Q4 2019 Earnings Call
Good afternoon, and welcome to the Archrock fourth quarter and full year 2019 conference call. Your host for today's call is making refine vice president of Investor Relations at Archrock.
I'll now turn the call over to misery side, you may begin.
Thank you John Hello, everyone and thanks for joining us on today's call with me today, our broad shoulders, President and Chief Executive Officer, Archrock, and Doug Aron Chief Financial Officer Archrock.
Yesterday, Archrock released its financial and operating results for the fourth quarter 2019, as well as annual guidance for 2020.
If you have not received a copy you can find me information on the company's website at Www Dot Archrock dotcom.
During this call we will make forward looking statements within the meaning of section 21 E of the Securities and Exchange Act 1934 based in our current beliefs and expectations as well as assumptions made by an information currently available to Archrocks management team.
Although management believes that the expectations reflected in such forward looking statements are reasonable.
It can give no insurance assurance that such expectations will prove to be correct.
Please refer to our latest filings with the FCC for Alister 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 be well reference certain non-GAAP financial measures, including adjusted EBITDA gross margin gross margin percentage and cash available for Devon 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 FCC I'll now turn the call over to Brad to discuss our trucks fourth quarter and full year results and to provide an update.
Thank you Megan and good afternoon, everyone.
Simply stated 2019 was a great gear for our truck.
The strong results, we reported yesterday once again reflect our exceptional customer service, our high quality compression assets and our commitment to enhance performance and profitability of the business.
At the same time, we continue to balance our opportunity set with our promise of capital discipline.
Leverage reduction.
In return of capital.
Let me share some of the years highlights.
We provided annual guidance for the first time and performed well against those targets.
Of note, we grew adjusted EBITDA by 18% as compared to 28 team.
We continue to transform and standardize our suites.
We delivered a very active new build program within budget.
Executed several highly strategic ethics asset sales and acquired elite compression.
Together these efforts reduce the average age of our compression equipment improve our competitive position and extended our runway for efficiency gains.
We enhanced our financial flexibility.
With a successful extension of our credit facility and senior notes offering during the fourth quarter. We believe we have eliminated archrocks need for external financing for five years or more based on our current long term plans.
And we pushed out a billion dollars a bond maturities by seven years.
Last.
We stay the course on our three year capital allocation plan to increase our dividend, 10% to 15% annually.
Maintain a dividend coverage ratio of at least two times.
And reduce leverage to below four times by the end of 2020.
These 20, Nike achievements among others further solidify our position as the leader and U.S. natural gas compression.
Although commodity markets are off to a volatile start this year the compression business is inherently more stable compared to other energy sub sectors with direct exposure to commodity prices or to early cycle activity based services like drilling and hydraulic fracturing.
As we emphasized in the past demands for our compression services is highly correlated to natural gas production.
Looking into 2020 forecasts show record U.S. natural gas production in the U.S.
That said our customers are in the midst of the business model transition that prioritizes sustainable free cash flow over growth.
This should reduce volatility through cycles, and bolster the financial viability of CMP and midstream energy companies. However, this shifts will no doubt result in a moderation of the natural gas production growth rate in 2020.
On global natural gas demand structural increases are materializing as forecasted and this demand should increase again in 2020.
Natural gas exports this year will benefit from LNG facilities, which came online in 2019 and as low natural gas prices continue to support competitive economics.
In addition to LNG higher natural gas demand is being driven by pipeline exports to Mexico.
Power generation and use as it petrochemical feedstock.
These indicators point to consistent demand for compression services.
But as we enter this normalizing market, we would expect some differentiated impact to our customer activity levels across business segments and geographies.
Turning to our operations in contract operations, we entered 2020 for the position of strength.
With our focus on large horsepower units deployed in midstream applications and in the best U.S. basins are 2019 exit utilization was 89%.
And we drove an increase in contract operations gross margin to 63% in the fourth quarter.
Nearly 400 basis points versus 2018.
Our production oriented business aggressive cost management and customer commitments provide us with good visibility into our outlook for the coming here.
Even as industry drilling and completion activity moderates.
As you would expect at a healthy even is flattening market our backlog remains positive.
In 2020, we will continue to benefit from the contract price increases implemented in 2018 and 2090.
