Q2 2020 Archrock Inc Earnings Call
Your host for todays call is making report Vice President Investor Relations at our crop I.
I would now let's turn the call over to Miss His report you may begin.
Thank you Dan Hello, everyone and thanks for joining us on todays call with me today are Brad Childress, President and Chief Executive Officer, Archrock, Doug Aron Chief Financial Officer Apart.
Yesterday or truck released its financial and operating results for the second quarter 2020, if you're not received a copy you can find information and the company's website www dot our truck.
During this call we will make forward looking statements in the meeting section 21 E.
Securities Exchange Act 1934.
And our current beliefs and expectations as well like assumptions made by and information currently available to Archrocks management team.
Although management believes that the expectation is 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 FCC Relistor factors that may cause actual results to differ materially from those and the forward looking statements made during this call.
In addition, our discussion today, we'll reference certain non-GAAP financial measures, including adjusted EBITDA gross margin gross margin percentage and cash available for dividends.
A reconciliation of these non-GAAP financial measures chart GAAP financial results. Please see yesterday's press release, and our form 8-K first to the FCC.
I'll now turn the call over to Brad to discuss Archrock and Archrock second quarter results and provide an update of our.
Thank you Megan and good morning.
I appreciate everyone joining our conference call today last night, we posted solid second quarter results in the context of one of the most difficult environments the industry at Archrock I've ever faced.
As we highlighted for some time Archrock provides critical U.S. natural gas infrastructure and the company is built by design to enter market cycles.
Yes, the backdrop of global pandemic.
Economic slowdown and precipitous decline in commodity prices the resilience of our business was tested and demonstrated during the second quarter.
Our impressive performance was driven by outstanding execution in the field and significant progress our cost and capital savings efforts.
Among the accomplishments in the quarter, we generated EBITDA of $101 billion flat compared to the prior period.
We improved our contract operations gross margin percentage by 400 basis points sequentially and annually the 66%.
We reduced <unk> expense by more than 6% from $31 billion in Q1 to $29 million in the second quarter.
Our second quarter Capex was down meaningfully year over year, but remain somewhat elevated as we took delivery of units to meet orders that were placed by customers and 29 thing.
Aside from these units, which are already out earning revenue we put the brakes on additional 2020, new equipment Capex.
This will drive substantially less spend in the second half a year and we've reflected this lower investment in the updated guidance that Doug will cover later in the call.
We generated free cash flow in the core and thereby demonstrated our differentiated financial flexibility.
Our adjusted EBITDA is holding up well and we paid down a small amount of debt in the quarter, which kept our leverage ratio largely unchanged from the first quarter.
4.1 times.
As a result of our lower Capex spending we expect our second half free cash flow generation and debt repayment to accelerate significantly.
And we continue to pay an attractive dividend complemented by peer leading dividend coverage.
As discussed last quarter in light of market conditions and in order to maximize profitability cash flow and our financial position, we proactively initiated an aggressive cost and capital reduction effort.
Our push to rightsize the organization for activity levels cut across all business segments and our corporate overhead.
Today I'm pleased to share that we are well underway to deliver the annualized cash savings are between 75 and $85 million promised in may.
We expect these savings will accelerate in the second half of the year as planned.
We anticipate no new equipment Capex for the remainder of the year end of slashed, our full year 2020, capex budget as compared to 2019 by more than $240 million at the midpoint of our revised guidance.
We're already seeing substantial declines and maintenance capital.
Maintenance capex down 40% compared to the first quarter.
We expect continued benefits from lower make ready capital and have optimized maintenance practices, while maintaining our excellent customer service and safety standards.
I don't see any sense, we implemented several actions to reduce discretionary spending in compensation expense.
We continue to manage overtime hours tightly and the previously announced salary reductions for certain employees. The executive leadership team as well as reductions to board retainer fees went into effect in June.
Well the entire management team is focused on retaining our great talent through this downturn.
As business softened further during the quarter, we made it difficult decision to take deeper action.
This included furloughs and layoffs in several business units and segments.
We remain steadfast in our drive to maximize our free cash flow and maintain our differentiated financial position.
We continuously evaluate additional savings initiatives and are committed to a rigorous and ongoing analysis of our costs as the market evolves.
