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Archrock, Inc. (AROC)

Q1 2019 Earnings Call· Tue, Apr 30, 2019

$38.07

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Transcript

Operator

Operator

Good morning. Welcome to the Archrock First Quarter 2019 Conference Call. Your host for this morning's call is Paul Burkhart Treasurer and Vice President of Investor Relations at Archrock. I will now turn the call over to Mr. Burkart. You may begin.

Paul Burkhart

Management

Thank you, Diana. 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 Aron, Chief Financial Officer of Archrock. Yesterday, Archrock released its financial and operating results for the first quarter of 2019. If you have not received the copy, you can find 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 Archrock's 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 dividend. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see our press release from yesterday and February 19, 2019, in addition to our Forms 8-K furnished to the SEC. I'll now turn the call over to Brad to discuss Archrock's first quarter results and to provide an update on our business.

Brad Childers

Management

Thank you, Paul, and good morning, everyone. I'm pleased with our solid first quarter performance as Archrock continues to deliver strong earnings growth while increasing our operating horsepower in multiple U.S. basins. The supportive market conditions we experienced in 2018 remain in place today as evidenced by our strong level of customer commitments. Our primary focus for the first quarter was on executing accretive growth opportunities to deliver strong results to our investors. With that in mind, I'd like to highlight several of our first quarter accomplishments. Our first quarter net income of $19 million was up $17 million, compared to the first quarter of 2018. Adjusted EBITDA increased by 13% as compared to the prior year period. Our dividend was 10% higher over the prior period and we delivered strong dividend coverage of 2.8 times We grew contract operations revenue by 13% compared to the prior year period, reflecting an increase of 8% in our average operating horsepower, and the benefit of further price increases. We delivered strong results in our aftermarket services business as well. Revenues at AMS were up by more than 5% compared to the prior year period on an attractive gross margin of 18%. Leverage at the end of the first quarter was 4.4 times, reflecting the reductions we achieved over the past year. And we remain on target to realize sub 4 times leverage in 2020. Our first quarter out-performance keeps us on pace to achieve our full year 2019 guidance of adjusted EBITDA of between $370 million and $400 million. Turning to our operations. Our contract operations business delivered disciplined growth and solid financial performance. We are executing well and for the eighth quarter in a row, we grew our operating fleet of compression assets. We believe the abundance and low-cost supply of…

Doug Aron

Management

Thanks, Brad, and good morning. Archrock delivered another quarter of strong financial results. Revenues for the first quarter totaled $236 million, reflecting an increase of 11% compared to the prior year period. Adjusted EBITDA for the first quarter was $91 million, an increase of 13% over the first quarter of 2018, driven by higher operating horsepower and improved pricing. Net income for the first quarter of 2019 was $19 million, a substantial increase compared with the $2 million in the first quarter of 2018. In contract operations, revenue improved for the eighth consecutive quarter to $183 million, up 13% from the first quarter of 2018. This increase resulted primarily from higher operating horsepower across our fleet and again secondarily from rate increases. We achieved a gross margin of 59%, benefiting from price increases implemented in January, partially offset by schedule maintenance activities and ongoing inflationary pressures across the industry. We continue to expect a full year margin of 60% to 62% as we benefit from strong execution, pricing strength and ongoing cost management. In our aftermarket services segment, we reported first quarter revenues of $54 million, an increase of 6% over the prior year quarter. Gross margins for AMS was 18% compared to 17% in the prior year first quarter and consistent with our full year expectation of between 17% and 19%. SG&A totaled $29 million for the first quarter compared to $28 million, last year. For the full year, we continue to expect SG&A to total between $118 million and $124 million. For the first quarter, our growth capital expenditures totaled $111 million. Maintenance CapEx for the first quarter of 2019 was $15 million, consistent with our full year 2019 guidance of between $57 million and $63 million. We generated, we've generated $11 million from asset sales in the…

Operator

Operator

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of TJ Schultz with RBC Capital Markets. Please proceed with your question.