We implemented additional rate increases this year.
However, we expect the incremental revenue impact will be more muted.
Spot pricing remains at attractive levels, given type utilization, but it is beginning to plateau pricing prerogative is varying by market and by horsepower size.
We'll also remain focused on innovation.
Efficiency and improvement in 2020.
This is critical to our success and ongoing position as a market leader.
And even more important as the market normalizes.
Our efforts include progress on our fleet standardization and technology investments.
On the fleet will look for additional ways to create our assets, where it makes strategic sense.
In 2019, we generated $76 million from asset sales of 220000 horsepower.
This high grading, we'll continue to be a substantial contributor to our gross margin performance in the contract operations segment and should positively contribute to our deleveraging effort.
On technology 2020 marks the second year of our efforts upgrade our platform.
And our employees are working diligently and across functions to implement these changes.
Over the long term this will result in improved equipment uptime.
And exceptional customer service experience and operating cost productions.
We believe this investment in our technology platform will further enhance our value proposition to our customers.
And yield attractive returns for our investors.
Moving to our aftermarket services segment.
Capital constraints for customers to defer maintenance activities through year end.
This remains a small portion of our overall business typically representing less than 10% of our gross margin.
And with the Diminimus capital requirements, our aftermarket services segment enhances overall corporate returns.
We have seen some green shoots so far in 2020 with an uptick in major maintenance from customers in the mid continent, South, Texas and the Rockies.
Well, it's a bit early to declare a recovery in full swing, we're encouraged by recent activity levels.
We remain confident in the long term outlook for the segment given the growing installed base of customer owned equipment over the past few years and our prior experience through cycles.
In the meantime, well control, we can by prioritizing high margin business within our HMS operations and optimizing our cost structure.
Our third quarter 2019 earnings call, we previewed a path to free cash flow generation in 2020.
Supported by a significant reduction in growth capital expenditures, so less than $125 million.
Our 2020 budget reaffirms, our cash flow, our free cash flow expectation and fine tune our growth capex forecast to reflect our latest customer engagements and view of the market.
We now forecast annual growth capital of between 80 and $100 million.
At the midpoint this new build program represents a 70% reduction compared to 2019.
Our 2020 growth Capex, we focused on high return large horsepower opportunities with premium customers primarily in the Permian basin.
And as of today over 80% of our 2020 growth Capex has already been contracted customers.
While our guided Capex range implies no growth to slight decline in operating horsepower. This year, we believe the current market environment warrants additional prudence.
In addition, we substantially improved earnings power of our existing fleet over the past few years.
We've designed the business to adapt to market conditions and are confident our 2020 plan is the best for our company and our shareholders.
Before turning the call over to Doug I'd like to step back and reflect on a bigger picture.
The company's transformation over the past several years puts us in an enviable position within the compression industry and the broader energy landscape.
And my time with Archrock, our fleet has never been younger and our competitive position has never been better.
This gives me confidence in the resilience of our cash flows through cycles, and our ability to deliver consistent and solid operational performance.
Our 2020 plan highlights archrocks compelling and increasing value proposition through free cash flow generation.
A better balance sheets, and sustainable return of capital to shareholders.
With that I'd like to turn the call over to Doug for review, our fourth quarter and full year performance and provide additional color on our 2020 guidance.
Thanks, Brad.
Truck ended 29 team on a high note with strong fourth quarter performance.
Fourth quarter revenues totaled $246 million, reflecting an increase of 6% compared to the prior year.
The adjusted EBITDA of $113 million was 15% over the fourth quarter of 28 team and was driven primarily by higher operating horsepower and pricing increases.
The fourth quarter results included $6 million and gains related to the sale of assets.
Net income for the fourth quarter of 2019 was $46 million and included a $40 million release.
Offered tax valuation allowance and a $26 million long lived asset impairment both noncash.
Even adjusting for these items, we reported significant year over year growth in net income.
Turning to our business segments in contract operations, we had record revenue of $204 million up 16% from the fourth quarter of 2018.
This increase as compared to the prior year resulted from higher operating horsepower and rate increases implemented across our fleet at the start of the year.
