Ladies and gentlemen, good morning. Welcome to the Archrock Fourth Quarter 2023 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, Abby. 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 2023, as well as annual guidance for 2024. 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 trust management team. Although management believes that the expectations reflected in such forward-looking statements are reasonable, it can get 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 in our Form 8-K, furnished to the SEC. I'll 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. Simply put, 2023 was a tremendous year for Archrock. We exited the year with excellent fourth quarter performance, building significant momentum in utilization, pricing, and profitability. As we wrap up a record-breaking year for our company, I want to extend my congratulations to our dedicated employees on an extensive list of accomplishments. Among the highlights, our teams worked around the clock to meet our customer's sharp increase in demand. We grew our contract compression operating fleet by 214,000 horsepower, excluding sales of non-strategic assets, and we increased our exit fleet utilization by 300 basis points to an all-time high of 96%. As we met this demand, we recorded over 4.4 million man-hours and drove 22 million miles. In this exceptionally busy environment, and despite a dynamic labor market, we continue to deliver industry-leading safety performance, achieving a total recordable incident rate of 0.05. And for the third consecutive year, we achieved zero lost time incidents. We more than doubled the net income in earnings per share compared to 2022, and we grew our adjusted EBITDA by 24% year over year. This step change in our earnings power enabled us to return more than $105 million in capital to our shareholders through two dividend increases and the initiation of a share buyback program. We also concurrently delivered outstanding dividend coverage of 2.4 times and drove our leverage ratio to an all-time low of 3.5 times. From the separation of the international and fabrication operations at the end of 2015, to the navigation of two significant market disruptions in 2016 and 2020, and our steps to high-grade our fleets, our technology, and our markets, I'm exceptionally proud of the strong market and financial position we've built through multiple years of effort to transform our company.…

Thank you, Brad. Good morning and thanks to all of you for joining us. 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 2023 was $33 million. This included a non-cash $4 million long-lived asset impairment as well as a non-cash $1 million increase in the fair value of our investment in ECOTECH. We reported adjusted EBITDA of $120 million for the fourth quarter 2023. Underlying business performance was strong in the fourth quarter as we delivered higher total gross margin dollars for both segments on a sequential basis. Results further benefited from $2 million in net asset sale gains related to non-strategic horsepower sales. Included in our quarterly results was a $4 million increase in selling general and administrative expenses during the fourth quarter. We do not anticipate this level of expense will continue as it was largely related to the increase in performance-based short-term and long-term incentive compensation expense given the outstanding year our employees delivered and the dramatic outperformance relative to earlier expectations in 2023. Turning to our business segments, contract operations revenue came in at $213 million in the fourth quarter, up 3% compared to the third quarter. This increase was primarily driven by higher pricing. Compared to the third quarter, we grew our gross margin dollars by 4%. This resulted in a gross margin percentage of 64% for the second straight quarter. In our aftermarket services segment, we reported fourth quarter 2023 revenue of $47 million, up slightly compared to the third quarter despite typical seasonal softness, and up 12% on a year-over-year basis. Fourth quarter AMS gross margin of 22% compared to the third quarter of 20% and 17% versus the prior year period. We exited the…

Thank you [Operator Instructions]. And we will take our first question from Jim Rollyson of Raymond James. Your line is open.

Good morning, Brad and Doug. Brad if I just kind of step back and look at guidance for the year for EBITDA for CapEx it's pretty obvious you're going to get to that 3 times leverage by year end and obviously throw off a lot of free cash flow as we go through this year. And I'm just kind of curious you kind of hit some of your targets on the leverage side and you have an awful lot of opportunity to you know, not only supply customer demands for incremental horsepower in your in your CapEx budget, but you're going to have a lot of opportunity to provide capital back to shareholders, which you've been doing. Just curious as that, you know, you kind of get down the road here. How do you think about allocating that between the buyback program, between growing dividends, you know, the board and yourselves have been pretty conservative on raising dividends and not getting too far out over your skis. But it seems like a lot of things are lining up for that to kind of crescendo into more capital returns or just maybe how you think about that as we go forward given the outlook for the year?

Sure. Thanks, Jim. I'll speak and then let Doug talk me up. Number 1, we're super excited about the financial flexibility that we've built to put us in this position to offer the level of returns that we can now deliver in this business and to our shareholders. As I'm stated in the prepared comments when we look at this financial flexibility our option set to return capital shareholders is really good. And we're going to use a returns-based approach to decide whether that where that incremental cash can best go to maximize returns for our investor’s growth in the core business, which we're investing at really nice returns right now and our customer base wants our services in some ways they can't get enough compared to increases in the dividends or share buybacks. So, it's all going to be driven by our analysis of where we can obtain the best returns for our investors.