Beyond our cost reduction efforts, we continue to transform our fleet streamline our business and invest in technology to extend our runway for efficiency gains.
Building on our success in 2019, we continue to manage improving our compression fleet accelerating EBITDA recognition from less strategic and an economic horsepower and bringing in additional cash to redeploy toward debt reduction.
During the quarter, we sold 24000 horsepower that had an average age of nearly 30 years.
And just after quarter end, we sold a portion of our MSP business, which will result in gain on sale income during the third quarter of about $9 million.
As we do every quarter. We also conducted an extensive review our fleets and identified compression units that were either not likely to go back to work or did not warrant additional investment to put back in the field.
From this review we retired 184000 operating horsepower the resulted in a noncash impairment of $55 million.
[noise]. This number was larger than in past quarters, due primarily to the sharpness of the downturn and customers determining the portions of their production operations, we're no longer economic.
Unsurprisingly some of our equipment that is service those locations is also no longer economics redeployment based on its age or configuration.
On our technology upgrading work, we're making good progress on expanding our communications and remote monitoring capabilities throughout our field operations.
That investment is proceeding nicely and we expect to start seeing benefits from this investment in the 2021 timeframe.
Now I'd like to turn to the market and outlook for our businesses.
At the time of our first quarter earnings call. It was clear the covered 19 pandemic would cause severe commodity demand and price impacts as well as widespread capital reductions by our customers.
We took quick action to prepare for the inevitable downturn without knowing the exact timing and magnitude of the pending change in demand for our compression services.
The market deteriorated quickly and sharply during the second quarter as a result of the cobot 19 pandemic.
The rig count fell over 60% during the second quarter and U.S. dry gas production fell from over 94 Bcf a day two as low as 86 Bcf a day.
While we will not try to predict the timing of a recovery we began to see signs of stabilization in the overall market and in our compression operations entering the third quarter.
Oil prices have improved off of April as the pace of rig count declines is slowing and we've seen modest growth in natural gas production or read in recent weeks as shutting wells have resumed production.
Should current oil prices hold up we could also see some producers look to allocate capital to the large backlog of drilled but uncompleted wells in the second half of this year.
Well all of these improvements are encouraging.
And we're hopeful we've seen the worst of the downturn visibility remains limited.
As we closely monitor market developments, we will continue to control what we can to physician archrock for success.
Turning to our operations in contract compression, our strong execution and cost savings initiatives drove an increase our gross margin percentage versus the first quarter despite lower horsepower.
Our first touch on the challenges during the second quarter.
With a sharp drop in commodity prices producers in midstream or quickly rationalize costs in some cases. This resulted in the return of our compression equipment from the field.
Our long term contracts standby strategy and focus on large horsepower midstream applications certainly helped mitigate the impact.
However, our second quarter operating horsepower and exit utilization still declined.
We continue to work closely with our customers to support their businesses.
Maximize our operating horsepower and maintain revenue and pricing as best we can.
On the strongly positive note, we drove an increase in contract operations gross margin to 66% in the second quarter up 400 basis points on both the sequential annual basis.
As a reminder, a significant portion of our operating costs are variable a key advantage as we made adjustments to align our business with market conditions.
I also want to highlight that in the midst of a global pandemic and severe energy downturn.
We had record safety performance and continue to provide excellent customer service and equipment uptime.
This speaks to our strong safety culture.
And to the result in great talent of our employees.
Moving onto our aftermarket services business with the effects of cobot 19 and decreased commodity prices.
Customers are preserving capital and still delaying maintenance activity on their equipment.
This resulted in a revenue and gross margin decline often already low base.
As we've yet to see any changes in Fms customer behavior, we remain focused on optimizing our cost structure.
Turning to our capital allocation strategy, our message is consistent with last quarter and our focus remains on balancing appropriate levels of investment.
Debt reduction and shareholder return.
With infrastructure already in place to support Us natural gas production and meet the needs of our customers for the next few years our priorities are.
First shareholder returns even during this downturn.
We believe having a reliable and attractive dividend is important to our investors and to the value of our company.
And we will continue to work with our board each quarter to assess our forward use a future cash flows and the dividend.
Our second but equally important priority at this point of the cycle is to execute all available measures to reduce our debt and protect our financial position.
Ultimately, we believe somewhere between 3.5 and four times is the optimal leverage level for our stable compression business.
