Archrock, Inc.

Good morning. Welcome to the ARCROC first quarter 2022 conference call. Your host for today's call is Megan Repine, Vice President of Investor Relations for ARCROC. I will now turn the call over to Ms. Repine. You may begin.

Thank you, Rob. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of ARCROC, and Doug Aaron, Chief Financial Officer of ARCROC. Yesterday, we released our financial and operating results for the first quarter of 2022. If you have not received a copy, you can find the information on the company's website at www.archrock.com. During this call, we will make forward-looking statements within the meaning 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 information currently available to our TROC 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 to our discussion today, we'll reference certain non-GAAP financial measures, including adjusted EBITDA, gross margin, gross margin percentage, free cash flow, free cash flow after dividend, and cash available for dividend. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see yesterday's press release in our form 8K furnished to the SEC. I'll now turn the call over to Brad to discuss our truck's first quarter results and to provide an update of our business.

Thank you, Megan, and good morning, everyone. I appreciate everyone joining the call today. It's certainly been an eventful start to 2022 for the energy industry, with all eyes now on North American oil and gas supply. For our truck, fundamentals in our natural gas compression business strengthened during the first quarter. At the same time, we continue to prioritize and advance our long-term strategies, high grading our fleet, harnessing technology across the organization, and increasing our focus on sustainability. First quarter highlights include the contract operations revenue increased $4 million or 3% from the fourth quarter as we grew our operating horsepower and benefited from the initial price increases we implemented late last year. Strong customer engagement drove bookings 40% higher on a sequential basis. This is providing us great visibility into new starts, through the remainder of 2022 and well into 2023. Our team did an excellent job maximizing our profitability in an inflationary environment, delivering a 61% contract operations gross margin. This is consistent with our annual guidance range and meaningfully above historical levels in this phase of the cycle. Last, AMS revenue increased 14% on an annual basis and their customers began catching up on major maintenance. We've also enhanced our free cash flow outlook for the year. When we laid out our 2022 capital program on last quarter's call, we indicated non-core asset sales would be an important financial tool for us during this reinvestment period. I'm pleased to share that in May, we closed the sale of an additional non-core compression horsepower package of assets for proceeds totaling $56 million. And we now expect to generate positive free cash flow after dividends in 2022. This transaction, like others we've completed over the past few years, creates significant value for our truck. We're selling horsepower at attractive multiples and redeploying the proceeds to help advance our strategic priorities and to fund our investment in new standardized large horsepower. This new horsepower will be deployed in the more stable midstream segment of the market for decades to come. These strategic divestitures have improved our returns and position us well to continue to reduce greenhouse gas emissions from our fleet. Moving on to the market backdrop, the macro environment during the first quarter further reinforced our outlook for the year. Recent midstream underinvestment and limited spare capacity drove commodity prices higher during the quarter and resulted in strong booking activity as our customers implement their 2022 growth plans. U.S. natural gas production forecasts continued to tick higher, with the EIA now forecasting an annual increase of 4% in both 2022 and 2023. We're even more excited about the larger-term outlook, Geopolitical tensions have quickly driven the realization that a more diverse energy mix is needed to satisfy global energy demand and preserve energy security. In particular, we're encouraged by the growing potential for another wave of LNG projects that would result in a meaningful call on U.S. natural gas production and therefore our natural gas compression services. These secular forces lay the foundations for a more robust and sustained upturn than previously anticipated. With the increasingly critical role natural gas will play to decarbonize energy, we now have the opportunity as an industry to further strengthen the case for natural gas by reducing emissions across the value chain. We intend to do our part and help our customers with low emissions solutions. Powering a cleaner America is the right thing to do. for our customers, our environment, our shareholders as we seek to maximize the value of our natural gas platform. Turning to our contract operation segment, our