Good morning, and welcome to the Archrock Third Quarter 2022 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, Regina. 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 third quarter 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 Archrock's management team. Although management believes that the expectations acted 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, 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 and our Form 8-K furnished to the SEC. I'll now turn the call over to Brad to discuss Archrock's third quarter results and to provide an update of our business.

Thank you, Megan, and good morning, everyone. Results for the third quarter reinforce my excitement about what lies ahead for Archrock. Demand for natural gas remains resilient and the market conditions for large midstream compression are excellent, as evidenced by several leading indicators across our business. Third quarter highlights include that we generated adjusted EBITDA of $92 million, reflecting solid underlying business performance and sequential growth in total gross margin dollars. In addition, quarterly results benefited from a net gain on the sale of assets as we continued to advance our fleet high-grading strategy. The market for contract compression continues to be strong, backed by a sharp customer demand, high utilization of existing compression equipment and long lead times for new build units. For the second quarter in a row, we grew our operating horsepower by 100,000 horsepower excluding asset sales. We increased our exit utilization by 200 basis points to a record 89%, achieved 90% utilization as of the end of October and expect the utilization will continue to increase through the end of the year and into 2023. Spot rates for our compression services are tracking and utilization higher as we made additional progress on repricing our installed base of horsepower during the quarter. Year-to-date bookings have doubled compared to this time last year. And our backlog remains robust. This is providing us great visibility into horsepower growth, utilization and as a result, pricing power for the remainder of the year and into the next. During the quarter, we also sold small non-core units, totaling 124,000 horsepower. Included in this number is a sizable asset sale transaction, divesting approximately 100,000 horsepower, including all of our remaining active small horsepower units in South Texas, East Texas, the Barnett and Louisiana. Fleet high-grading efforts have been central to our strategy…

Thank you, Brad. Let's take a look at a summary of our third quarter results and then cover our financial outlook. Net income for the third quarter of 2022 was $15 million and included a noncash $4 million long-lived asset impairment. We reported adjusted EBITDA of $92 million for the third quarter of 2022 compared to $99 million last quarter. Excluding net gains on the sale of assets, our EBITDA declined by approximately $1 million. Underlying business performance was solid, relative to internal expectations. We increased our total gross margin slightly on a sequential basis and by $3 million compared to the third quarter of 2021 in the face of meaningful cost inflation and despite nonstrategic asset sales totaling 134,000 horsepower. Turning to our business segments. Contract operations revenue came in at $170 million in the third quarter, up $4 million or 3% compared to the second quarter. Operating horsepower and pricing, both increased sequentially. Compared to the second quarter, we grew our gross margin dollars slightly as higher revenue was partially offset by increases in make-ready parts and lube oil expense. Our third quarter contract operations gross margin percentage was 58% and was largely consistent with our expectation for gross margin percentage to decline in the second half of the year before resuming growth in 2023. We are experiencing the lag effect typical of our business at this point in the cycle and believe we are seeing the bottom of our financial performance. In our aftermarket services segment, we reported third quarter 2022 revenue of $43 million, up $7 million compared to the year ago period or 19%. Third quarter AMS gross margin of 17% was up 200 basis points year-over-year as higher revenue drove better cost absorption. Growth capital expenditures in the third quarter totaled $39 million, similar…

[Operator Instructions] Our first question will come from the line of T.J. Schultz with RBC Capital.

First. on the methane capture technology, I do understand it will be complementary to your core business. How should we measure the commercialization of that technology? As you start to market it, does it help win your new business? Do you monetize leak mitigation? If you can just provide any framework for how you measure that as a competitive advantage for you all, how it's value enhancing to contract compression? And then also how the IRA maybe expedites that?

Thanks for the question. First, on the prospect of what it's going to mean to Archrock commercially, it's going to take time for us to build out what that's going to look like for a few reasons. Number one, we really are just at the front end of actually engaging customers in that commercialization discussion; two, the lead time for us to fabricate and receive units is going to put it out into mid in the second or third quarter of 2023. And over this timeframe, we expect to do the work to gain clarity on how impactful this could be. On the positive side, however, I want to conclude by pointing out that we think that this technology could have wide applicability with 50 million-horsepower in the market today, a number of locations that could benefit from this -- from our technology in this device and customers increasingly focused on managing their emissions. We're looking to market this to the intersection of those customers that are looking at their internal cost of carbon, focused on mitigating the methane that they could contain with our technology. And we think that looking forward, it could be very impactful for the business. But candidly, we need time to build out that commercial model.

And T.J., this is Doug. I'll just add for the avoidance of doubt, we are not entering the fabrication business. That will be an outsourced skill that Archrock is not reentering and are excited very much about this opportunity.

Okay. Makes sense. We'll stay tuned. Switching gears, maybe, Doug, on capital allocation, you mentioned line of sight to leverage below 4x. You also indicated the opportunity to increase shareholder returns next year. So I guess the question is, is pricing power you expect meaningful enough to do both in 2023, even with CapEx next year above '22 levels or as you invest in this undersupplied market and presumably realized better returns? Is the message just that you expect to be able to increase shareholder returns before maybe you explicitly hit that 4x leverage threshold?

Yes. Great and fair question. And I'll start with the caveat, of course, that as we think about shareholder returns, that's something we talk with our board with quarterly. But T.J., I think, what we're seeing now is, again, that line of sight to 4x. In terms of the capital investment that you talk about, we'll give guidance for CapEx for next year in our fourth quarter call. But as Brad mentioned in his script, the benefit of a couple of million dollars of asset sales, a portion of which we'll be redeploying into that growth for next year. I would say, yes, it very much will be on the table, perhaps before we achieve 4x, but instead, once we have a confident line of sight to that, and as you described, with the pricing environment, we think we're seeing with demand being really good and equipment availability being very tight. Back to, again, quote Brad, this is perhaps the most exciting time we've ever seen in this industry.

T.J., one thing, let me just add to Doug's answer on that. When we're looking at 2023 right now, I would definitely suggest that the catalyst for short-term performance in our business are excellent, and our business is positioned well to take advantage of them. The combination of market demand, where we're seeing bookings already out into 2024, record utilization, strong pricing prerogative and line of sight to leverage of below 4x. We'll give more clarity when we give 2023 guidance, of course. But I am ambitious, we are ambitious that we can look at achieving growth as well as an increase in shareholder returns in the near term. We look forward to talking more about that when we get to offer 2023 guidance.

[Operator Instructions] Your question will come from the line of Selman Akyol with Stifel.

I guess, first of all, just kind of going back to the electric side of it. Can you talk about that a little bit more in terms of the demand that you're seeing and just what the supply chains look like for putting more of this compression into electric?

Yes. We're seeing good bookings right now for electric motor drive. In fact, looking at our growth CapEx budget for 2022, I think that about 15% of our CapEx will go toward electric motor drive units, both in the form of converting our existing horsepower to electric motor drive as well as in building new units for delivery in 2023. As that demand looks right now for 2023, we see it incrementally picking up, but we also think this technology change is not going to be super rapid in the near term. It looks like it's going to be a measured ramp with that percentage increasing every year by some number of percentage points, but probably more in the 5% to 10% range than -- higher than that. And the reason for that is just that the electrification of the field that is getting power to so many locations is going to prove to be, I think, more time consuming, and it's just going to going to stay longer than a rapid conversion to electric butter that would prevent.

Got it. Can you just say if you're seeing a premium pricing for that relative to -- if you had 2 new units on driven off of diesel versus 1 driven off of electric? Are you getting the pricing for that?

A couple of thoughts on that. The first is that our units that we have in the fleet today are natural gas driven, meaning we take a portion of the natural gas that we would compress and use that to -- we've learned that in our unit to provide the power to drive the compressor. So we don't use diesel. We use natural gas. And there's a great efficiency in that. We're using some of the customers' production right now. In contrast, when we provide electric motor drive, then we have to bring, or the customer has to bring electricity to that location and pay out-of-pocket cash for that electricity. And that's a big distinction on incentivizing customers that want to electrify. It really has to be -- that incremental cost for power has to be incentivized by their emissions ambitions. So that's a comparison of the 2. So it's not diesel versus electricity. It's natural gas, which doesn't have a current cash cost versus electricity, which does. And finally, to address your question directly, while we're seeing premium pricing in the market for our entire fleet today, the returns we expect on motor drive -- electric motor drive and gas-fired are basically part of the same, very comparable. The rates are different, but the returns will be the same to us overall. Fortunately, those returns are excellent in this current market environment.

And then is carbon capture an opportunity for you guys, compression standpoint?

There will be multiple opportunities for us to evaluate participating in the carbon capture economy as it grows. First, carbon capture is going to require some compression. And so we are definitely in the market to evaluate where we can provide compression for carbon capture projects for our customers. Second, the compression operations generate quite a bit of carbon and there are technologies that are pretty nascent but developing to look at how to capture small-scale carbon emissions and sequester them also. So those are 2 opportunities within the carbon capture economy that's too develop that we'll be evaluating, but it's very early going on that level of smaller-scale carbon capture.

There are no further questions at this time. I'll turn the call back over to Mr. Childers for final remarks.

Great. Thank you, everyone, for participating in our third quarter earnings call. When I think of where Archrock stands today, I'm excited about what lies ahead for our business. We are well positioned operationally and financially to capitalize on opportunities in the compression market as the demand for our services increases. Thank you all very much.

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.