Archrock, Inc.

Good morning, and welcome to ArchRock Second Quarter 2020 Conference Call. Your host for today's call is Megan Repon, Vice President of Investor Relations at ArchRock. I would now like to turn the call over to Mrs. Repon. You may begin.

Thank you, Devin. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of ArchRock, and Doug Aaron, Chief Financial Officer of ArchRock. Yesterday, ARTRAC released its financial and operating results for the second quarter of 2020. If you have not received a copy, you can find the information on the company's website at www.artrac.com. During this call, we will make forward-looking statements within the meeting of Section 21E of the Securities and Exchange Act of 1934. based on our current beliefs and expectations, as well as assumptions made by and the information currently available to our TRACS management team. Although management believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Please refer to our latest filings with the SEC for a list of factors that may cause actual results to differ materially from those in the forward-looking statements made during this call. In addition, our discussion today will reference certain non-GAAP financial measures, including adjusted EBITDA, gross margin, gross margin percentage, and cash available for dividends. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see yesterday's press release and our Form 8-K furnished to the SEC. I'll now turn the call over to Brad to discuss R-TROC's second quarter results and provide an update of our business.

Thank you, Megan, and good morning. I appreciate everyone joining our conference call today. Last night we posted solid second quarter results in the context of one of the most difficult environments the industry and ArchRock have ever faced. As we've highlighted for some time, ArchRock provides critical US natural gas infrastructure, and the company is built by design to endure market cycles. It gets to the backdrop of a global pandemic economic slowdown, and precipitous decline in commodity prices. The resilience of our business was tested and demonstrated during the second quarter. Our impressive performance was driven by outstanding execution in the field and significant progress on our cost and capital savings efforts. Among the accomplishments in the quarter, we generated EBITDA of $101 million, flat compared to the prior year period. We improved our contract operations gross margin percentage by 400 basis points sequentially and annually to 66%. We reduced SG&A expense by more than 6% from $31 million in Q1 to $29 million in the second quarter. Our second quarter CapEx was down meaningfully year over year but remained somewhat elevated as we took delivery of units to meet orders that were placed by customers in 2019. Aside from these units, which are already out earning revenue, we put the brakes on additional 2020 new equipment cap-ins. This will drive substantially less spend in the second half of the year, and we've reflected this lower investment in the updated guidance that Doug will cover later in the call. We generated free cash flow in the quarter and thereby demonstrated our differentiated financial flexibility. Our adjusted EBITDA is holding up well and we paid down a small amount of debt in the quarter, which kept our leverage ratio largely unchanged from the first quarter at 4.1 times. As a result of our lower capex spending, we expect our second half free cash flow generation and debt repayment to accelerate significantly. And we continue to pay an attractive dividend complemented by peer-leading dividend coverage. As discussed last quarter, in light of market conditions and in order to maximize profitability, cash flow, and our financial position, we proactively initiated an aggressive cost and capital reduction effort. Our push to right-size the organization for activity levels cut across all business segments and our corporate overhead. Today I'm pleased to share that we are well on our way to deliver the annualized cash savings of between $75 and $85 million promised in May. We expect these savings will accelerate in the second half of the year as planned. We anticipate no new equipment CapEx for the remainder of the year and have slashed our full year 2020 CapEx budget as compared to 2019 by more than $240 million at the midpoint of our revised guidance. We're already seeing substantial declines in maintenance capital, with maintenance capex down 40% compared to the first quarter. We expect continued benefits from lower make-ready capital and have optimized maintenance practices while maintaining our excellent customer service and safety standards. On our SG&A spend, we implemented several actions to reduce discretionary spending and compensation expense. We continue to manage overtime hours tightly, and the previously announced salary reductions for certain employees, the executive leadership team, as well as reductions to board retainer fees went into effect in June. While the entire management team is focused on retaining our great talent through this downturn, as business softened further during the quarter, we made the difficult decision to take deeper action. This included furloughs and layoffs in several business units and segments. We remain steadfast in our drive to maximize our free cash flow and maintain our differentiated financial position. We continuously evaluate additional savings initiatives and are committed to a rigorous and ongoing analysis of our costs as the market evolves. Beyond our cost reduction efforts, we continue to transform our fleet, streamline our business, and invest in technology to extend our runway for efficiency gains. Building on our success in 2019, we continued to manage and prune our compression fleet, accelerating EBITDA recognition from less strategic and uneconomic horsepower and bringing in additional cash to redeploy toward debt reduction. During the quarter, we sold 24,000 horsepower that had an average age of nearly 30 years. And just after quarter