customers are proceeding with their growth plans for the year as they also return cash to shareholders. Compared to the fourth quarter, we grew our operating horsepower by 28,000. As our customers take advantage of higher commodity prices, horsepower stops are at historically low levels, and we expect start activity to accelerate as the year progresses. The recovery and our exceptional customer service drove a 40% sequential increase in horsepower bookings during the quarter, and we're effectively sold out of several horsepower categories. This is a great indicator of what lies ahead for our truck. with strong visibility into compression demand now reaching well into 2023. In the context of a high inflation environment, I'm proud of our gross margin performance. We expect inflationary pressures will persist at least through the remainder of the year. As a result, we implemented another pricing increase in April and are prepared to take additional commercial action as necessary to protect our margins. In addition to rate increases, we continue with tight cost control and are in the early stages of leveraging an upgraded technology platform in our field operations, recently installing expanded telematics across our fleet and launching a new suite of mobile tools for our field service technicians. We're just four months in and have more work to do to operationalize and integrate these enhancements into our business. Over time, I'm confident we will achieve increased asset uptime improve the efficiency of our field service technicians, improve our supply chain and inventory management, reduce the miles driven by our field service technicians, and lower our emissions and carbon footprint. Moving to our after-market services segment, we saw improved performance for the third quarter in a row. Revenues were up 14% compared to the prior year period. Parts activity has been the primary driver of top line growth since the recovery began as our customers resume internal maintenance programs. And more recently, we've seen encouraging trends on the services side of the business as well. We expect the business to benefit from improving market conditions going forward and are focused on growing higher profit AMS business activity. In support of this, we implemented rate increases for our AMS business as well. In summary, our multi-year efforts to high-grade all aspects of our operating platform are reflected in our first quarter performance, and I'm confident that these investments in our customer base, our fleet, our technology, and our talent will continue to pay dividends and differentiate us as the current upcycle continues to unfold. Our capital allocation remains clear. We intend to make strategic investments high return investments in our fleet to grow prudently and profitably with our customers and continue our dividend commitment all while maintaining a healthy balance sheet and financial flexibility. In addition to returns, our commitment to helping the oil and gas industry decarbonize is a critical element of our investment strategy. Through work led by our internal sustainability, technology, and new ventures teams, we've already advanced our fleet hydrating strategy and accelerated investment in electric compression. And most recently, we agreed to acquire a 25% minority stake in Ecotech, a company with impressive and tested technology that identifies and quantifies methane gas emissions. In addition to the strategic investment, we will also begin working with our customers to bring Ecotech's suite of solutions to support their sustainability goals as many of them are committing to thoughtful ESG strategies to measure and reduce their methane emissions. Ecotech provides a highly differentiated offering. It is proven technology that is already applied in the landfill, biogas, utility, carbon credit, and air quality industries. It continuously monitors methane emissions. which is a competitive advantage given our expectation for the market to transition to a standard that requires measured and quantified emissions. And it includes an integrated software compliance engine that provides auditable data. In addition to advancing our ESG strategy and helping our customers, this is a financially compelling opportunity that can create meaningful shareholder value for our truck as we work to connect Ecotech's proven technology with our leading U.S. natural gas compression infrastructure and customer network. As for next steps, we intend to demonstrate this proven suite of methane monitoring and mitigation products in oil and gas applications this year with a handful of customers, and we look forward to updating you on our progress later in the year. Last, I'll mention this is the first of what I hope to be an expanding set of products and services we can bring to our customers to help them produce, compress, and transport natural gas in an environmentally responsible way. With that, I'd like to turn the call over to Doug for a review of our first quarter performance and to provide color on our 2022 guidance.