TJ Schultz

Analyst

Great. Thanks. Good morning. I think just first to the producers, the heighten focus on capital allocation and free cash flow, that's pretty well discussed at this point on our end. I'm just curious is there a notable change in discussions with the customers that translates this better, to better line of sight on your growth, whether that's shown up and just been able to contract horsepower sooner, is that tighter supply benefiting rates? Just how should we best think about the customer change in behavior playing out to your benefit?

Brad Childers

Management

Sure. The way we're experiencing this is that, our customers we believe are tipping the balance between outsourced and owned currently to favor more outsourced equipment, especially in the high-growth markets. I think that dynamic is driven by a lot of characteristics that we provide in our business for our customers to begin with which is the great footprints were already where they need to grow with great servicing capabilities as well as access to equipment. My point is that, is, their focus on free cash flow has really been I think a factor amplifying that push to outsource. Probably it's limited to compression, but I'm speaking about our business to outsource more of their compression activity today in high-growth areas than they would have in the past is amplified by their focus on their own capital allocation priorities.

TJ Schultz

Analyst

Okay, good, makes sense. And then aftermarket services, you've pointed out before that newer compression is approaching a major maintenance cycle. Can you just flesh that out a bit more? Is that something you see accelerating this year, or is the outlook in aftermarket benefiting from this cycle, something that, that's kind of beyond 2019?

Brad Childers

Management

The comment that we share there is that as more compression equipment has entered the market over the past years, more major maintenance activities around that customer-owned equipment is good. Fortunately, this happen to our aftermarket services parts, maintenance and shop businesses to help them with those major maintenance activities. And since the amount of compression that's owned by our customer base is steadily grown year-over-year, it's good for our aftermarket services business. So we intend to utilize that growing market to those capture revenue, incremental revenue as well as continue to improve the profitability of the segment, which is part of what you're seeing already in our performance.

TJ Schultz

Analyst

Got it. Just lastly from me, just any general expectations on growth CapEx in 2020, just directionally from 2019, especially as you're thinking about lead times for orders next year?

Brad Childers

Management

So this is Q1 of 2019, we're pretty happy that we just initiated annual guidance for the first time and we're working with that, and 2020 is still ways ahead. But part of my commentary does lead to I believe some idea that natural gas production, which is the biggest driver of our business, we expect growth in natural gas production to continue, but some moderate in future years, including we think starting in around 2020 and 2021. That does imply we expect to have a moderating CapEx spend as we look into those out years. And that is our overall forecast right now, but it's based on production growth, which continues, it just moderates nicely this quarter our capital priorities.

TJ Schultz

Analyst

Okay, great. Thank you.

Brad Childers

Management

Yes. Thank you.

Operator

Operator

Our next question comes from the line of Daniel Burke with Johnson Rice & Company. Please proceed with your question.

Daniel Burke

Analyst · Johnson Rice & Company. Please proceed with your question.

Brad, question for you. You alluded to on a look ahead positive free cash flow in later 2020, I want to make sure I understand what that means. Is that, are you defining free cash flow as total operating cash flow less CapEx pre-dividend, post-dividend? Just want to make sure we understand what you're contemplating.

Brad Childers

Management

Yes. So look, we're looking at as a total free cash flow number. How far we get into pre-dividend or post-dividend is really the issue, but clearly post CapEx.

Daniel Burke

Analyst · Johnson Rice & Company. Please proceed with your question.

Okay.

Brad Childers

Management

The way we're thinking about free cash flow and that includes growth CapEx. So that's the way we're targeting it right now. Ultimately, we think that business should be funded to generate total free cash flow.

Daniel Burke

Analyst · Johnson Rice & Company. Please proceed with your question.

Okay, got it. So think of it is a two-step process. Is there a sense yet shifting that CapEx query? Is there a sense yet for whether this year's growth CapEx is trending toward the higher or lower end of the bound of two figures that we have? (ph)

Brad Childers

Management

No, too early to tell. We're in the, we stayed in the range that we articulated I think a mere eight or nine weeks ago. And we believe that right now, we're in our guidance. We like the guidance range that we remain in. But this year still has some dynamics to see play out on how much we spend to support growth in the year versus in, and in out period. And so this guidance range that we're in, we're still comfortable with.