We delivered gross margin and contract operations of $128 million up from $105 million in the prior year quarter as we benefited from price increases a larger and high graded operating fleet as well as focused cost management.
Fourth quarter gross margin percentage of 63% was up 1% compared to last quarter and up nearly 400 basis points from the prior year quarter.
And our aftermarket services segment, we reported fourth quarter 2019 revenue of $42 million compared to $57 million in the prior year fourth quarter.
Typical fourth quarter seasonality was even more pronounced in 2019 as budget constraints drove continued deferrals and customer maintenance activities.
Considering the challenging market in 2019, our ongoing efficiency initiatives drove impressive gross margin performance.
Fourth quarter Amex gross margin of 15% was flat compared to the fourth quarter of 2018.
For the year, we delivered gross margins of 18% within guidance and up from 17% and 28 team and 15% in 2017.
SGN, a totaled $31 million for the fourth quarter compared to $21 million for the prior year period and $30 million last quarter.
We had an increase in technology investment during the fourth quarter of 2019, while a benefit from tax autumn audits and settlements included in the fourth quarter of 2018 results also affected year over year comparability.
For the fourth quarter growth Capex totaled $59 million, bringing our full year growth capex to $300 million inline with our guidance.
Maintenance and other Capex for the court fourth quarter of 29 team was $23 million, bringing the full year total to $85 million and below our guidance.
We successfully completed two significant debt transactions during the quarter, which further increased our financial flexibility I'm very pleased with a continued support from our lenders and the debt markets a testament to the health and steadiness of our business.
In November we also closed an amendment to our 1.25 billion dollar asset based revolving credit facility extending the maturity to 2024, and a slightly more favorable pricing grid.
And shortly after in December we completed a $500 million senior notes offering where the coupon of 6.25%.
Given strong demand, we upsized the offering by $100 million proceeds from these senior notes, which mature in 2028, we're used to repay borrowings under our revolving credit facility.
We exited the year with total debt of $1.8 billion effectively unchanged from the third quarter. We also had available liquidity of $670 million up from $246 million in the prior quarter.
With growth and adjusted EBITDA during the quarter, we continued to chip away at leverage exiting the year with a leverage ratio of 4.2 times. This is down from 4.3 times in the prior quarter and compares to 5.2 times at the end of 2017 pro forma for the merger.
We firmly committed to our leverage reduction goals. We're we're firmly committed to our leverage reduction goals and continue to expect leverage below four times by the end of 2020.
This will be driven by adjusted EBITDA growth as well as absolute debt reduction by the end of the year.
We recently declared a fourth quarter dividend of 14, and a half cents per share or 58 cents on an annualized basis unchanged from the prior quarter and reflecting an increase of 10% over the prior year.
Our latest dividend represents a compelling yield of 7% based on yesterdays closing price, especially given the protection provided by our industry leading dividend coverage.
Cash available for dividends for the fourth quarter of 29 team totaled $64 million, leading to a robust fourth quarter dividend coverage of 2.9 times.
Finally on guidance all of the test customary details can be found in the materials published last night and for the purpose of this call I'll keep my comments high level.
With the visibility and our outlook and relatively stable and relative stability of our business. We're sticking with our recent practice of providing annual guidance.
Our 2020, adjusted EBITDA range of $415 million to $450 million reflects an annual increase of 4% at the midpoint.
This growth is driven by our contract operations segment, which will benefit from a full year contribution contribution from elite compression and slightly higher pricing.
We also expect to build on the management margin improvement achieved in 2019 by realizing the benefits of a more standardized fleet and continuing our focus on controlling costs.
And our amex business, the midpoint of our guidance Revpas represents flat gross margin dollars.
We are hopeful for a meaningful recovery, but prudently are not counting on one as a reminder, the first and fourth quarters generally experienced some seasonal weakness compared to our second and third quarters.
Turning to capital on a full year basis, we expect total capital expenditures of $165 million to $195 million of that we expect growth capex to be between 80 and $100 million.
Maintenance Capex should mirror 2019 levels and other capex will be up compared to 2019 as planned due to higher technology investment.
2020 is an important here for Archrock. The final period of a three year capital allocation plan and a year that will pave the way for an even better framework in the future.
With that we'd now like to open up the line for questions.
Thank you ladies and gentlemen.
