Good morning. Welcome to the Archrock’s Fourth Quarter 2021 Conference Call. Your host for today’s call is Megan Repine, Vice President of Investor Relations at Archrock. I will now turn the call over to Ms. Repine. You may begin.

Thank you, Julian. 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 fourth quarter and full year 2021 as well as annual guidance for 2022. If you have not had a chance to receive 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 our 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 the call. In addition, our discussion today will 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 statements, please see yesterday’s press release and our Form 8-K furnished to the SEC. I will now turn the call over to Brad to discuss Archrock’s fourth quarter and full year results and to provide an update of our business.

Thank you, Megan and good morning everyone. I am happy to be with you today to discuss our strong fourth quarter and 2021 results and our outlook for 2022 and beyond. As I look back on the year, we delivered operational excellence, demonstrated the cash generating power of our business and advanced several strategic priorities and we achieved all of this with and despite the pressures of reduced revenue due to the market downturn, a tight labor market, significant inflationary pressures and the continued imposition of COVID-19. I want to offer my heartfelt thank you to our dedicated employees who never miss a beat to help us deliver these results in 2021. Among the accomplishments for the year, our proactive actions to maximize financial performance delivered positive net income and record free cash flow after dividend at the bottom of the cycle. We maintained strong capital and cost discipline, sharply reducing new equipment capital to align with the market for the second year in a row. Growth CapEx totaled $37 million during 2021, down 53% compared to 2020. In addition, we reduced our SG&A year-over-year after normalizing for the non-recurring tax benefit that we recorded in 2020. We achieved exceptional safety performance, made possible by the safety culture permeating our entire organization. In 2021, we delivered 51 weeks with no recordable incidents. We continued to repay a considerable amount of debt, while at the same time, returning a significant amount of capital to shareholders. Since the end of 2019, we have demonstrated the stability of our cash flows, repaying $314 million in debt and returning $178 million to shareholders. Over the last 3 years, we have invested nearly $50 million in a digital transformation, capped by the achievement of several important technology milestones in 2021. We completed the installation of…

Thanks, Brad, and good morning. Let’s look at a summary of our fourth quarter and full year results and then cover our financial outlook. Net income for the fourth quarter of 2021 was $6 million and included a non-cash $6 million long-lived asset impairment, a $3 million insurance settlement related to damages caused by Hurricane Ida and nearly $1 million in restructuring costs. We reported adjusted EBITDA of $83 million for the fourth quarter of 2021. Our fourth quarter adjusted EBITDA performance put us firmly ahead of our annual guidance range. Underlying business performance was strong in the fourth quarter as we delivered higher contract operations, gross margin dollars and lower SG&A. And we would have reported a sequential increase in adjusted EBITDA, but the more than $15 million in third quarter asset sale gains. Turning to our business segments. Contract operations revenue came in at $160 million in the fourth quarter, up slightly compared to the third quarter. Operating horsepower and pricing both increased sequentially. We delivered a strong gross margin percentage of 62%. This was ahead of third quarter levels and above our internal expectations as our operating team continued to pullout all the stops to manage costs in the face of continued inflationary pressures on labor, lube oil and parts. In our aftermarket services segment, we reported fourth quarter 2021 revenue of $36 million, similar to third quarter levels and up nearly 17% on a year-over-year basis despite seasonal softness as customers began catching up with maintenance deferred during the downturn. Fourth quarter AMS gross margin of 15% was consistent with guidance and third quarter performance. Growth capital expenditures in the fourth quarter totaled $13 million and reflected an increase in customer activity. Our full year growth CapEx of $37 million was down from $79 million in…

Thank you. [Operator Instructions] Our first question comes from TJ Schultz from RBC. Please go ahead, your line is open.

Hi, good morning. You made the comment that utilization held in better during this downturn when compared to prior cycles. And I assume that’s driven by the higher mix of larger horsepower and your divestments that you’ve talked about. But is there anything else you saw in the downturn that allowed utilization to outperform prior cycles and then coming out of this downturn? Is there any change to your view on how quickly you may see utilization start to increase as the market improves? And where would you expect utilization to exit this year?

