CEO of Archrock, and I would now like to turn the call over to Mr. Childers. You may begin.

Bradley Childers

Great. Thank you, operator. Good morning, everyone. With me today is David Miller, the CFO of Archrock and Archrock Partners. During our call today, I will review our second quarter operating results and share our market outlook. David will review our second quarter financial results and provide third quarter guidance.

This quarter's results were driven by excellent execution in the field and on our cost and capital reduction program, which produced strong operating performance despite continued low customer activity levels and pricing pressure. We generated EBITDA as adjusted of $83 million on $204 million of revenue in the second quarter, compared to EBITDA as adjusted of $80 million on $213 million of revenue in the first quarter. We improved contract operations gross margin percentage by approximately 250 basis points sequentially from 61% in Q1 to 64% in Q2, and we reduced SG&A expense by 19% from $35 million in Q1 to $28 million in Q2.

The cost and capital reduction program that drove these results prioritizes maximizing our cash flow, maintaining liquidity and strengthening our financial position in order to navigate the current cyclical trough with success and set up Archrock to capitalize on the strong secular growth in U.S. natural gas production that we believe lies ahead.

We initiated this cost and capital reduction effort immediately upon completion of our Spin-off transaction in November of 2015. Year-to-date, we've taken several significant actions. We've reduced our headcount by 23%. Now combining this with the reductions that we made in 2015, our headcount is down by about a third.

For the second year in a row, in order to better align with the current market environment, we've continued to hold salaries and pay rates flat and have reduced incentive compensation throughout the Company. In addition, the executive team and the Board of Directors have voluntarily reduced base salaries and long-term incentives for the executive team and retainer and meeting fees for the Directors.

We've implemented systematic improvements to our field maintenance practices that drove much of the reduction we achieved in operating expenses and maintenance CapEx. From an SG&A perspective, actions we implemented in the first quarter produced a significant sequential decline in SG&A in Q2.

We significantly reduced both growth and maintenance CapEx expenditures. Year-to-date, our total capital expenditures were $72 million compared to $161 million at this point in 2015. And we remain committed to reducing our full-year 2016 capital budget by approximately 50% to 60% compared to 2015.

Finally, in the second quarter, we reduced Archrock's consolidated debt by $38.5 million, with $19.5 million of the reduction at Archrock Partners and $19 million of the reduction at Archrock. The reduction at Archrock does not include an incremental $44 million received related to the PDVSA expropriation settlements, which were used to reduce debt in July.

We believe these efforts have taken significant costs out of our operations while we continue to provide superior service to our customers and sustain excellent equipment run-time availability and maintenance standards.

Now turning to our operations, in the second quarter, our net operating horsepower declined by 138,000 horsepower or 4%, which was a smaller decline than the first quarter. Revenues declined 8% sequentially as we felt the full impact of the first quarter horsepower declines and continued to see pricing pressure.

The decline in our operating horsepower in the second quarter was driven primarily by the continued efforts of our customers to reduce costs by optimizing their compression equipment, shutting in uneconomic wells and reducing compression capacity at locations where production has been reduced.

From a play perspective, a little more than 50% of our operating horsepower reductions came from conventional dry gas plays, with the remainder distributed fairly evenly across the other basins in which we operate, with the exception of the Permian which grew modestly in the quarter.

From an application perspective, we saw an incrementally higher level of horsepower declines in our wellhead group compared to our gathering and gas lift applications. And I want to point out, it was with these headwinds and top line pressures from both a horsepower decline and pricing perspective that Archrock's operations teams drove excellent gross margin performance increasing the gross margin to 64% in the quarter. The solid gross margin performance is attributable primarily to disciplined labor management in the field as well as improved maintenance practices.

In our aftermarket services business, revenue improved modestly in the second quarter, though AMS revenues continue 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 continued as fewer opportunities have led to very competitive pricing. It's important to note that compression maintenance cannot be deferred indefinitely however and we expect an uptick in this business as the environment improves. Until that time, we remain focused on the utilization level of our AMS workforce and maintaining gross margins through this challenging period.