Question. Please press star one telephone keypad.
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Our first question comes from the line of Kyle.
Well one securities. Please proceed with your question.
Hey, good morning, everybody.
Good morning.
In the in the release and in your comments you highlighted a reduction in the age of the fleet that you have now.
As we're thinking about the capital needs beyond 2020, and and I realize this is much more long dated question, but.
The change in the age of your fleet to reduce the demand for capital over the next couple of years or how should we think about this aspect of the business.
Interesting question and.
Twist of fleet question. So Kyle this the short answer is.
The capital demand that we see is really more driven by activity in the marketplace. We just went through.
Two and a half years of is complete.
Build out of new infrastructure in North America in the us in particular and Thats really the driver of of our capital budget. I mean, this was an unprecedented levels of growth and natural gas production and we are a piece of that key infrastructure that provides.
Provided that transportation.
The U.S., so thats really the driver.
But on the other hand, taking the Longview as you intimated that this business was a roll up that began sometime in the nineties.
Through the early two thousands period and in light of that and the location a whole bunch of the compression assets that we've had historically we have had an internal campaign.
Improving.
The operational.
Capability, the competitiveness and the profitability of our fleet and we certainly have turned down and and pulled equipment out of the fleet. We thought did not compete effectively on those metrics and we've invested in equipment that we believe compete exceptionally well.
For the future and so some of that Capex does reflect that migration of our fleet over a long period of time says we get to a point, where the age of the fleet. The competitiveness of the fleet location of fleet has improved at the level. It has today it will and it should have a longer term ability to generate better returns I.
I think thats, probably the way I would characterize it more than it would reduce capex, which I see as market driven.
Got it guys Thats very helpful and and then.
You had a really healthy dividend coverage ratio in 2019, it was around 2.8 times and that should be comfortably above two times in 2020.
Just wondering if you have any preliminary thoughts around increasing shareholder returns with free cash flow this year.
So as we as we get to that year three as Doug said in his prepared remarks.
Our capital allocation commitment that we made coming from the simplification transaction in the consolidation of Archrock partners back in 2018.
We will be entering into kind of a new out new capital allocation.
Program, but right now we've been focused on debt reduction leverage reduction.
And funding self funding our growth Capex in what was just really robust growth market as we move to more normalized market as we move past that commitment that ends this year as we get leverage down below four times.
We will absolutely step back in reevaluate our capital allocation priorities to ensure that we are maximizing the opportunity to drive.
Returns to our investors what that exactly looks like it's too early to tell.
The management team is going to look and put that plan together make a recommendation to the board, but we expect that plan to include every lever we can pull to maximize returns to our investors whether that's in the form of additional dividend increases over time at a rate that makes sense, whether it's in the form of share buybacks we saw.
We'll want to fund our operations long term out of existing cash flow workforce, whether that's incremental debt reduction. We believe all those leaders are going to be fully available to us and on the table.
Got it thanks for the color I appreciate it.
Thank you. Our next question comes from the line John Watson with Simmons Energy. Please proceed with your question.
Thank you good morning.
Good morning.
Brad to what extent are you expecting the shift units between basins. This year, given the potential for decreasing activity in certain regions and how how will that impact utilization.
We do expect to see some shifts the areas that are going to attract more start activity for us. This year will be the Permian of course, probably followed by the Rockies and the primary location that we expect horsepower to to come out.
These include the mid continent.
Area, especially the scoop stack area.
And possibly also.
The central Texas, and Barnett location, otherwise, we see tremendous stability throughout our operation with growth primarily in the Permian in the Rockies. So thats what it would look like geographically, we don't however expect to see that become a large amount of horsepower moves its going to be on incremental but does the horsepower moves.
We expect to see again thinking about the market.
And what I'd said, though we're really expecting this would be very stable market overall.
With some of the geographies that are more dry gas oriented or the older shale plays that are not as competitive to be the areas more horsepower has the potential to decline.
And I would think shifting a greater percentage of your fleet to the Permian is accretive to your overall margin profile can you walk us through other puts and takes.
Between the low end in the high end of your gross margin guidance within contract ops.