Good morning, TJ. Look, thanks for the question. You’re right, by the way. I think the position in the larger midstream position of horsepower is definitely an aid to stabilize utilization in this most recent market cycle compared to prior cycles. But I think another expression of that is reflected in the amount of upgrading we’ve done not just on size and positioning in the market, but at just improving the quality of our fleet through investments and divestments over the last 5 years plus. And that results in night, just a higher quality, more stable operation. I think that’s the second part of it. To the second part of your question, we’re pleased to see utilization already moving up a couple of percentage points so quickly in this market today. And we think that, that is a good sign of things to come. I’m not sure we will keep up the pace of 2 percentage points of improvement per quarter. But we do expect to see utilization continue to tick up at a pretty good pace as the market tightens.

Okay. And what was the comment on price increases, are you able to push through price increases right now even at utilization where it is?

We are. We are. And I appreciate that question because what I need to highlight is that not all parts of the fleet are at the same level of utilization. On our largest horsepower category in the close to 1,800 horsepower and up, especially utilization in the market is already tight. And that’s the reason we’re ordering new equipment today is that the market just doesn’t have any. And so in that category, we’re seeing pricing is very good, and we have increased our spot pricing in that category particularly. There are other categories of smaller horsepower where utilization is lower, and it’s harder to push a price increase through. So what we try to do in disciplined way and working with our customers so as to not catch them off guard with their budget process is to where we have the ability to move pricing up in our contract have that dialogue early. And yes, we’ve already – we pushed through pricing at the end of 2021, and we’re still continuing to implement those price increases, especially on the installed base in 2022.

TJ, I might also mention lead times on new equipment are really starting to push out. I mean I think in that large horsepower class, frankly, new build equipment is starting to push somewhere into the, call it, mid-40s to low 50s depending on who you ask. So I think that’s instructive of a market that we started to see more as sort of the upturn as opposed to coming out of a downturn, and I think can help you appreciate that, yes, pricing is moving back up, particularly on that large horsepower class.

Okay, thanks. And then just lastly, on the electric motor drive horsepower, do you see that trend accelerating even more into 2023? I guess just what made 25% of the CapEx mix on electric, the right percentage this year? Is it availability from suppliers, demand from customers? Just trying to think about how that mix of horsepower new spend may shift over the coming years.

It’s more a pull through and identification of the market from our customers is availability or supply driven. So that’s where we see the market moving. We believe that over time, we will see the increasing electrification of the oil field, including compression. And this is the start. I’m going to point out, however, that we’ve been operating electric motor drive horsepower in this industry and certainly at Archrock for a number of years. But in the past, it has been driven by locations that have had the most stringent air quality regimes placed on it, for example, in the Northern Rockies. So that’s where we’ve seen it in the past. And what’s happening now is we are seeing an expansion of demand for emissions management as well as increasingly available power generation and distribution in the field. I think that’s going to be the gating item is that we see electrification as an opportunity to reduce emissions, but it’s going to require the power grid continue to expand, and that’s not going to happen rapidly, but I believe it’s going to happen steadily.

Got it. Thank you.

Thank you.

Our next question comes from Daniel Burke from Johnson Rice. Please go ahead. Your line is open.

Yes. Hi. Good morning guys.

Good morning.

Let’s see, Brad. When I look at the outlook on the contract upside for gross margin percentage to be flat to down a touch year-over-year, I guess the question I would have is, are you achieving net pricing gains as we look at ‘22 versus ‘21, or is the right baseline then to think that the pricing gains you are capturing are largely offset by the input cost pressures that you, industry and everyone will continue to contend with?

Yes. No, we think we are achieving net pricing gains and the difference that’s not allowing that to come through in the gross margin line is primarily driven by increased investment in make-ready, Daniel, because we have to – we just have to invest more right now to put more of the units back to work. And so that’s helpful to drive up utilization, but it does stabilize or have extra expense in the gross margin line that you are not – that’s getting the way of you seeing that net pricing gain come through. And what we are excited about on that is that even with that, if you look to at our overall revenue per horsepower over the last four quarters, even six quarters, it’s been very stable and now it’s slightly improving. We expect to see that continue to improve even though we are investing a bit more in make-ready and put horsepower grow both our operating horsepower and improved utilization.

Okay. That’s a helpful point. Can you – well, let me ask one on maintenance. I know Doug mentioned a couple of reasons, maybe, call it, maintenance CapEx per deployed horsepower be a little bit higher, how we better understand the lower horsepower returns element of that trend in ‘22 and whether that also maybe dissipates a bit taking a longer view?