Turning to the Partnership, Archrock Partners experienced proportional declines in operating horsepower and revenue during the second quarter, but improved gross margin percentage to 65% from 62% in the first quarter. SG&A at the Partnership was down about 17% sequentially to just under $20 million.

Improvements in costs at the Partnership were primarily driven by cost reduction activities undertaken at Archrock. Archrock Partners' strong cash flow produced a distributable cash flow ratio of 2.67x and it enabled us to reduce debt in the quarter, though leverage at the Partnership increased to 4.9x debt-to-EBITDA and continues to be a primary focus of Archrock and Archrock Partners in 2016.

Now I'd like to turn to the market and our outlook for the businesses. Despite increased volatility over the last couple of weeks, we believe overall energy market conditions have shown signs of improvement during the last few months. Both natural gas and oil prices improved after lows from the first quarter, rig count has stabilized and has seen modest growth in recent weeks, and some of our customers are showing indications of turning their attention back to new development opportunities.

In our business, we saw a modest increase in new orders in both contract operations and aftermarket services and we're expecting a modest increase in our growth capital for the year to meet customer demand and growth pace for equipment types that are highly utilized in our fleet and in the market.

If the recent improvement in market conditions is sustained, we expect the increased level of customer activity experienced in the second quarter to continue and a moderation of horsepower returns in the second half of 2016. As a result, we expect lower horsepower declines in the second half of the year than we experienced in the first half.

Longer-term, we believe our business continues to be 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 the year 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 U.S. will continue to drive higher levels of demand for LNG export, pipeline exports to Mexico, power generation and industrial uses.

This year, we saw the first LNG export project begin operation and several of the other LNG and petrochem projects are under construction and expected to lead the increasing demand for natural gas starting in late 2017 or early 2018. And Archrock has a strong operating presence and solid customer relationships throughout the U.S., including in the basins that will supply natural gas to meet this growing demand. We plan to leverage our market position, service capability and existing fleet and capital strength to grow our business and our cash flow when and as natural gas production expand as expected.

And finally, in light of current market conditions and our ambitious expectations for future growth of natural gas and our business, I'd like to discuss our financial strategy to position the Company to participate in and capitalize on this growth.

As you know, last quarter we reduced Archrock's dividend and Archrock Partners' distribution and concurrently amended Archrock Partners credit agreement to increase covenant leverage as critical steps in our efforts to address leverage concerns at Archrock Partners, maintaining liquidity, operate within our cash flow and begin to reduce our debt levels. At the same time, we focused on reducing cost and capital expenditures across the board, including operating expenses, SG&A and maintenance and capital growth expenditures. In addition, we've evaluated and will continue to evaluate alternatives to strengthen the financial position of Archrock Partners.

Finally, we recognized that many of our investors own our securities for their yield characteristics. With this in mind, we will work to position Archrock and Archrock Partners so both companies can once again be in a position to grow their respective dividend and distribution.

In order to get to the point where cash payments can increase, we believe that we need to see a path to achieving certain financial targets, including a debt-to-EBITDA ratio at Archrock Partners trending toward 4x or lower, sustainable distributable cash flow coverage at Archrock Partners and adequate liquidity at Archrock Partners to support the growth opportunities ahead of us in the marketplace. Through our multipronged approach to maximize our cash flow, protect our liquidity and solidify our financial position, we are dedicated to work to achieve these objectives as soon as possible.

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

David S. Miller

Thanks Brad. I'll start with a review of second quarter results and then cover guidance for the third quarter. Archrock generated EBITDA as adjusted of $83 million on revenues of $204 million in the second quarter, compared to $80 million of EBITDA as adjusted on revenues of $213 million in the first quarter of 2016. Net loss attributable to Archrock stockholders was $4.5 million in the second quarter of 2016, compared to $1.8 million in the first quarter.