end, we sold a portion of our AMS business, which will result in gain on sale income during the third quarter of about $9 million. As we do every quarter, we also conducted an extensive review of our fleet and identified compression units that were either not likely to go back to work or did not warrant additional investment to put back in the field. From this review, we retired 184,000 operating horsepower that resulted in a non-cash impairment of $55 million. This number was larger than in past quarters due primarily to the sharpness of the downturn and customers determining that portions of their production operations were no longer economic. Unsurprisingly, some of our equipment that has serviced those locations is also no longer economic for redeployment based on its age or configuration. On our technology upgrading work, we're making good progress on expanding our communications and remote monitoring capabilities throughout our field operations. That investment is proceeding nicely, and we expect to start seeing benefits from this investment in the 2021 timeframe. Now I'd like to turn to the market and outlook for our businesses. At the time of our first quarter earnings call, it was clear the COVID-19 pandemic would cause severe commodity demand and price impacts, as well as widespread capital reductions by our customers. We took quick action to prepare for the inevitable downturn without knowing the exact timing and magnitude of the pending change in demand for our compression services. The market deteriorated quickly and sharply during the second quarter as a result of the COVID-19 pandemic The rig count fell over 60% during the second quarter, and U.S. dried gas production fell from over 94 BCF a day to as low as 86 BCF a day. While we will not try to predict the timing of a recovery, we began to see signs of stabilization in the overall market and in our compression operations entering the third quarter. Oil prices have improved off of April lows, the pace of rig count declines is slowing, and we've seen modest growth in natural gas production in recent weeks, as shutting wells have resumed production. Should current oil prices hold up, we could also see some producers look to allocate capital to the large backlog of drilled but uncompleted wells in the second half of this year. While all of these improvements are encouraging, and we're hopeful we've seen the worst of the downturn, visibility remains limited. As we closely monitor market developments, we will continue to control what we can to position our truck for success. Turning to our operations and contract compression, our strong execution and cost savings initiatives drove an increase in our gross margin percentage versus the first quarter despite lower horsepower. I'll first touch on the challenges during the second quarter. With a sharp drop in commodity prices, Producers and midstreamers quickly rationalized costs, and in some cases, this resulted in the return of our compression equipment from the field. Our long-term contracts, standby strategy, and focus on large horsepower midstream applications certainly helped mitigate the impact. However, our second quarter operating horsepower and exit utilization still declined. We continue to work closely with our customers to support their businesses and maximize our operating horsepower, and maintain revenue and pricing as best we can. On a strongly positive note, we drove an increase in contract operations gross margin to 66% in the second quarter, up 400 basis points on both a sequential and an annual basis. As a reminder, a significant portion of our operating costs are variable, a key advantage as we made adjustments to align our business with market conditions. I also want to highlight that in the midst of a global pandemic and severe energy downturn, we had record safety performance and continue to provide excellent customer service and equipment uptime. This speaks to our strong safety culture and to the resolve and great talent of our employees. Moving on to our aftermarket services business, with the effects of COVID-19 and decreased commodity prices, customers are preserving capital and still delaying maintenance activity on their equipment. This resulted in a revenue and gross margin decline, often already low base. As we've yet to see any changes in AMS customer behavior, we remain focused on optimizing our cost structure. Turning to our capital allocation strategy, our message is consistent with last quarter, and our focus remains on balancing appropriate levels of investment debt reduction, and shareholder return. With infrastructure already in place to support U.S. natural gas production and meet the needs of our customers for the next few years, our priorities are, first, shareholder returns, even during this downturn. We believe having a reliable and attractive dividend is important to our investors and to the value of our company. And we will continue to work with our board each quarter to assess our four views of future cash flows and the dividend. Our second but equally important priority at this point of the cycle is to execute all available measures to reduce our debt and protect our financial position. Ultimately, we believe somewhere between 3.5 and four times is the optimal leverage level for our stable compression business. Before turning the call over to Doug, I'll leave you with a few thoughts on what I believe is ArchRock's compelling value proposition, one that stands out when you look not only at the realm of energy investments, but across other income-oriented sectors as well. We continue to demonstrate predictable cash flows, an attractive free cash flow yield, as well as a durable, well-funded distribution. And while the coming quarters won't be free of challenges, I'm excited to prove out what our differentiated business model and financial framework can deliver today and well into the future. With that, I'd like to turn the call over to Doug for a review of our second quarter performance and 2020 outlook.