Daniel Burke

Analyst · Johnson Rice & Company. Please proceed with your question.

Got it. And then maybe one last quick one. I assume, we're just seeing some sort of frictional impacts, but looks as though overall utilization did just the touch if we look at the total fleet end Q1 versus end year, is there anything to point to other than some frictional elements there? It looks like you still got most of this year's newbuild fleets deliver across the course of the next few quarters.

Brad Childers

Management

Overall utilization remains strong and it's very supportive of what we think; if not, it's less than a percent. It's rounding in movement and the timing of how fleet activity occurs, both from a start and a stop perspective. So the fact that it moves around a little bit at a very high utilization rate is nothing to make anything of yet. I think we're still in a very constructive growth environment, very constructive pricing environment and we intend to make sure that we're leveraging both.

Daniel Burke

Analyst · Johnson Rice & Company. Please proceed with your question.

Got it. Okay. Appreciate the answers, guys. Thanks.

Brad Childers

Management

Yes. Thank you.

Operator

Operator

Our next question comes from the line of John Watson with Simmons Energy. Please proceed with your question.

John Watson

Analyst · Simmons Energy. Please proceed with your question.

Brad, on the horsepower retirements, I want to dig in there. I think it's been about 100,000 retired annually in recent years. Is that a reasonable expectation for 2019, where we sit today? I'm trying to get a feel for where available horsepower could be at year-end given the expectation for 285 to 345 of gross additions?

Brad Childers

Management

John, stepping back and thinking about the fleet overall at 3.6 billion horsepower level we've grown to and are very proud of, we still see that the fleet will likely have horsepower dropout at a rate of, I'm picking a number 3 percentage a year, which is just thinking about a 30-year kind of life of that equipment. So that would be a natural follow-up from a 30-year life if all that equipment have been added radically. So that your number is responsible along the lines of that math. But we don't actually forecast impairments or call it activity. In fact, it's really based upon the horsepower that comes back in from our customers after earning a good return on the field for a while, we reassess whether or not that equipment is both operationally still what we want to put out in the field and whether it's going to generate the right economic returns. And based upon that assessment as that horsepower comes in is how we determine the calls. It's not based upon a forward look or a periodic plan regarding a particular category or set of horsepower. It's that makes it lumpy quarter-over-quarter and a little less predictable, I know. But at the macro level, thinking about a 30-year fleet at 3.6 million horsepower, I would say your math is responsible.

John Watson

Analyst · Simmons Energy. Please proceed with your question.

Okay, great. That's very helpful. And you mentioned the pricing increase year-over-year for high demand units, the larger horsepower units, and I was wondering if you could help us think about that on a gross margin basis or gross margin per horsepower basis. If we look at the Q1 number, what's the gap between a unit that you're deploying today and what you printed in Q1, can you give us any qualitative color there?

Brad Childers

Management

I'm thinking not a lot because it's a couple of dynamics. One, what we're referring to on that 20% price level is really spot pricing from a year-over-year perspective. And as you probably know when you put units out, the number of units [indiscernible] go out in a particular quarter on a 3.6 million horsepower base, makes it pretty challenging to move the overall gross margin number radically. So that makes it a challenge to give you. The only other thing I'll point out is that, our, first quarter for us was a good quarter. I'm very pleased with how we performed and we still believe we're in our annual guidance range of 60% to 62%, so we see improving profitability as we move through the year. And we're going to capture that.

John Watson

Analyst · Simmons Energy. Please proceed with your question.

Okay, great. And lastly from me, on newbuild units today for the larger horsepower units, what's the good number for per horsepower build cost for us to be thinking about as we model in 2020 and beyond?

Brad Childers

Management

We, yes, we would guide with the amount of large horsepower we're building right now that newbuild cost has come down on a per horsepower basis compared to what we've seen historically. And so I think, you're responsible to stay in the $800 to $850 of horsepower range.

John Watson

Analyst · Simmons Energy. Please proceed with your question.

Okay. Okay, great. Thanks for the color, guys. I'll turn it back.

Brad Childers

Management

Yes. Thank you.

Operator

Operator

[Operator Instructions] Our next question comes from the line of Tom Curran with B. Riley FBR. Please proceed with your questions.

Tom Curran

Analyst · B. Riley FBR. Please proceed with your questions.

Brad, when it comes to the commitment on your large horsepower newbuilds that you in since late 2018, have there been any meaningful shifts in the composition of basins and/or customers relative to the mix of commitments you secured during the summer, or do have any reason or perhaps emerging science to expect any type of meaningful mixed shift?

Brad Childers

Management

Sure. Yes thanks. So look, overall the question is no, but with a few nuances. So overall, no, we still feel that our build is about 50% moving into the Permian and still where we see the largest amount of growth. The other half is moving to other play, very consistent with what we saw in growth the other half is moving to other play, very consistent with what we saw in 2018. But in the mix of the other play, we have noted an increment of activity in both Northern Rockies as well as in the Marcellus Utica, that's moved up incrementally. And we've noted a slowdown that we believe is likely to be short-live in the mid-continent plays of the SCOOP and STACK as producers are sorting through some of their subsurface issues. Those are the nuances, but it's overall in my opinion is still the same, which is 50% moving to the Permian and 50% into other plays, and more demand than I think we can meet. We're still at the point where we are restraining our CapEx to our capital priorities, even though we're growing really well with some, with our customers where we can support them. There's still a tremendous amount of need in the marketplace that's beyond our current capital spend.

Tom Curran

Analyst · B. Riley FBR. Please proceed with your questions.

That's helpful. Thanks. And then I was struck that the winning bidder in the sale of Kodiak Gas Services proved to be a European player based in Stockholm, a multinational PE firm in Ellis. As far as I know, this is the first time we've seen smart experience European money come into the U.S. contract compression niche at least in recent history. What are you seeing out there in the M&A landscape, and how has the pipeline of prospects evolved since last summer in terms of both the number of deals and their attractiveness?

Brad Childers

Management

Well, as you know, we don't really comment on M&A activity. Just as an observation I would say, it's always good to see new CapEx come in, new capital come into the marketplace. We think that the infrastructure investment opportunities in U.S. natural gas and oil production right now are at a peak level. They are extreme capital as needed and so it's good to see for us capital coming into the market and whether the form it's coming into. On the M&A landscape itself, we also still believe that the market has room for some consolidation. We love to see more consolidation occur. If it's value adding for our investors to do so, we intend to be a player in the space and aggregator and a consolidator. And if it's something that others would find more efficiency and we're happy to see others consolidate as well, so we think all consolidation is good for our space. So that's the largest part as I can go.

Doug Aron

Management

Tom, I might just highlight a nuance in there that I think is important. And Brad touched on it, we use the word infrastructure, but the buyer of those assets is distinctly an infrastructure fund, which as you, look, I'm relatively new, having joined Archrock last August, but I think when I first joined, there was still very much within the banks that cover us and institutions that cover us this sort of do we bucket compression into oil field service or into infrastructure. And I think we've been trying to pound the table for a while that we very much are part of the infrastructure landscape. You look at the natural gas that's growing and the infrastructure that's required to support it, I would highlight that as an important part of, I think of EQT, right, in EQT Infrastructure fund out of Europe that purchased Kodiak. And so that to me was a strong positive, and says that now we might have a very different audience as folks think about compression in the US.

Tom Curran

Analyst · B. Riley FBR. Please proceed with your questions.

Doug, I think that's a great point. I couldn't agree more your quick study.

Doug Aron

Management

Well, well caught it anyway.

Tom Curran

Analyst · B. Riley FBR. Please proceed with your questions.

Thanks. Thanks for the feedback, guys.

Brad Childers

Management

Thank you.

Operator

Operator

There are no more questions. Now, I'd like to turn the call back over to Mr. Childers for final remarks.

Brad Childers

Management

Great. Well, thank everyone for joining our call this morning. 2019 will benefit from strong dynamics that are driving oil and natural gas production growth in the U.S. We hit the ground running in 2019, and we look forward to updating you on our second quarter results later this summer. Thanks, everyone and have a great day.

Operator

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.