Yeah, and Jim, I just would pop it up by saying I'd you know it’s there's obviously a bit of a what have you done for me lately, right? But as I said in my remarks our year-over-year dividend increase represents 10%. So, look we're going to keep looking for ways to add value and that'll be a bit dynamic. It's you know, we said we intend to be sort of a steady presence on share buybacks and I think all of the above are the boxes at the moment that we plan to check

Certainly, it's a high-class problem to have. And Brad on the market, it's interesting you know kind of feels like you've had a market that's been tight because of under investment. Industry has been picking up investment. But as we roll into '25 and in the next few years beyond because of the LNG build out you referenced, obviously volume demand for gas is going to go up which kind of implies compression demand should proportionately go up and yet when I look at what yourselves and your peers are doing, growth CapEx across the space for the public guys at least seems like it's actually coming down a little bit in '24 versus '23. Which kind of feels like it maybe sets up for this tightness to continue I'm curious how you think about that what your customers are thinking about that. Because it obviously could be a challenge for the industry.

I cannot speak for the industry, but what I can suggest is that capital remains very disciplined and tightly allocated in the space. And I think there are a few reasons for that that are really good for the industry overall, and certainly good for compression and for Archrock and our investors. Number one, cost of capital is up a bit. Everybody knows that right now. Cost of equipment is up quite a bit. And so just the overall returns that the marketplace is going to offer has to take into account those increased costs. That means prices, rates, returns have to go up. Second, it's not just about the cost. It's also about the allocation. Investors are demanding better returns from our industry. And let's face it, for the last decade, our industry has not had a fantastic track record. Returns must go up across the sector. That includes in compression, just to meet investor expectations. And for these reasons that I think, that equipment and new investment equipment is going to remain tight and constructive for the industry overall.

Makes perfect sense. And then last, just you highlighted kind of being still in the fairly early days in your investment in digitizing and automating operations. Curious kind of how you think about the long-term impact on margins from that investment?

Thanks for the question. I like the question a lot. So first, I'm going to say that what we've done to really transform our platform is going to be great for our customers. The level of service, the level of uptime that we can generate and deliver to our customers with our improved platform is going to be tremendous. And second, the platform is now in place. But what isn't in place is we're not practicing it yet as well as we can. We have this new business model in place and our employees are just now adapting to a fully-functioning platform, and we're going to be finding opportunities to deliver improved performance for -- I think, for years to come with all the tools that we've now put in place that gives us a flood of good information. It gives us live feed information that we can respond in real time. It gives us much more data that we can analyze from a predictive maintenance perspective. So the power of the tool, I think, is tremendous. And then finally, directly to your question, what this should do for investors in the future, is that with this new service offering with the quality of service that we can deliver to our customers, we believe we should be earning higher margins and better returns because we're delivering more value to our customers. So over time, I think that we're going to see both revenue impacts, but certainly also cost efficiency impacts on the new platform.

And we'll take our next question from Selman Akyol with Stifel. Your line is open.

Thank you, good morning. I guess, first, just starting off, can you just talk about the supply chain? And is there any improvement there? Or are you still seeing long lead times and constraints there?

Thanks, Selman. Yes, there actually has been some improvement. We see that Caterpillar's lead times are into the 40- to 45-week time frame. We still see on the electric motor side, longer lead times of a year or so on the VFDs that are required, the variable frequency drives that come and required to operate those units. So -- but overall, Caterpillar is in, the VFDs are still out. And then other supply chain bottlenecks that were pervasive last year have, for the most part abated with single individual spots where we may have some individual supplier issues but nothing that we were not able to or have not been able to work through pretty efficiently to not impact our offering to our customers.

Got it. And then I know you already said you're sold out for new equipment in 2024. Curious, just anything on make-ready. Do you have any additional horsepower sitting around that you can put back in the field?

Yes, at 96% utilization, we're highly utilized, but we are not 100%, and we still have some horsepower that we can reinvest in and get made ready and put to work in the market. We're certainly going to work on that.

Got it. And then you talked about 2025 in terms of having initial discussions, but I'm wondering, can you just maybe elaborate, are you seeing price improvements over '24? Is there a tenor lengthening on any of the contracts? Are you getting inflation pass-throughs in any of those conversations?

A couple of questions there. Let me try to take them in order. So, I'll just start with pricing, and then I'll turn to 2025. So, for pricing, we absolutely are going to get in 2024, the full year benefit of all the price increases we implemented in 2023, which, as you know, when you implement them in the year, you only get partial uplift in the year you're implementing the price increase. So, we'll get 12 months of those prior price increases in 2024. Second, we still see pricing pressure and the opportunity to get current market pricing on our fleet as it rolls over in 2024. So, there's some more pricing momentum that we're going to capture in 2024 as the fleet rolls over and as some units benefit from pricing mechanisms built into the contracts that get an annual price increase. So yes, we absolutely see pricing opportunity in 2024. We expect to capture it. And then finally, on 2025, these are not just early discussions. These are bookings. 2025 is already with committed horsepower moving into that year.