Turning to our segments, in contract operations, revenue came in at $163 million in the second quarter, down from $176 million in the first quarter, due to lower operating horsepower and continued pricing pressure. In the second quarter, much like the first quarter, roughly two-thirds of the declines in revenues related to the declines in operating horsepower and about one-third related to declines in pricing. Gross margin improved to 64% in the second quarter, up from 61% in the first quarter, due mostly to the solid cost management that Brad discussed earlier.

In aftermarket services, revenues of $41 million in the second quarter were up 11% compared to first quarter revenues of $37 million. Activity levels picked up in the second quarter due to the seasonality of the business and customers releasing their budgets for the year. Gross margins declined 100 basis points sequentially to 17%, but remained at a reasonable level in the current market due to our efforts to tightly manage the labor and other costs.

SG&A expenses were $28 million in the second quarter, down 19% from approximately $35 million in the first quarter, as we are seeing the benefits of right-sizing activities and savings initiatives implemented during the first quarter. However, I will note that we did receive a one-time benefit to SG&A of approximately $1.4 million in the quarter on the settlement of an outstanding franchise tax claim. Depreciation and amortization expense was $52 million for the second quarter. Interest expense was $21 million compared to $20 million in the first quarter.

During the second quarter, on a consolidated basis, we determined that approximately 130 idle compressor units totaling approximately 39,000 horsepower would be retired from the active fleet. As a result of the retirement of these units, we recorded a $10.7 million long-lived asset impairment charge. 100 of these units were owned by the Partnership and an impairment charge of $7.7 million was recorded at Archrock Partners.

Additionally, during the second quarter, we reviewed the carrying value of units which had been called from our fleet in previous years and are available for sale. Based on that review, we took an additional impairment of approximately $3 million at Archrock on a consolidated basis. Approximately $1 million of this amount was recorded at Archrock Partners.

In the second quarter, we took further actions to reduce our costs. These actions resulted in a $2.3 million restructuring charge, primarily related to severance benefits and consulting fees. Of this amount, approximately $1 million was allocated to Archrock Partners. Additionally, we recorded $0.7 million in restructuring charges at Archrock associated with the spin-off of Exterran Corporation.

From a capital perspective, in the second quarter, Archrock's growth capital expenditures were $9 million, down 75% from the first quarter levels of $37 million. Maintenance CapEx for the quarter was $10 million, down slightly from first quarter levels of $11 million.

As previously disclosed, pursuant to the separation agreement entered into in connection with the Spin-off, a subsidiary of Exterran Corporation intends to contribute to Archrock subsidiary an amount equal to the remaining proceeds they received from PDVSA Gas relating to the sale of Exterran Corporation's subsidiaries and joint ventures' previously nationalized Venezuelan assets.

In June 2016, Exterran Corporation's subsidiary received payments of $24.5 million from PDVSA and transferred cash to our subsidiary equal to that amount. Because this payment was received late in the day on June 30, it was not available for debt reduction in the quarter.

Additionally, Exterran Corporation subsidiary received another payment from PDVSA in July for $19.5 million, and has transferred that cash to Archrock subsidiary. The aggregate $44 million received from Exterran subsidiary was used to repay debt at Archrock in July. As of July 31, 2016, PDVSA owe the remaining principal amount of approximately $37.5 million.

Second quarter ending debt on a consolidated basis was $1.56 billion, down $38.5 million on a cash basis from first quarter 2016 levels. On a deconsolidated basis, Archrock's Q2 2016 debt balance was $152.5 million, down $19 million versus Q1 2016 levels. Available but undrawn capacity on Archrock's revolving credit facility was approximately $187.5 million at June 30, 2016. Pro forma for the $24.5 million received from Exterran subsidiary on June 30, Archrock's deconsolidated debt balance would have been $128 million and available capacity would have been $212 million.

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 second quarter, compared to $7.1 million in the first quarter. This distribution will be used to fund Archrock's $6.7 million quarterly dividend that will be paid on August 16, 2016, which is flat to Archrock's first quarter dividend. Archrock's cash available for dividend coverage was 2.55x for the second quarter. Coverage in the quarter did benefit from a one-time settlement of a state tax claim of approximately $4.4 million.