Yes. So, just to be clear, you are asking about the – or higher maintenance – the guidance on that end as related to…

I am asking you about the year-over-year step in maintenance CapEx, and you mentioned lower horsepower returns as one of the contributors to that. And I just wanted to better understand that factor.

Let me try to answer part of it and then make sure we are on point to, Daniel. If we are not asking the question not answering the question you asked, please, please tell us. The main step up in the maintenance CapEx that we are seeing for the year, it’s really driven by the timing of fleet overhaul demand and fleet maintenance demand. When we add units to the fleet, it takes – they go roughly 3 years before they have their mid-life cycle, roughly 6 years to 7 years before we have a major maintenance event. And when we see an uptick in our major maintenance activity, it’s primarily driven by the operational needs of the units. That’s what we are seeing for the step-up in our maintenance CapEx this year. And that’s – it’s just totally driven by the fleet, by timing and by maintenance.

In the lower – yes, the less horsepower returns, meaning as utilization goes back up, you have got more maintenance that has to be accomplished versus units that come back that don’t require that maintenance. Daniel, apologies, I had to go back and look at my note as to what I said in the guidance and now I appreciate what you were asking, but it’s really – it’s a utilization question, more active horsepower is more maintenance.

Okay. That’s fair. And thanks for circling back to that element of it, Doug. All that makes sense. Let me ask one final one, maybe a more straightforward question. Does – when I look at the EBITDA guidance for this year, just to be clear, does the high end of the guide incorporate any assumption or any amount of asset sale gains?

It does not.

Okay, great. Thank you for the clarification. Alright, guys. I will leave it there. Thank you.

Thanks Daniel.

Our next question comes from Kyle May from Capital One Securities. Please go ahead. Your line is open.

Hi. Good morning everyone.

Good morning Kyle.

Following up on the – hi Brad, good morning. I want to follow up on the electric motor drive horsepower that you talked about. Maybe two questions here. First, can you talk about the cost difference between electric drive versus your other equipment? And then second, are there any notable differences on the operations between different types?

So, on the first part of the question, the cost for acquisition is really comparable for electric motor drives compared to internal combustion-driven natural gas-fired compression. On the operating expense, candidly, the OpEx for the maintenance of electric motor drive is incrementally less expensive than natural gas fired. One point that, that doesn’t take into account, however, is someone has to actually pay for the price of power, and that’s the customer who pays for the price of the electricity. So, that’s the way it stacks out. And then finally, from an operational perspective, no, there are not significant operating differences. Though, the reason the electric motor drives are incrementally less expensive to operate is, candidly, they are also less demanding for operational maintenance than an internal combustion engine.

Got it. Okay. That’s helpful. And then maybe one, shifting gears to maybe broader optionality for the business. But we are hearing more about carbon capture projects more recently. And I was wondering if you could share any thoughts about how Archrock and the compression business could potentially factor in?

Yes. So, the market is struggling quite a bit. I understand the full scope of carbon capture opportunities. I will end my comment with that. But as I look at the broader stepping even back further and the goal we have around emissions management, you are not going to be surprised to hear that our first focus is to control what we can control initially and then continue to expand our perspective and potentially our activity to help our customers with the full scope of emissions management and emissions and carbon capture. So, starting with the stuff that we can do first, the switch to electric motor drives is not going to be inconsequential to the marketplace. We see a lot of the incremental growth really should be and will take electric motor drive horsepower across all horsepower classes, and that’s a good thing for the business overall. We also see that our migration to large horsepower equipment is also a step in the right direction, both in limiting the amount of emissions and pollutants coming out of the compression part of the oil and gas business. So, those first two steps have already taken place. And then also with the technology we have put in place, we are really focused on improving overall performance for our customers run time and that should reduce the number of trips we make into the field to really attack our miles driven and the amount of admissions we are generating from that activity. Those are the closest to home opportunities that we are focused on now, and we expect to make some good progress on. As we make progress on those other opportunities, including monitoring and leak detection and repair as well as thinking about capture opportunities for CO2 and carbon capture are in the sites of things the industry is working on and focused on. The challenge is small-scale carbon capture at the level we look at for a production location and a compression location is still way too expensive and with more action from the government in the form of carbon offsets or direct pay subsidies, we just don’t see that we are going to reach that level of having capture in the near-term. The carbon capture opportunities that are likely to hit the market first are going to be all at really massive scale. And then it will move as the carbon economy develops, we see it could move into smaller carbon capture opportunities. And when and as that happens, we expect to be a participant.

Understood. And I appreciate all the additional color there. Maybe one last question and as we think about the budget for this year, can you just help remind us, does Archrock see the full benefit of that new equipment this year, or is there going to be in the 2023?

Yes, Great question, Kyle. So, we won’t see all of the benefit. The spending is forecasted to be largely ratable for the year. And so as you think about it, the stuff we spent in the first quarter, we will get benefit four quarters to three quarters and then down. I would say for the most part, that quarter of that capital budget that we spend in Q4 really won’t start to see the benefit for until Q1 of next year. And again, as you think about that guidance and then maybe ask, well what about the same capital that was spent in Q4 of 2021 that was off of a base that was less than $40 million, so will be dramatically different. But all that should be reflected in our current guidance.

Got it. Appreciate the time this morning.

Thank you.

Thank you.

Our next question comes from Selman Akyol from Stifel. Please go ahead. Your line is open.

Thank you. Good morning. Just wanted to follow up a little bit on the CapEx comments or at least start there. So, you noted sort of 40 weeks to 50 weeks extended lead time. And I think in your opening comments, you also discussed some pretty positive conversations with the producers. So, if I start thinking about 2023 and lead times extending, should we be expecting your CapEx budget to increase over the year as you guys start spending money in order to secure slots for 2023 for assets?

No. What we have put in our CapEx budget for the year, we think, is what is in the year for the guidance that we have offered. It would take an unforeseen injection of a cool opportunity for us to think about spending more a year, and we are just not seeing that. Also, with lead times out as far as they are, we think that we – it’s going to be hard to spend more in 2022 candidly than that because lead times are already pushed into 2023. So no, we are very comfortable with CapEx budget that we have laid out. We don’t expect to see an increase, never say never. But if there is an increase, it’s going to be one we are going to be talking about why it increased with an identifiable opportunity – category or opportunity attached to it.

Understood.

And selman, I may just top it up with saying that we have – again, we have no plans, full stop on that, as Brad said, our guidance is our guidance. That said, if we can continue to convert 20 year-plus old equipment and sub-400 horsepower into the more highly demanded either electric motor drive or larger equipment, it’s going to need to happen pretty soon, but as Brad said, you are looking at 50 weeks. And as you also sort of part of your question would be 2023 CapEx, we are obviously not yet ready to guide on what our ‘23 CapEx number is going to be. Brad also mentioned in the prepared remarks that we are focused on continuing to try to target leverage long-term between 3.5x and 4x on generating as close to free cash flow positivity or breakeven, albeit in a growth cycle like the one we are in right now, have that being breakeven is very much a goal. So, the focus has not changed here. And I think that it won’t change as we try to triangulate on all three of those things.

Got it. And I appreciate that. I was really just trying to understand the dynamics between ordering long lead time equipment and what you guys have to commit capital in order for that. So, very helpful in all of that. In terms of the asset sales, I presume that will be assets that are generating EBITDA, and that’s been captured in guidance as well, your thinking?

Yes. Again, asset sales are not included in guidance because they are very difficult to forecast. That said, yes, in 2021, and in 2020, we sold some assets that were producing EBITDA and we sold some assets that were in our idle fleet. So, that will continue to be the case as we look to high grade all parts of our business and move towards more midstream focused, larger horsepower.

Understood. And then just the last one for me, can you guys – you took a restructuring charge for $1 million in that large, but can you just maybe explain a little bit of what was being written down?

What I will tell you, the categories, historically, when it was larger in 2022 were largely around reductions in force. We had some building disposals, the type of thing that it would be nothing else stands out to me of that $1 million.

Alright. Thank you.

Thank you.

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

Great. Thank you, everyone, for participating in our Q4 review call. We are entering a multiyear upturn in natural gas, and I am excited about the value our franchise can deliver today and well into the future. I look forward to updating you on our progress next quarter. Thanks, everyone.

This concludes today’s conference call. You may now disconnect.