Before turning the call over to Doug I'll leave you with a few thoughts on what I believe is archrocks compelling value proposition.
One that stands out when you look not only at the wrong energy investments, but across other income oriented sectors as well.
We continue to demonstrate predictable cash flows an attractive free cash flow yield as well as endurable well funded distribution.
Well, the coming quarters won't be free of challenges I'm excited to prove out what our differentiated business model and financial framework can deliver today and well into the future.
With that I'd like to turn the call over to Doug.
A review of our second quarter performance in 2020 outlook.
Great. Thank you Brad let's look at a summary of our second quarter results and then cover our financial outlook.
We maintain flat adjusted EBITDA of $101 million compared to the second quarter of 29 team.
Lower revenues were more than offset by intense cost management.
Our second quarter adjusted EBITDA included $2 million, a net losses related to the sale of assets.
We recorded a net loss for the second quarter of 2020 or $30 million, which included several onetime charges the majority of which were noncash.
As Brad mentioned, we retired 184000 operating horsepower and recorded a $55 million long lived asset impairment during the quarter.
We also took a $2 million restructuring charge related to severance benefits and had a $4 million noncash loss associated with the early retirement of debt.
Finally, we had an $8 million noncash income tax benefit during the second quarter.
Excluding these items, we reported net income of approximately $25 million.
Turning to our business segments contract operations revenue came in at a 188 million in the second quarter down from 207 million on the first quarter due to lower operating horsepower pricing pressure and horsepower on standby, however, gross margin improved to 66%.
Due to solid cost management.
And our aftermarket services segment, we reported second quarter 2020 revenue of $32 million down from $43 million in the first quarter.
Customer activity remained low given cost constraints and market uncertainty.
We had a few cost items come in above our forecast for the quarter, including higher warranty expenses. We also experienced lower labor utilization during the quarter, given the often lumpy nature of RMS work and as we continue to balance retaining our high quality technicians with rightsizing the business for activity levels.
Both resulted in second quarter HMS gross margin that was below our mid teens target.
As DNA was down nearly 2 million compared to the prior quarters $31 million as we saw the initial benefits of discretionary spending reductions and other cost savings.
For the second quarter growth capital expenditures totaled $23 million to $23 million down more than 50% from $40 million to $49 million during the first quarter.
We also reduced maintenance and other capex during the second quarter of 2000 $20 million to $18 million from 23 in the prior quarter.
Our total debt of $1.8 billion reflected $8 million and net debt repayments during the second quarter.
Our credit facility doesn't mature until 2024, and we currently have over $400 million and available liquidity.
Our leverage ratio of 4.1 times was essentially flat compared to the prior quarter, but down from 4.4 times from the second quarter of 2019.
We expect debt repayment to accelerate in the second half of the year, which will mitigate the expansion of our go forward leverage ratio and tell the market recovers and we can deliver on our goal of three and a half to four times.
We recently declared a second quarter dividend, a 14.5 cents per share or 58 cents on an annualized basis unchanged on a quarterly and annual basis.
Our dividend payout is supported by our internal cash generation strong balance sheet and robust dividend coverage.
Cash available for dividend for the second quarter totaled $58 million, representing peer leading dividend coverage of 2.6 times.
Our existing dividend represents a compelling yield of 8% based on yesterdays closing price.
We remain committed to returning cash to shareholders and to reducing our debt from available free cash flow.
Ill and with some commentary on our 2020 outlook as you know the relative resilience of our business allowed us to provide an updated 2020 outlook in may as many companies were pulling guidance due to the covert 19 pandemic and commodity price declines.
Based on solid second quarter execution, and our current view of the market, we still expect to deliver between 380 $420 million and full year 2020 adjusted EBITDA.
And with our cost and capital reductions, we've enhanced our outlook for free cash flow and cash available for distribution for the year.
We've provided some adjustments to segment forecast in the press release issued last night.
We are maintaining a wider adjusted EBITDA guidance range given continued market volatility.
And contract operations were largely on track for the year as lower horsepower and revenue is being mitigated by aggressive cost management.
And I am asked were trending below expectations provided in may as our customers are further delayed releasing their budgets for maintenance work.
Turning to capital on a full year basis, we've lowered our total capital expenditure range to $130 million to $155 million or down about 8% at the midpoint compared to previous guidance.