Turning to the financial results for the Partnership, Archrock Partners' second quarter EBITDA as adjusted was $71 million, up 3% as compared to $69 million in the first quarter of 2016, primarily driven by operating and SG&A cost reductions that offset sequentially lower revenues. Net income was $3.3 million in the second quarter, compared to $0.5 million in the first quarter.

Revenue for the second quarter was $140 million, as compared to $151 million in the first quarter. The decline in revenue was again primarily attributable to the operating horsepower declines and pricing pressure already noted. Revenue per average operating horsepower was $49.75 for the second quarter, down 3% compared to $51.14 in the first quarter. Cost of sales per average operating horsepower was $17.52 in the second quarter, down 10% compared to $19.54 in the first quarter of 2016.

Gross margins were 65% in the second quarter, up from 62% in the first quarter of 2016. SG&A expenses for the second quarter were $20 million, a reduction of approximately 17% or $4 million compared to the first quarter of 2016. Distributable cash flow was $47 million in the second quarter 2016, up from $44 million in the first quarter. Our distributable cash flow coverage was 2.67x in the second quarter compared to 2.51x in the first quarter of 2016.

Turning to CapEx, Archrock Partners' capital expenditures for the second quarter were approximately $11 million, consisting of $5 million for fleet growth capital and $6 million for maintenance activities. This marks a 52% reduction in capital expenditures compared with the first quarter.

On the balance sheet, Archrock Partners' total debt decreased by $19.5 million sequentially and stood at $1.4 billion as of June 30, 2016. Available but undrawn debt capacity under Archrock Partners' debt facilities at June 30 was approximately $247 million. As of June 30, 2016, Archrock Partners had a total leverage ratio, which is covenant debt to EBITDA as adjusted as defined in the credit agreement, of 4.9x as compared to 4.7x at the end of the first quarter. Archrock Partners' senior secured leverage ratio, which is senior secured debt to EBITDA as adjusted as defined in the credit agreement, was 2.5x at June 30, 2016 as compared to 2.5x at the end of the first quarter.

Now let's discuss guidance for Archrock for the third quarter, which includes the consolidation of Archrock Partners' results. In contract operations, we expect revenue of $155 million to $160 million, with gross margins in the 61% to 63% range. Although market conditions have seen some improvement, we do expect to see some additional declines in net operating horsepower. Margins are expected to be down slightly from Q2 due to a modest seasonal pickup in maintenance activities in Q3. For AMS, we expect revenues of $37 million to $42 million, with gross margins between 16% and 18%. We believe our aftermarket business will be generally in line with the second quarter.

On SG&A expenses, we are targeting $27 million to $28 million for the third quarter as we continue to take actions to manage our costs. 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 $130 million, which is consistent with guidance provided on our first quarter all. Within our total CapEx outlook, however, 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 now expected to be in the $40 million to $45 million range, roughly 40% lower than 2015 levels and $15 million lower than our guidance on the first quarter call.

New build capital expenditures are expected to be in the $60 million to $80 million range for the full year 2016, which represents a 40% to 60% reduction from 2015 levels. This is a $15 million increase from the guidance in the prior quarter, driven primarily by the award of projects by customers requiring equipment that is in tight supply both in our fleet and in the market.

At Archrock Partners, we expect new build capital expenditures to be in the $30 million to $50 million range and maintenance capital expenditures to be in the range of $30 million to $35 million for the full-year 2016.

As a final note before we 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 Belleli subsidiary. As discussed last quarter, Exterran Corporation's results have been reported as income from discontinued operations, net of tax, in Archrock's consolidated statements 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 in lieu of our typical earnings release because we are not at this time able 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 put this limitation into account and we will not be filing Archrock's 10-Q today as we traditionally have 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 the Partnership's 10-Q later today, consistent with past practices.

Since this process is ongoing, we cannot 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 to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Bhavesh Lodaya with Credit Suisse. You may begin.

Bhavesh Lodaya

Congrats on another impressive quarter. So first of all, gross margins at 65%, I believe that's one of the highest we have ever seen. So I appreciate the color on the cost savings efforts and I believe my question is, how sustainable are the margins in the mid-60s, especially keeping in mind the activity levels will likely increase going ahead?

Bradley Childers

Sure. It is really a standout performance at the gross margin level, but we believe that the systematic approach we've taken to improve our business will drive sustained improvement to our gross margin percentage. That said, when we return to more of a growth cycle, there are incremental investments to make units ready and to start them up in the field and to transport them that will provide another headwind for the maintenance of gross margin.

So on a consolidated basis, we've guided to 61% to 63%, and I know that's not APLP alone pressure, but that's the perspective at Archrock. So what we believe, a lot of what we've done is sustainable and we are moving into guidance that is above 60%, in the 61% to 63%, on a consolidated basis. There will be some incremental headwinds when the growth cycle resumes, but we're more than competent for that with growth in our cash flow. So you're right about some headwinds that will hit us.

Bhavesh Lodaya

And onto the new orders you mentioned you saw in 2Q, can you maybe add some color to the size of the horsepower, the regions you are seeing this incremental demand from and how long did it take to actually come online and add to the operating HP?

Bradley Childers

So the order activity that we're seeing is weighted more toward large horsepower than small horsepower in this current market. We see more demand in gathering applications than we see in wellhead currently. I think that's an expression of some of the buildouts that are being completed in a few of the plays. So that's where we're seeing the growth, is more on the large horsepower.

As far as the time it takes, from the time we book until the time we start, the range is pretty wide, candidly from a couple of days to several months. So it's really a wide range depending upon the customer needs. Fortunately, with the fleet capacity that we have, we're able to meet demand on a short-term basis very promptly within just a couple of weeks, one of the advantages of the otherwise having such a large idle fleet.

And from a significant infrastructure perspective, we are in a capital position also where we need to in growth plays with large customers that need equipment that's in tight supply in the market and in our fleet, we are able to deploy that capital, and that timeframe is usually a couple of months.

Bhavesh Lodaya

Right. And I apologize if I missed this, did you update the growth CapEx guidance for 2016 or is it still $25 million to $40 million, $25 million to $45 million?

David S. Miller

We updated the growth CapEx guidance at the MLP to $30 million to $50 million.

Bhavesh Lodaya

Okay, thanks for the update. And then finally, like just given some of the updates in the broader energy space, have you seen any compression assets come to market for potential acquisition?

Bradley Childers

We continue to look at the marketplace and we want to and we'll take actions to look at high quality assets that are in growth plays that will fit well with our operations. What's exciting about those opportunities is that we believe we can bring those assets on without expanding our infrastructure incurring incremental SG&A. So we think that is a very cost-effective way to grow the business, and we will keep looking. We have seen asset packages over the last 12 and 24 months but none where we saw the right alignment on the factors that we think are critical to success to pull the trigger on.

Bhavesh Lodaya

Great. Thank you for your time.

Operator

Our next question comes from Mike Urban with Deutsche Bank. You may begin.

Michael Urban

So recognizing that you guys just spent a lot of time and effort going through the Spin and kind of cleaning up the structure, you have seen some companies in kind of the broader MLP and related space look to buy back in their MLPs just given some of the challenges in that market, is that something that you've looked at or an analysis you've looked at or do you still think you are ultimately in mid or long run getting a lower cost of capital from the current structure?

Bradley Childers

It's definitely a structural change that we have evaluated, and candidly, as we look forward into the market, we will continue to evaluate all options that we should to think about continuing to strengthen APLP and the cash flow and the ability for APLP to both grow as well as to increase distributions.

So, it is something we've looked at, it's something that we will continue to look at. I would point out that some of the factors that drove more recent consolidations are not really present in our scenario. Where they've done it to address leverage, their leverage issues have been more acute. In some instances, they've done it to address the fact that the GP being in the high splits rendered accretive growth very hard to achieve. Neither factor of which is acute or present in our scenario.

And we haven't given up and we don't think the market has, that the GP/MLP hold-co structure ultimately offers value in the upside in the form of the yield valuation that can be applied as well as in the opportunity to have multiple currencies to facilitate for example acquisitions.

And then finally, our main focus during this market is to stay really aggressive in managing our liquidity position in both entities ultimately to both preserve our operations through this cycle, which we're going to do with success, and be positioned at the back-end of this cycle to be able to grow our business. And that drive to preserve liquidity is what's really the focus of our structural decision-making and the way we're thinking about managing our actions through this period.

Michael Urban

Very helpful, thanks. And then I guess operationally, extremely severe downturn in some major structural changes across just the broader energy spectrum. Specific to your business though, have you seen any notable share shifts or have you seen any opportunities to move into or grow in markets where maybe you were underexposed or maybe vice versa where someone is continued to be perhaps irrationally aggressive, I guess just any changes that you've noticed over the course of the down-cycle in terms of market position and share and things like that?

Bradley Childers

Interesting question, I think I have kind of two points to make on that, and just make a quick note. The first is that what we noticed is that when utilization industry-wide tips down below something in the mid to low 80s, and it certainly did that last quarter, when it tips down below, the pricing aggressiveness really does increase structurally in the market for equipment that is at that level of utilization. And so we have seen a lot of aggressiveness on pricing in order to just protect positions in the marketplace. And we too, by the way, have been aggressive in helping our customers with their OpEx in order to protect market position during the cycle. So, one of the main drivers that we've all experienced is that pricing aggressiveness and that utilization percentage appears to be kind of a pivot point for how aggressive the market is.

The second, we do see some shifting in plays where the growth in the future is going to come from, in the near-term out of the Texas and Louisiana area and in the long-term including in the Marcellus and Utica, and so we see more market share positioning, and candidly, some opportunities for us to attack those markets aggressively. And we're definitely trying to make sure that we're positioning ourselves to do so, so that we are in the right position and with the right relationships when and as natural gas growth occurs, which as you can hear, we're pretty bullish on. At the tail-end of this cycle, we see significant demand growth for natural gas ahead and we want to be well-positioned, we believe we will be well-positioned, to participate in that.

Michael Urban

Great, thank you.

Operator

Our next question comes from Blake Hutchinson with Howard Weil. You may begin.

Blake Hutchinson

I was interested, Brad, on your thoughts regarding how we should think about pricing here. I know in the first half of the year, typically seasonally you go through some major reconfiguration fleets and it can act on a bit of a lag. Should we think of pricing here as kind of proportional to your commentary on horsepower declines, meaning it eases a bit and maybe we stay in that two-thirds/one-third type of realm or do we still have some catching up to do here for the broader fleet to get on to kind of what we would call a mark-to-market price?

Bradley Childers

Blake, as you know, I'm most comfortable talking about pricing for legal reasons in the rear-view mirror and not so comfortable thinking about pricing guidance forward. So that's a real tough question for me to really answer, as you can imagine. What I would repeat a bit is the discussion I had just on the last question, and that is that I think pricing remains fairly aggressive as long as utilization is below 80% range. But it can't go low or lower forever. So I think that we're still going to be in a very aggressive pricing market with utilization in the ranges that it is in the industry overall.

Blake Hutchinson

Okay, fair enough. I apologize for putting you in a bad spot on that one. And then just helping us understand functionally how the business is working and how you achieved such high margins, just refresh us, in terms of frictional mobilization expenses, when you're subject to these returns, that's the customer is paying those, so that's something that we don't necessarily see that gets reintroduced, I think you kind of hit on this earlier but just wanted to be sure, so when you start thinking about actually getting into an add-back scenario, that that's reintroduced?

Bradley Childers

Yes, I think I got it. When you think about the two sides of going and putting a service on location, the mobilization expense is generally borne by the service provider, that is us, to mobilize, put the service on location and get it started. There is incremental expense associated with that even before revenue begins. So that's part of the expense we see on the mobilization side. On the de-mob side, typically the customer bears the expense, and that's not going to change.

Blake Hutchinson

Okay, got you. Appreciate that. And then just to give us a little insight perhaps on appetite for new equipment, I take it that everything you spent in the first portion of this year, back half of last year, is in the field and is there some potential benefit from that entering that gives you a little more confidence in kind of net attrition levels or is it already out and active?

Bradley Childers

The bulk of it is out and active to the extent it was delivered in Q1. We still have some deliveries Q2 and then obviously Q3 and Q4 that have yet to be activated. But what we see with it, it's at a lower level overall in the marketplace but stability in our expected start activity based on the investments we've made.

Blake Hutchinson

Great.

Bradley Childers

Just to say it more specifically, the equipment goes to work very promptly.

Blake Hutchinson

Got you. And then just finally, any reason to believe differently that any ensuing payments from Venezuela would be applied directly to debt reduction?

Bradley Childers

Fair question but we just were very pleased to have received the payments to date that we've received. It's fair to say we had a healthy dose of skepticism as to when we would receive payments out of Venezuela, given the extreme circumstances and economic conditions in that country right now. So while we have a commitment from Exterran to past on future payments received from Venezuela, and these most recent payments are indication they want to make good on their debt, it's still maybe a stretch given the risk of regime change and the extreme conditions that they are suffering in Venezuela. So I'm not going to venture to handicap the odds of receiving the next payments.

Blake Hutchinson

I understood, but could it possibly be for debt reduction if they do come in?

Bradley Childers

That's right.

Blake Hutchinson

Okay. Thank you very much. I'll turn it back.

Operator

Our next question comes from TJ Schultz with RBC Capital Markets. You may begin.

TJ Schultz

I guess just one thing on the distribution, and I do appreciate all the context on how you will evaluate restarting growth in MLP distributions, my question is a little more I guess just technical in nature on the distribution when you do get to that point, assuming market conditions go as expected. So you're obviously carrying a lot of excess coverage at the MLP now. Would you look at that point on increasing distributions gradually in order to be able to provide line of sight on a longer path of distribution growth as you bring coverage down or would you be more inclined to reset the distributional level that gets you to a certain coverage point that you think is sustainable long-term, and I'm just trying to think about capturing the IDR cash flow sooner rather than later as part of that decision process?

Bradley Childers

Sure. Very challenging question to answer from the position we're in today, because the balance of factors that will go into it are several. But I would say that when we make the recommendation on when it's time to and we're in a position and those factors are satisfied to increase, we'll look at the ability to fund CapEx again with both equity as well as with debt, we'll look at the strength of our cash flow generation and the other capital demands we have on the business including internal and potentially external to figure out how to deploy that capital, but we would be inclined to want to distribute the cash that is best used by returning it to our stockholders.

And so I wouldn't say that we have yet any game-plan that says we're going to do it only incrementally or that we don't have a plan to do it only incrementally, but that we would try to make sure we understand the highest value that that capital can be used for which would compete capital distribution with debt reduction, growth opportunities internal and external and setting it out. And that's about the most guidance I think I can venture.

TJ Schultz

Okay, great. I understand. Thanks very much.

Operator

And that concludes the question-and-answer session. I will now turn the call over to Brad Childers for closing remarks.

Bradley Childers

Great. Thank you everyone and thanks for participating in our second quarter call today. We believe we've taken and will continue to take the right steps to right-size our business, to deliver attractive margins and to position Archrock to navigate both this current cycle and to set up Archrock to capitalize on the expected strong secular growth in natural gas production that we believe lies ahead.

We'll continue to maximize the performance that our relatively stable compression business delivers, and as we do, we'll remain focused on providing exceptional coverage and service to our customers, protecting our balance sheet, liquidity and leverage positions and maximizing our free cash flow. Thank you and I look forward to updating you on our call following the third quarter. Thanks very much.

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