So on the gross margin when the contract ops I'll take a quick shot at the biggest drivers and then Dugald taught me up in all likelihood, but when I think about the opportunity it's going to be driven on driven primarily around how pricing develops through the year on the revenue side and our opportunity to continue to take.
Cost out.
Of the organization impacting the upside potential on gross margin. Similarly.
As a competitive competitive business of the market may sharpened.
Given that it's flat.
We could see more price competition on the margin that could also impact it as well as obviously a stop activity exceeds our expectations or starts fall below our expectations that could provide an increment of downside pressure to our guidance range. So those are the primary drivers that I see.
Doug anything on top of well I'd just complement John on.
Trying to get us to tighten between 61, and a half and 63% looking for incremental color. There is is well done I'd say for an annual guidance range, we're still comfortable with those as the sort of goalposts and.
Brad did a nice job of outlining what what could contribute to those whether we're at the midpoint, our or higher or lower end will depend on unrelated things he talked about.
Perfect I appreciate you all taking a stab at it.
Very well done on the Capex side, I will turn it back.
Thanks.
Thank you. Our next question comes from the line of Daniel Burke with Johnson Rice and company. Please proceed with your question.
Hi, good morning, guys.
Good morning.
Let's see so so plainly the message today and implicit guidance is that the the contract markedly really stabilizer for you guys at a run rate that appears to be pretty consistent with which you kind of seen post elite and ladder 2020, but I guess just one question given the scale of the 2019 growth program.
Is there any lingering newbuilds sort a tailwind.
But you got headed into Q1 20.
You know Daniel I would tell you that there's there's probably a little bit in terms of some units that we took delivery of in January that werent. Yet started I mean, we have as good a cash flow conversion as I believe there there is our.
This in the energy business in terms of what we pay for.
Versus when we convert that to cash flow generation.
But it isn't it isn't gigantic so.
In terms of the pace of our investments I think or or more.
Said another way as if you start to think about our annual guidance range and we've moved away from quarterly guidance that you would expect this stuff both the tail end of last year's Capex and then what we will be spending in that $80 million to $100 million range. This year that you would see that the majority of that come online in the.
Second quarter of 2020.
Okay.
All right. That's a helpful got those thanks, Doug.
And then let's see.
Brad you're always pretty circumspect on the pricing front, but.
Pass you guys have kind of alluded a reference. This can you can you talk about me portion to sleep.
Still sort of sub.
Able.
What portion of C suite, you were able to push through.
Pricing increases as you rolled the calendar 2020.
Well I can talk about the the structuring of where the fleet is and give you give you an idea. So we had.
About 60% of the fleet that was available for.
That was out of term and available for a price increase and of that.
Good portion of its was in a month to month non strategic relationship context, where we were able to push through price increases.
But the price increase was to get units that have recently come out of term up to current market pricing and as we've had price increases now for successive years.
The available differential between where are those contracts rolled out of two the pricing we could roll them into is definitely more modest than we experienced in in 18 and 19.
And that's why we gave the guidance, we did which is that we still find the price environment at these high utilization levels constructive and attractive.
But it is plateauing and so we're keeping everything at a market price.
In a tough year, where are the optics for our customers are little more challenging.
So we're happy we were able to is to bring that pricing up on those contracts that were available to us and just shows the strength of the high utilization we have in the market today and what is silly.
Natural gas production Levered business with the natural gas price.
Production levels looking good for 2020, and certainly looking good long term.
Great. Thanks, and then maybe just one one last little discussions like around gas lifts now versus say a year ago at this time.
I don't I don't think they've changed our gas lift to the portion of the fleet on gas lift remains at about 25%.
And that that is stable and flat. So we havent seen a drastic change in that notwithstanding a tapering off of drilling activity.
In the Permian and other plays.
It also use gas lift so I haven't seen or had any discussions of of the real change in that dynamic.
So far in 2020.
Okay.
Great that I'll leave it there guys. Thanks.
Thanks.
Thank you Sir our next question comes from the line of Tom Curran with B. Riley. Please proceed with your question.
Thank you.
Meg and welcome to your first call with Archrock and best of luck.
Thank you.
So a few guidance questions for me.
Just for that the technology program do you still expect to spend a total roughly 25 million. This year and then whatever the final estimate is for this year could you provide us with the breakout between SG nine capex.