This is largely being driven by maintenance Capex savings as we continue to optimize our maintenance practices.
Our updated growth Capex range of $70 million to $85 million adjusts the high end of our prior range down by $5 million.
To sum it up our expected operating performance combined with a reduced capex profile and the second half of the year will drive an acceleration of free cash flow generation.
We expect full year free cash flow generation after dividends to be substantial approaching $100 million, which we expect to use to repay debt.
With that Devon, we'd now like to open up the lines for questions.
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Our first question comes on line of calming with capital One Securities. Please proceed with your question.
Good morning.
Good morning.
Brian you mentioned that compression operation started to stabilize entering the third quarter can you talk more about what you're hearing from your customers and also what you're seeing in the field.
Sure.
So when we look look at the timing of this positive we had an amazing may I mean, it's it really hit so so quickly and what we saw for the quarter was.
Sharp increase in stop activity is customers right sized for production levels in for economics.
Bookings and starts you basically came to a strong stop and standby activity hit a record pace that is the number of units we put on.
Standby, which could work, which we still collect revenue, but at a lower rate.
What we saw already.
Coming into Q3 is that stop activity as is already moving to a more normalized level I'll remind you that thats a normal part of our business.
And standby horsepower about half of what went on standby initially has already come back off standby.
And so those are the positive that we've seen bookings. However continue to lag is would be expected given production expectations, but is that normalization of stop activity and the return of.
Horsepower this previous lunch on standby the full operations that are some of the indications we have seen look on a bright spot point out that despite the market in the timing. We had we did see incremental growth in a couple of markets, including the northeast and the Haynesville.
As some dry gas production was was brought back on I think to offset some of the decreases that we saw at least partially in the showplace. So it wasn't all bad and those are the highlights in the way I think about what we are seeing currently in the market.
Got it Okay. That's helpful and as my follow up you.
You highlighted the gross margin percentage really strengthened in the second quarter and it sounds like maybe that's partially due to some of the equipment being on standby, but I guess as that equipment returns and you look at the back half of the year can you go into more detail about how you're thinking.
Cost management, and then maybe if that.
Better margin is sustainable beyond 2020.
Sure.
So first off the field team did an outstanding job managing what we have is a highly variable cost structure and they just did a great job managing it to both rightsize the business and obviously based on our results to get ahead of the market declines and we saw savings in all of the components of our.
Sure Labor.
Parts as well as lube oil there was as you pointed out Kyle a contribution from the standby revenue, which as zero.
Most zero operating cost associated with it.
But our guidance range moved up for a contract operations gross margin.
And to 63% to 65%, which is indicating the amount of that improved profitability, we expect to hang onto certainly in 2020.
We're not going to really comment beyond that but we're going to be very ambitious about how will we can continue to drive profitability into this business.
And in 2021, we're looking forward to getting more of the results from our technology investments into our profitability as well so we're pretty ambitious about how well we can drive this.
That sounds great.
Going back and Keith Thanks.
Yes. Thank you.
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Our next question comes from line of Daniel Burke with Johnson Rice.
A question.
Hey, good morning, guys.
Good morning.
Brad just just kind of think about the trajectory.
The business in the second half year and in terms of contracted horsepower.
Thank you very one way to ask this I don't know.
Work, but would you asking what sort of a normal run rate stop activity, that's what's going to prevail in the second half the year.
Okay.
One way to think about that I mean, there won't be a lot of net ads.
I was wondering how to think about stops.
Yeah, So number one.
I'm going to just express that visibility into the market is not great.
And.
The communications that our customers right now still look at.
Think of flat to slightly declining level of gas production.
Throughout the course of the year and so we don't see that theres going to be a lot of.
Bookings or growth available in the market.
And at same time, though we also see stabilization around the horsepower levels required support for current gas production.
So.
And finally, our guidance includes our expectations for what's going to happen to revenue and contract operations and I think thats. The my commentary and that is the best indication that we have in forecasting horsepower changes for the rest of the year.
Okay.
Yes fair enough with just two quarters it gets a little easier to box that in.
All right.
Maybe maybe a smaller one then on the M.S. side.
I think you were Doug highlighted there there was a sale.