Thank you, Brad, and good morning. Let's look at a summary of our first quarter results and then cover our financial outlook. Net income for the first quarter of 2022 was $2 million and included a non-cash $7 million long-lived asset impairment. We reported adjusted EBITDA of $81 million for the first quarter of 2022, largely consistent with our internal expectations and keeping us on track to deliver our full-year financial objectives. Turning to our business segments. Contract operations revenue came in at $164 million in the first quarter, up $4 million or 3% compared to the fourth quarter. Operating horsepower and pricing both increased sequentially. We delivered a strong gross margin percentage of 61%. This level is consistent with our annual guidance range and impressive given the inflationary pressures that our operating team is up against. In our aftermarket services segment, we reported first quarter 2022 revenue of $34 million, down from $36 million in the fourth quarter as planned due to seasonal softness. However, revenue was up 14% on a year-over-year basis as customers began catching up with maintenance deferred during the downturn. First quarter AMS gross margin of 15% was consistent with fourth quarter performance and 300 basis points higher year over year. Growth capital expenditures in the first quarter totaled $29 million, up from $13 million last quarter as we invest in new equipment to meet customer demand. Maintenance and other CapEx was $16 million, bringing total capital spend for the quarter to $45 million. We exited the quarter with total debt of $1.5 billion down $14 million compared to year end. We had available liquidity of $435 million as of March 31st. Our leverage ratio at quarter end was four and a half times. And as Brad mentioned, the $55 million in asset sale proceeds during the second quarter essentially pre-funds a third of our growth capital this year and puts us in a position to repay a small amount of debt this year even with the acquisition of our stake in Ecotech and as we invest in our fleet. I am confident that our ability to drive higher quality EBITDA growth is accelerating, and over time, we intend to meet our long-term leverage objective of 3.5 to 4 times. We recently declared a first quarter dividend of 14.5 cents per share, or 58 cents on an annualized basis. Today, this dividend level represents an attractive yield of 7%. Cash available for dividend for the first quarter of 2022 totaled $41 million, leading to healthy first quarter dividend coverage of 1.8 times. As we reinvest in our business, our quarterly dividend will remain a fundamental pillar of our 2022 capital allocation, reflecting our confidence in ArchRock's strong cash generation capacity. Earlier this year, we provided our full year 2022 outlook, including the expectation that our financial performance would gradually recover over the course of the year and end 2023. Year to date, our underlying business performance is playing out as planned. We expect our year to date asset sales will result in a net benefit of $15 million to our adjusted EBITDA. This will be partially offset by $2 to $3 million in incremental SG&A associated with the ESG ventures Brad discussed. Taken together, we are raising the low end of our annual guidance range and now expect between $330 and $360 million of adjusted EBITDA for 2022. Our full-year CapEx guidance is unchanged, including our expectation for growth CapEx of around $150 million. With that, we'd now like to open up the lines for questions. Rob?

At this time, in order to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. And again, if you would like to ask a question, press star, then the number 1 on your telephone keypad. And we do have a question from the line of Kyle May from Capital One Securities. Your line is open.

Hi. Good morning, everyone. Good morning.

Brad, I wanted to start off with the investment in Ecotech. And sorry, kind of a bunch of questions rolled into one here, so bear with me. But I guess first, can you tell us the size of your investment in Ecotech? And then secondly, how you anticipate the investment will change or enhance the underlying business? And then finally, I think you mentioned maybe a handful of customers are going to I guess, get a trial run with it. But any more, I guess, thoughts on kind of when that gets rolled out to, I guess, the broader customer base?

Sure. So number one, we're really excited about what this could do for not just our business, but also for the industry at large. We believe that producing gas in the most environmentally responsible way is a pathway to continue to improve the overall emissions footprint of the industry and and candidly prolong the life of an amazing amount of investment that's taken place over decades to bring energy to the U.S. and to the world. So we think that this is all aiming in the right direction. We're super excited to be a part of it. The Ecotech solutions are really a unique offering in that they bring continuous monitoring with the ability to pinpoint and quantify using a suite of tools and the compliance engine for reporting and data management. So it's a really, I think, very strong integrated suite of services and products that competes very effectively with others that are in the market helping today with methane monitoring and mitigation. So we're really excited about the suite of products. Look, we're in the early stages of this investment. We have confidence in this technology and it's been proven in other spaces But we're moving into the phase where we'll demonstrate it and its success with some oil and gas customers over the coming, I think, months, maybe even quarters. And as we do that, we'll have more to talk about in the future. But what we believe it does is it allows us to enhance the service offering we have very proximate to our compression assets, to our compression service footprint, and expand the suite of offering of services that we can bring to our customers what could be a very productive way so kyle that's uh it's look it's a really exciting development for us at our truck and we look forward to talking about it more in the future but you know at this early stage that's about what uh that's really all we want to share at this stage i think yeah kyle like um the only thing maybe i'd add on to one piece of your question was what would our uh what does our investment maybe allow them to do and i think

I would expand that certainly allows an opportunity perhaps to expand some equipment offerings, and then notably our contacts in the oil and gas space accelerate that for a team that hasn't spent much time there.

Okay, got it.

No, that's helpful, and I appreciate the additional color there. I also wanted to ask on the non-core assets that were sold in the second quarter, really just trying to get a better sense of what those assets were contributing, but can you give us any more details about maybe the EBITDA contribution, the horsepower, or any additional details just so we can kind of think about how that's going to change the business going forward?

I'm just looking at Megan in terms of what we've done historically. I know what the numbers are, but if we shared that on past transactions, Megan, you're going to have to remind me.

So what we can say, and in our prepared remarks, we mentioned that there was a $15 million net benefit from the transactions that we've done year to date. And you can look at the net gain or the gain in our financial statements for this quarter. And then on top of that, there's about a $17 million net gain that we will realize in the second quarter. That information will be in our queue that we'll file later today. And then offsetting that gain is about $4 million of lost EBITDA from those assets. So that's probably at this point what we can share about the transactions. there definitely were some assets that were operating and contributing EBITDA.

Yeah. Look, I'd add to that, Kyle, again, thinking about, you know, as you guys plan then future, you know, $4 million of EBITDA for the remainder of this year, you would then sort of think about that as a main transaction and annualize that into next year. But again, you know, as we talk about that, that allows us to, know fun capex for newer larger equipment um you know the average horsepower size on the stuff we sold is is sub 400 um and and back to brad's point on these being sort of non-core assets for us and our focus being more on midstream newer larger horsepower this very much continues that strategy for our truck that's great now that's really helpful and and one more if i can

sneak it in. Appreciate the comments. Gross margin was on the contract upside, I think around 61%. Just curious if you can give us any more thoughts about what you're seeing in the market currently with costs, labor, inflation, and the supply chain.

Across the board, inflationary pressures are up. The labor market We're in the mid-single digits from a percentage increase year-over-year. For parts and materials, we're in the candidly low teens for a percentage increase on a year-over-year basis. And from a lube oil perspective, we're close to 30% in a year-over-year increase scenario to give you a scale of what it looks like. So to come out with the gross margin that we did and that we plan to is going to continue to require both great revenue management, which we're committed to, as well as tight cost controls. So those are the ranges that we're experiencing overall. But we're also very optimistic that we reaffirmed our guidance, that we can deliver, I think, a very productive and very profitable year, notwithstanding these headwinds.

Yeah, look, everybody's dealing with them in terms of inflation in every business. I suppose that we're thankful if you can be in this type of environment that utilization has gone back into sort of that magic 85% and we're expecting it to be higher, which does allow us with equipment tightness, long lead times on new equipment, Kyle, to do everything we can to push that through to our customers.

That's great. I really appreciate all the time this morning, and I'll leave it there.

Thanks.

Your next question comes from the line of Selman Ackle from Stiefel. Your line is open.

Thank you. Good morning. Good morning. A couple quick ones for me. So you guys referenced seeing bookings higher by 40%. Can you maybe talk about where you were seeing that by Basin come from?

Yes. Across the board, we saw great bookings in multiple plays. The lead for us, as well as for others, probably at the 70% of our bookings came out of the Permian, or at least the increase in our bookings quarter over quarter. So that's followed by still the good productive bookings and activity in the Eagleford, in the Mid-Continent, as well as the Navarro and the Bakken. And then what was really pleasing is we also saw a nice uptick in bookings in some of the conventional plays. And with this kind of a gas price, that's to be expected. What's so positive about that for us is it really gives us a chance to reactivate and re-employ idle horsepower in those plays. And so we saw that as a really nice positive for the quarter. But broad-based increase across the board by play. with a strong pull to reactivate idle force power.

Appreciate that detail. If I could just ask, can you remind me on what's your exposure to the Haynesville?

We actually saw a positive increase in the Haynesville too. It was just so incremental it didn't hit my list. But we have a modest position in the Haynesville. I'll just remind you, the Haynesville has a lot of midstream presence, a bit of ownership, and still very robust initial production levels. initial pressure levels coming out of the production. And so we have a nice business of midstream assets located in the Hainesville, but as a percentage of our portfolio, quite modest. Got it.

And then also in your comments, you talked about pushing through price increases. And I know you talked about aftermarket services there too. And I'm just sort of wondering, where do you think margins could get to with price increases rolling through?

Well, on the very positive side, We're seeing, as Doug mentioned, utilization moving up past the mid-80s. And as that happens, that pricing prerogative really goes to us. Second, as I mentioned in my prepared remarks, we're virtually out of and we're completely out of horsepower in several categories. And by the way, we believe the market is as well. And finally, we've implemented two price increases recently. but on a short-term basis. And given commodity prices and the inflationary pressures I described, we think they're well justified. So that makes us optimistic that we can continue to defend our margins. But in this inflationary environment on a short-term basis, I think defending our margins with these moves is about what we should hope to achieve. Longer term, however, I would point out that we believe the investments we've made in our fleet, in our technology platform, are going to give us a much better opportunity as we hopefully get to a balance of inflation and pricing to increase margins over time. We're not in a position to quantify that. It's just an ambition that we have to help realize some of the returns on the investments we've made.

Got it. And then just one last one on Ecotech. If you can... You mentioned that you can bring contacts and introductions to the oil and gas industry, and so I'm just wondering what other industries are they currently serving where they have a stronger presence at? And, yeah, maybe you could just tell me a little bit more about them.

Yeah, so, look, obviously it's a small company. The good news is it's technology that's been proven over a very long period of time, and they have presence today in utility. and in waste and biogas are a few of the areas where they've proven out their technology. And so that's just a good footprint to leverage. Also, the technology they offer is demonstrated in the marketplace. It's not an uncommon technology, but the technology that they have perfected is to build a suite of integrated products for both the monitoring, the data management engine, as well as the pinpointing of the location and quantification of a leak to allow immediate elimination mitigation. So it's that suite of products that we're most excited about going forward. But that's just a little bit more about them. And we'll talk more about them in coming quarters after we've had a chance to really work with our customers and see how well we can apply this to several locations.

I would maybe just add to that that, you know, yes, a small company, but, you know, in speaking to the proven technology in the landfill space, as an example, without mentioning any publicly traded companies by name, they do list customers that include among the largest in that space and folks that, you know, are very focused on ESG and, you know, and good monitoring. So again, when we talk about proven technology and high-quality customers, while a small company, these guys have technology that we're very excited about.

Great. Glad to hear it. Thank you.

And there are no further questions at this time. Now I'd like to turn the call back over to Mr. Childers for final remarks.

Great. Thank you, everyone, for participating in our Q1 review call this morning. As we noted, We continue to drive strong customer activity and believe we are well positioned, operationally and financially, to capitalize on opportunities in our business as the demand for our services increases. I look forward to updating you on our next call next quarter. Thanks, everyone.

This concludes today's conference call. Thank you for your participation. You may now disconnect.