Selman, just for the avoidance of doubt here, what I'll add to that is, I think Brad and I both mentioned in our prepared remarks, we've seen nine consecutive sequential quarters of revenue per horsepower growth. That number on our fleet is still below the current spot price. Not going to share the difference between those two prices, as much as I know, that would be your next question. So, I'll preempt it. But just to simply say that again, Brad made a great point, I think, in response to the first question around both cost of capital and still, albeit abated some inflation on new build horsepower, yes, pricing in 2025 and where those contracts are coming is still ahead of what you're seeing in reported results and in some cases, moderately to significantly ahead.

Great. Well, I will leave it there. Thank you so much for the color.

And we will take our next question from Steve Ferazani with Sidoti. Your line is open.

Morning, Brad, Doug. Thanks for all the detail on the call. Just want to talk about the -- first about the sold-out 2024. I'm just -- I'm sure I know the answer, just checking anyway. Is this all going to the Permian? Or is it overwhelmingly going to the Permian?

60% of our new bookings and new equipment are going to the Permian. So that's a very, very easy answer. We're excited about the growth we're accomplishing there. I mean, the basin is unrelenting right now in its demand, and we're happy to provide the equipment for it.

Great. The 96% utilization, obviously, you're benefiting from your lack of returns. And I think you've indicated that's predicated in part on the elevated lead times, which still are long. However, there was some thought that some of the gas plays would start coming back this year ahead of LNG export demand. Now with natural gas prices where they are, are you seeing any risk or any movement in some of these gassier plays to return equipment, knowing even with a year lead time, they're not going to need it?

I want to address the first part of your premise first and then come to the gas, the dry gas plays. And that is that, as I tried to emphasize in a comment a minute ago, I do not believes that the tightness in this market, the high utilization in the compression space, which is pretty consistent across our peers and us, is driven solely by tight supply chain. I think that the capital allocation that the industry is pursuing right now to constrain capital that's now more expensive is a major part, and the difference is important because if it's just a supply chain issue, then it's going to get fixed. If on the other hand, it's that the market is demanding higher returns, which I believe it is. And that we, our peers in the industry are allocating capital more prudently in a more disciplined way, then I believe the returns for our investors as a sector and as an industry remain higher. I just think that I don't -- I'm not in the position of agreeing with the supply chain being the driver of this comment. I want to make sure that we're communicating that clearly. As for pricing, the gas price and the impact on dry gas plays, we are not seeing much of a pullback. Remember that in our business, we're 70% to 75% tied to much more liquids-prone, liquids-rich plays with associated gas. And for the remaining part of our business that does have direct dry gas exposure were highly leveraged to production, and while the drill bit influences the level of production over a longer period of time, these short-term fluctuations do not come through in our business very sharply. And finally, even with the current low natural gas price, we incrementally grew our horsepower in a couple of the dry gas plays in the fourth quarter, which just shows that people are still investing and getting ready for the increased production that LNG is going to require in the future.

Great. That's helpful. Thanks. I know it's probably way too early for this since you just gave 2024 guidance, but you opened your books a couple of months ago on 2025 bookings. Anything you can give us on early color?

Not knowing exactly what color you're looking for. I'm serious, I would suggest that it's really a continuation of what we saw in '23, what we saw for bookings for '24 moving into 2025, it's going to be weighted heavily as you open with for Permian bookings, but we're booking large horsepower only and electric motor drives, is the combination of equipment that we see the market really wanting from us and our customer base wanting from us for 2025.

And we will take our next question from Elvira Scotto with RBC Capital Markets. Your line is open.

Hey, good morning, everyone. Thanks for all the detail on the call. I just had one follow-up question to the previous question. With the capital discipline that we're seeing within the compression, Archrock and your peers? And then with supply chain issues easing, is there any risk that we would see a shift to more owned compression?

Elvira, thank you for the question. You know the market, as I said in the past, we believe, from an overall perspective, is about 70% owned and about 30% outsourced. And what we see right now is that, that ratio is not really changing, with the exception of in the Permian Basin, we think that the amount of lease horsepower and horsepower provided by providers like Archrock and our peers, is a lot higher than that 30% mark in the space overall. The final thing I'll point out is that for customers that wish to go buy their horsepower, they're still going to be paying a lot more. We've seen about 30% inflation in the cost of a new build unit over the last three years. So costs are up sharply for them to acquire it. The second gating item is going to be access to trained labor to operate the equipment. And so, it's not just about capital allocation. It's also about the expense and the ability to deploy the right expertise to operate the equipment in the field that's really supporting growth by growth in our sector and for the compression outsourced service providers in Archrock right now.

And that concludes today's question-and-answer session. I'd now like to turn the call back to Mr. Childers for final remarks.

Great. Thank you, everyone, for participating in our Q4 review call. I'm excited about the value of our franchise can deliver today and well into the future. We hope you'll join us for what we expect to be a lucrative ride. I look forward to updating you on our progress next quarter. Thank you, everyone.

Ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.