Didn't sound like it was particularly sizable but I was wondering if it didn't have any impact on on gross margin for the full year as we kind of looking at the scale and try to balance where in that guidance range.
You will fall out for the year.
Yes, not really.
The business we sold was.
A small portion of that business by the way as great team has a good business. It just so happen however that given some changes in that subsections subset of both of the market.
So we had a buyer that was able to value at well and accelerate for us a lot of the value that we saw in that business too.
But at a time when our capital allocation priorities in debt reduction when do well served by monetizing some of that future value, which is what we did in that transaction. So we're really pleased with that transaction is one of the incremental steps in the context of we're doing all we can do to figure out where we can monetize and energy.
Is that.
And I just would add Daniel that from a modeling perspective, because it was as Brad pointed out relatively soft small in the Grand scheme that it shouldn't have an impact them.
Our guidance again, our range there really more reflects.
Okay, even less villa visibility in the CMS business.
For the back half the year, but.
We're hopeful we've captured the right range for that and what we put out updated guidance.
Okay guys work.
Okay. That's helpful. I'll Oh go ahead.
Thanks, Dave.
Our next question comes from the line of Brian Thanks, with B. Riley FBR. Please proceed with your question.
Hi, good morning, guys.
Morning.
Doug you mentioned youre, maintaining a wire EBITDA guidance, Bob understandable lithium sensible.
But what do you think or some other factors that would get you to the higher on them that range is it just activity levels or is there more room to actually save on the call side.
Okay.
I think activity levels, obviously have a big impact and we are we're continuing to be hopeful that our sales organization will fill needs where there are I mean, it all really comes down I think too.
Commodity price and as Brad highlighted do we start to see.
Drilled, but uncompleted wells pickup in activity in the back half.
You're modeling is going to be way better than ours, probably in terms of what to expect there.
We did as we just talked about with Daniel have the $9 million gain on sale of.
A portion of the HMS business. So I know it varies for each of you on the line as to whether you include that or you don't and our adjusted EBITDA. We do included.
Including that.
We think that that will be above that midpoint that we described previously if you don't.
It certainly will will be a little more challenging to get there at least based on what we know today. So.
That all of that goes into our thinking and the why a little bit wider than usual guidance range at this point of the year, but.
Again appreciate what the rest of the energy industry is going through more broadly just about every industry outside of Apple and Amazon and we feel pretty good about the 2020 outlook for Archrock.
That's helpful.
Thank you and then on M&A, certainly this and third in terms of capital allocation priority right now.
Just wondering what you're seeing out in the market with perhaps some of your competitors struggling right now.
You would potentially have on the appetite at the right right.
You know we.
Our perspective on.
On M&A and industry consolidation hasn't really changed on the one and we favor and would like to see consolidation wherever it occurs we think it brings discipline into the capital, especially capital side, especially of the industry and I think that.
As with other sub sectors there are certainly some.
There's costs that can come out through consolidation, we are absolutely a willing participant where we can find value.
And quality combined in the same operation for us.
I think that Thats always a good path to get some incremental growth.
Looking back we are still.
Clearly pleased with the acquisition, we had last year.
Of elite compression, which was but excellent equipment excellent team well run company and we were able to bring that onto our platform.
Really effectively but I'll point out that very often.
Stress doesn't come with quality in the operations and so we just want to make sure that we stick to our disciplined fleet strategy of growing and upgrading continuously the locations in which our businesses operate that is the basins.
The quality age and standardization of the fleet that we've continued to invest in and grow.
On that 0.1 of the things that we noted in the quarter is that that fleet upgrading work, which any acquisition has to be consistent with.
Has resulted in the average age of our fleet now in the range of between 10 and 11 years.
We have gotten to the point, where we are operating today, the most competitive and youngest fleet, we've ever had and any any consolidation or acquisition in which we participate.
Needs to be consistent with that strategy.
Great I appreciate the detail I'll turn it back thanks, guys.
Thank you.
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Two questions.
Is there no further questions I would like to turn the call back over some children any final months.
Thank you everyone for participating in our Q2 call. We believe we've taken and continue to take the right steps to position on track to navigate this current cycle and plan to continue to focus on cost and capital management for the remainder of 2020 I look forward updating you in our third quarter Paul.
Later in the year.
Thanks very much.
This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation have a wonderful day.
Hi.
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