For two talking about on just the technology project. The breakdown between those are correct that the total amount you expect to spend on.
On I guess its phase two or this year of the technology project and then the split between X gene and Capex.
Okay.
Yes, Tom we're just digging up now to make sure. We can give you a responsible answer to.
So the breakout for questions.
Okay, Yeah, sorry.
So yes in terms of the overall.
Dollar span and for 2020, we're looking like about 9 million of of Capex This year and.
Similar call it seven 8 million for SGN a.
So total a little bit below your 25 number.
Probably closer to the $16 million to $20 million range.
Great, Thanks, Doug and that our Brad sorry, Doug.
And then for.
Hey, Matt.
Similar question when it comes at a revenue split.
What was it.
Between parts and services for Fourq, you and then what do you assume it will be setting 2020 guidance.
That's the revenue question frame as.
And then I'll ask a similar one the John's for contract ops, what would be the case the key swing variables for HMS. This gross margin.
At that from the low into the high end.
You want to take that part first Brad.
Sure sure Yeah, let me just lower pulling up let me I can talk to the swing on SMS look on SMS, we've been we've been fairly disciplined and trying to bring the gross margin up that may have actually cost us an increment of revenue.
In prior periods.
Candidly kind of okay with that.
But the changes will be a combination of yes product mix to.
Take the lead off the first part of your question the more parts cells that we have that tends to be more of a drag on the other hand, thats SG nay lights and infrastructure light.
Margin dollars that come in on part cells and the higher end is the more service revenue, including.
Work in the field for our customers on their units as well as work in the shops for the customers on their units typically the higher the margin is.
But look the real driver behind MMS right now is that we have been in a very constrained environment for capital customers have been focused on deploying a lot of new horsepower and so I think that that has left a lot of pent up in deferred demand.
And growing deferred demand as more of the units that were set over the last few years are in need of more service. So while we're optimistic for an uptick we do need to see.
As deferred maintenance practices.
Bait and the customers get more active on the level of invest that they put into their existing equipment. So that's the that's the long answer.
Equipment mix customer activity levels.
Which will drive.
Pricing to be incrementally higher as they try to activate find resources for it including using including using Archrock.
Doug I'll turn it just on 19, SMS revenue was 37% parts and 63% service.
And Doug is that was that for Fourq you are the full year.
That was full year Q4, very similar 36 and 64.
Great.
I appreciate your fielding my questions.
You bet.
Thank you.
Next question comes from the line of TJ Schultz with RBC capital markets. Please proceed with your question.
Hey, good morning, sorry, just one clarification on guidance and pricing and the midpoint guidance I think you said it.
Tim to full year from a lead and then slightly higher pricing year over year.
Is that just.
Really saying you get the benefit of the improvements in pricing you saw in 2019 and then the assumption.
For this year is that you really are not factoring additional pricing increases. So we flex kind of the low end in high end, if you put through any pricing concessions or pricing increases from here.
No I think it was really a comment made at a bit of a higher level TJ I am if you just we look at Weve acquired a leader closed on that August Onest of last year, which meant we had the benefit of it four 512 some of the year. Obviously for 2020, we'll have it for all 12 months.
Also included in that transaction was the sale of the harvest assets.
And then on.
The price increases that were pushed through we'll we'll see those.
Those don't happen.
Always necessarily the same time.
And then then lastly, yes as Brad mentioned, there will be some price increases on some of the fleet that pushes through the sort of some of those get you to I think we said, 4% year over year EBITDA growth at the midpoint and.
Thats, if you think about where we're spending 80 to 100 million on growth Capex for this year to still see EBITDA growth you would attribute that to each of those factors that we just described.
Okay. Appreciate it thank you.
Thank you.
Thank you, ladies and gentlemen at this time there no further questions I would like to turn it back to Mr. Jones for closing comments.
Great. Thank you operator, and thank you everyone. We appreciate your interest in Archrock. Thanks to the hard work of our employees 2020 is off to a great start I'm confident we have the right plan to deliver value for our shareholders today.
Well into the future.
Forward to seeing you all out on the conference circuit and updating you on our first quarter results in mix. Thanks, everyone.
Thank you ladies and gentlemen. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation.