Q3 2020 Archrock Inc Earnings Call
[music].
Relations or crop.
Now I'll turn the call over to Mr. and Mrs. refined maybe.
You may begin.
Thank you Dan Hello, everyone and thanks for joining us on todays call with me today are Brad Childers, President and Chief Executive Officer of Archrock, and Doug Aron Chief Financial Officer Art.
Yesterday, our truck released its financial and operating results for the third quarter of 2020.
Not received a copy you can find the information on the company's website at www dot or truck.
During this call we will make forward looking statements within the meaning of section 21 E of the Securities and Exchange Act.
34 based on our current beliefs and expectations about the assumptions made by and information currently available to Archrock means.
Although management believes that these expectations reflected in such forward looking statements are reasonable it can give no assurance that such expectations will prove to be correct.
Refer to our latest filings with the FCC for a list of factors that may cause actual results to differ materially from those in the forward looking statements made during this call.
Our discussion today will reference certain non-GAAP financial measures, including adjusted EBITDA gross margin.
Gross margin percentage and cash available for dividend.
Reconciliations of these non-GAAP financial measures to our GAAP financial statements. Please see yesterday's press release, working K furnished to the FTC I'll now turn the call over to Brad to discuss our trucks third quarter results and to provide an update.
Thank you Megan good morning.
I appreciate everyone joining our conference call today.
Last night, we posted solid third quarter results. Despite significant demand headwinds brought on I covered my team.
I could not be prouder, how well the archrock team has responded to the challenges we faced this year.
Our stand out third quarter results were driven by excellent execution in the field and an unrelenting effort to attack our cost structure wherever possible.
Tony accomplishments in the quarter, we generated adjusted EBITDA of $113 million up slightly compared to the prior year period.
We defended our strong contract operations gross margin percentage driving more than a 100 basis point increase versus the prior year period after adjusting for nonrecurring tax benefit in this current quarter.
We further reduced <unk> expenses by 12% in Q3 on a sequential basis and also adjusting for that nonrecurring tax benefit.
[music].
We continue to pay an attractive dividend dividends complemented by pure leading dividend coverage.
And finally, we continue to generate robust free cash flow, both before and after dividends in the quarter.
Year to date, our free cash flow after dividends totaled $117 million.
This was a combined result of operating cash flow resilience, lower capex spending and approximately $50 million in noncore asset sale proceeds.
In total this has enabled us to repay borrowings on our credit facility and reduce our leverage to 4.0 times.
These positive quarterly outcomes demonstrate the impact of the aggressive cost reduction and operational improvement measures we've implemented over the last several months.
The disruptions to our industry required sacrifices from everyone at Archrock and I'm very grateful for the continued efforts of our employees everywhere.
We've taken significant action to squeeze cost out of our business and our efforts cut across all segments and all geographies.
We maintain disciplined capital spending across the board in growth maintenance and other capital expenditures.
Year to date.
Our total capital expenditures were $130 million compared to more than 300 million at this point in 2019.
We expect to reduce our full year 2020, total capex budget by $250 million or approximately 65% compared to 2019.
Reduced SGT substantially on a run rate basis in both Q2 and Q3.
We continue to tightly manage overtime hours and discretionary spending.
And the previously announced salary reductions for certain employees in the executive leadership team as well as reductions to board retainer fees all remain in effect.
Well were focused on retaining our great talent as much as possible. We've also had to make difficult decisions to rightsize the organization for the opportunities that.
This has resulted in a head count reduction of more than 20% since the end of 2019.
We continue to invest in technology, even as we manage costs tightly in this downturn, we've been investing both <unk> and capital dollars to lay the foundation for continued improvement in both our customer service delivery and our operating cost structure.
These investments will also help us reduce our emissions in carbon footprint in the future.
Finally, we continue to high grade our business year to date, we sold 133000 horsepower with an average age of 22 years.
And in July we sold a portion of our HMS business at an attractive multiple.
[noise] these efforts to upgrade our fleet invest in technology and enhance our operations and our profitability will continue to support our commitment to deliver on our capital allocation objectives, including delivering significant full cycle free cash flow.
Now I'd like to turn to the market and outlook for our business.
Overall energy market conditions have improved over the last few months compared to the second quarter.
You as natural gas and oil prices have stabilized at higher levels.
The rig count grew modestly during the third quarter.
And customers are beginning to draw down inventories of drilled but uncompleted wells.
At the same time, we're cautious about assuming an immediate and full recovery.
It is ultimately dependent on highly uncertain external developments, including the path of the code 19 pandemic.
And the timing and magnitude of future economic recovery.
Looking into 2021, most natural gas forecasts show a modest annual decline in U.S. natural gas production as producers limit drilling and completion activity to achieve maintenance levels of production and cash flows.
Accordingly, we're planning for softness in the compression markets persist into 2021 with the potential for improved conditions later in the year.
Beyond 2021, and long term, we remain confident in the positive fundamentals the critical infrastructure, we provide to our customers, particularly as natural gas provides an affordable reliable and cleaner burning solution to meet growing energy needs worldwide.
We believe natural gas will play a prominent role in a cleaner energy mix, even as energy or energy generation from renewables increases.
According to the U.S. <unk> natural gas has been the largest contributor to lower energy related greenhouse gas emissions in the U.S. electric generation sector as it continues to displace higher emission fuels such as coal.
In fact between 2005 and 29 feet U.S. natural gas production increased by 88% well energy Cotwo emissions in the U.S. declined by 14%.
We look forward to continuing to play an important role in keeping our customers natural gas streams flying.
Partnering with them to meet their safety and environmental objectives, and powering America well into the future.
Turning to our operations in contract compression were.
Focused on what we can control, including how we managed our cost structure, how we execute and how we service our customers.
Our third quarter results are evidence that our focus is paying off.
Revenue fell by 7% sequentially, primarily due to the full impact of quarterly horsepower declines.
Pricing decreased modestly and his overall holding up well.
The 148000 horsepower declined in the third quarter was a significant improvement compared to the losses, we sustained during the second quarter.
Our third quarter exit utilization declined to 83% from 86% at the end of the second quarter.
We expect to see modest horsepower declines for the next few quarters, but believe our multiyear fleet high grading efforts will keep us on track to outperform our utilization performance in the last downturn.
Even with the top line pressures.
Trucks operations teams drove excellent gross margin performance, we posted a 66% gross margin in the quarter or 63% adjusting for the tax benefit.
This is up nicely from 62% in the year ago period, and consistent with our annual guidance range.
In our aftermarket services business, we are focused on maximizing profitability and performance through this challenging period.
We believe that we have right sized the business for our opportunity set and we'll continue to focus on maintaining gross margin levels through this period.
In early in the third quarter, we made the strategic decision to sell a portion of our BNS business, bringing in additional cash, which we redeployed to debt repayment.
From a capital policy standpoint, we remain committed to our well defined capital allocation strategy, which focuses on two key priorities.
Shareholder return and reducing debt.
While others have been forced to get dividends Archrock has been able to maintain an attractive dividend and prudent dividend coverage through this sharp downturn.
Our dividend yield continues to compare well the other energy companies and other income oriented sectors.
Oh equal importance, we will continue to execute all available measures to reduce our debt and protect our financial position.
We strongly believe reducing debt and paying a dividend our key value drivers for Archrock and we're confident in our ability to do both in the current environment.
Before turning the call over to Doug I'll share with you then in September our company celebrated the 66 anniversary of our founding at South Coast gas company in 1954.
Well other companies in this industry have come and gone.
Our company has endured and grown to become the industry leader in U.S. natural gas compression.
With that I'd like to turn call over to Doug for review of our third quarter performance and outlook.
Thank you Brad and good morning.
Let's look at a summary of our third quarter results and then cover our financial outlook.
Our third quarter performance strongly supports our financial goals of protecting liquidity generating free cash flow and reducing debt.
We reported adjusted EBITDA of $113 million slightly higher than the third quarter of 2019.
Our third quarter adjusted EBITDA included $9 million and net gains related to the sale of assets and an $11 million net cash benefit from tax audit settlements covering a three year period.
60% of this tax benefit was recorded and asked DNA with the remaining 40% reflected in our contract operations gross margin.
We recorded net income for the third quarter of 2020 of $18 million, which included a few one time items the majority of which were non cash.
We recorded an $11 million long lived asset impairment during the quarter and took a 3 million dollar restructuring charge related to severance benefits and property closures.
Turning to the business segments contract operations revenue came in at $175 million in the third quarter compared to $188 million in the second quarter due primarily to lower operating horsepower.
Looking at our gross margin percentage, we continue to benefit from a highly variable cost structure, a key advantage as we continue to make adjustments to align our business with market conditions.
We remain on track to deliver a meaningful increase in our gross margin percentage compared to 29 chain despite revenue headwinds.
And our HMS segment, we reported third quarter 2020 revenue of $30 million down from $32 million in the second quarter.
RMS revenue reflected lower customer activity, given cost constraints and market uncertainty as well as lost sales from the divestment of our turbo charger business.
We drove our M. S gross margin percentage back up to our 2020 target delivering a third quarter gross margin percentage of 15%.
We continue to focus on higher margin business and optimizing our labor utilization during this slower period.
[noise] SDMA totaled $19 million for the third quarter compared to $29 million in the second quarter and $30 million for the prior year period.
Excluding the 7 million dollar tax benefit our third quarter SGN I was still down over $3 million on a sequential basis.
For the third quarter, we limited our growth capital expenditures to $6 million down more than 70% from $23 million during the second quarter.
Our last bit of new build spend for the year was completed in July with repackage and new units start up cost comprising the remainder of the growth capex during the quarter.
We also reduced maintenance and other capex during the third quarter of 2022 $11 million from $18 million in the prior quarter.
For the first three quarters of 2020, we completed nearly $50 million of asset sales as we continue to prune our fleet and divest non core businesses, where it makes strategic sense.
With a planned decline in capital expenditures and proceeds from asset sales debt repayment accelerated in the third quarter. This continues to mitigate the expansion of our go forward leverage ratio until the market recovers and we can deliver on our goal of three and a half to four times.
Our total debt of $1.7 billion reflected $77 million and net debt repayments in the third quarter and over $100 million since the beginning of 2020.
Our leverage ratio of 4.0 times was down compared to 4.1 times in the prior quarter and 4.3 times in the third quarter of 2019, we.
We exited the third quarter with ample available liquidity of $492 million.
We recently declared a third quarter dividend of 14, and a half cents per share or 58 cents on an annualized basis unchanged on a quarterly and annual basis.
Our dividend payout continues to be supported by our internal cash generation strong balance sheet and robust dividend coverage cash available for dividend for the third quarter totaled $77 million.
Our EBITDA is holding up well and we further reduced our interest and maintenance capital leading to strong third quarter dividend coverage of three and a half times.
We're proud of our ability to continue delivering value to shareholders through an attractive dividend yield even during this downturn.
Based on solid third quarter execution, and our current view of the market. We are tightening our full year 2020, adjusted EBITDA guidance range to 405 million on the low end and 420 million on the high end from 380 million to 420 as previously guided.
At the midpoint this implies a sequential decline in fourth quarter EBITDA as expected. This reflects modestly lower operating horsepower on a go forward basis normal normal seasonal Q4 softness and $20 million in third quarter items that will not recur.
Turning to Capex last quarter, we lowered our total capital expenditure range of $130 million to $155 million and today, we are tightening the range to between 128 and $140 million.
With our cost and capital reductions, we further enhanced our outlook for free cash flow and cash available for dividend for the year.
To sum it up with our strong base of cash flows cost and capital reductions and asset sales, we continue to maximize our free cash flow and cash available for dividend for the year, we now expect to deliver a $150 million or more and free cash flow this year after dividends.
Tools, which will support our goal of substantial debt repayments.
It's simply too early to lay out detailed guidance for next year on today's call, but I think it's worth any my remarks with how we are thinking about 2021.
Booking activity remains low which will drive capital reinvestment, even lower next year implied compared to 2020, particularly as we work to satisfy customer demand with underutilized equipment where possible.
While we expect our EBITDA to be down compared to 2020. This will be this will be more than offset by a moderation in spending positioning us to achieve substantial free cash flow after dividends once again in 2021.
And with that now we'd like to open up the line for questions Doug.
Thank you ladies and gentlemen at this time, we'll be conducting a question and answer session. If you'd like to ask a question you May press star one on your telephone keypad a confirmation total indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the Q4 participants using speaker equipment. It may.
Be necessary to pick up your handset before pressing the star key.
Our first question comes from the line of Kyle May with capital One Securities. Please proceed with your question.
Hey, good morning, everybody.
Good morning.
I appreciate the preliminary look at 2021 and I realize that you don't have formalized guidance yet but.
Brad I wanted to follow up on one of your comments and when you think about the next couple of quarters. How do you think about the trajectory or the rate of change and compression utilization compared to the three key rate.
Yes, so look utilization is the output from the factors that that that.
Our our the Drydock, which our bookings and stop activity and let me talk about those without giving you a quantification just because it is too early to preliminary and candidly.
The view right now into 2021, even through our customer's eyes remains opaque so.
What we do expect however is to see bookings continue to steadily pick up as we have seen in Q2, I mean in Q3 compared to Q2.
And we expect stopped activity to continue to moderate.
On.
As we saw so from Q2 to Q3, but for the lines to crash and having to see net horsepower growth, we're expecting still softness into the first part of 2021 with the opportunity to maybe see some re growth both in natural gas production and of course, then or.
Power in the back half of 2021. So that's my best shape of the curve that I can give you without without trying to quantify which would just be guesswork.
Totally understand thats helpful.
Also maybe switching over to cost control, it's nice to see.
The ongoing.
Attention to detail there can you give us any color. If there is more cost that you can take out and also how sustainable are these cost reductions.
Sure so on.
The good news front one of the things, we really like about the compression business is that on majority a lot of our costs.
Our opex are are highly variable by the way our capex also can be highly variable and it gives us a chance to really respond quickly to right size the business to both maintain profitability and as you've seen in 2020, not just maintain positive free cash flow that improve it. So it's just a real strength to the business model.
So that we can pull costs out.
The improvements you've seen in our profitability, we believe will be sustainable and we're going to continue to focus on expanding our gross margin over time the teams in the field both in contract operations and HMS had been just tremendously well focus on improving profitability.
In a way that is sustainable now of course, if we hit too much pricing headwinds based on utilization, we may see some give back in some erosion, but overall the profitability improvements we put into the business. We think are sustainable and candidly. We expect to see then expand over time as we leverage our investment in our technology.
Got it Thats very helpful. I appreciate the time this morning, I'll turn it back.
Yes. Thank you.
Our next question comes from the line of Daniel Burke with Johnson Rice and company. Please proceed with your question.
Hey, good morning, guys.
Morning.
Let's see.
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Brad I guess you alluded to this earlier, we compare this downturn to I guess was 15 and 16 can you talk about the horsepower you've had side line is it is it can you compare and contrast, maybe the horsepower yet sideline in 15 and 16 to whats occurred this year I would imagine the horsepower that that's been pushed the sideline or at least.
Fortunately at this years is pretty high quality, maybe more modern modern equipment and than was the case five years ago.
Yes, I can and I think your inclination is completely correct.
The improvements into the fleet that we've put in over the last you know certainly three to five even 10 years is really paying off in that the idle fleet today is younger larger and higher quality than we experienced in past downturns, that's going to put on give us.
The opportunity to put more of it back toward more quickly and at less cost and a reduced cost. So we like that aspect of what we have in the fleet today compared to what we experienced in prior downturns. So your your inclination is right. The other thing I would point out is that.
Even as we hit this downturn the equipment that we have been investing in which is equipment that is low.
Large horsepower and newer and younger fleet overall.
Remains well utilized and pricing remains very solid so we just see if that aspect of our fleet performing really well and it's just one of the one of the strong points and results of the investments we've made over the last several years.
Got it okay.
Okay, and then maybe a maybe one of the smaller points in the guidance update this morning.
There was a reduction in maintenance capex expectations for this year and.
I was just wondering is that is that sort of sustainable on a on a per active horsepower basis or what's going on to drive that that reduced expectation as this year's advances. It does it reflect more the fact that utilization has fallen off more than you expected or is it or is it that you're managing that program.
More more assertively.
Well its a combination number one the team is absolutely doing a great job managing our maintenance Capex one thing I'd point out is that we.
We do not manage the maintenance capex to the detriment of either customer service or to the equipment and standards that we have in place to maintain our equipment really well. So that's one.
Second however, you are seeing the benefit of both we have more new horsepower in the fleet. The average age of our fleet is this decrease.
As well as the fact that we've had some stop activity.
And all of that is decreasing our maintenance capex, but it's a combination of those factors, it's not really any single factor.
Got it and certainly.
We give them last one from me, maybe but given what's going on with a sort of natural gas pricing I wouldn't imagine there's still a meaningful component of standby horsepower, but I figured I'd I'd look to to mop that up as we we look at where your utilization is now compared to where I guess I guess that would be included in utilization to be fair, but maybe an update on where you stand with standby horsepower.
Sure the vast bulk of the standby horsepower has gone back to work and been turned back on.
We always maintain a small amount our customers maintain a small amount of standby horsepower just for operational reasons and the delta between what we see is a traditional annual run rate of normal standby horsepower coming.
Compared to that peak that we had back in the middle of the second quarter is down like 75%. So it's it's the significant improvement in the non STEMI horsepower that was that was a.
That was used during that time.
Okay, great well look guys I'll I'll leave it there. Thank you for the for the time today.
Yes, Thanks, Dan.
Our next question comes from the line of Selman a coil with Stifel. Please proceed with your question.
Thank you.
Appreciate the difficulty looking out into 2021, but I was just going to ask you can you talk about.
Well, maybe what you see out there by basin, and and I guess I'm, a little surprised to at least when speaking with other companies some sense of optimism with the strip over $3 and things potentially turning the quarter, but I'm not sure I really heard heard that from you guys. So just kind of curious if you could just.
Talk about it by basin, maybe what you're hearing from your produce from your customers.
Sure. So you know in our dry gas plays that are that are.
Where we have customers that are more driven by that commodity price.
Including the Marcellus and Utica.
We certainly share that optimism.
But for the balance of customers, including an associate in dry gas plays.
We're in well plays with associated gas production, we take them, we have a much more moderate view and the expectations that we seen both from analysts looking at natural gas production levels as well as in dialogue with our customers is that we still expect to see aggregate softness moving into two.
2021, with us with optimism and we're we're optimistic we're going to be able to pick up in the back half of 2021, but I think that maybe some of the discord you're hearing in the commentary.
He is looking at businesses that are driven by dry gas as opposed to businesses that include oil and associated gas production.
Appreciate that.
Just one other one for me.
Seen a lot of BNP consolidation or at least starting to see it or is there any thoughts on that in terms of relating to just sort of customer and customer concentrations.
Those kind of issues.
Yes, it doesn't throw up any concerns for us we have a stable base of just hop great customers that we get to do business with and is there looking at consolidating and bringing in more capital discipline and financial discipline into their operations and take costs out candidly longer term, we expect to be.
Beneficiary of that as one of the key outsourced service providers that can help them do that so we don't see any flags or any any any reasons to not be supported and optimistic that further discipline and consolidation overall in the sector is good for the strong participants we plan to be one of them.
Understood and if I could just ask one more and I'm sorry.
Anymore thoughts in terms of asset sales is 2021 is that just always continually say under review should we expect more or is there anything you can say there.
Yeah, it's been continuous 2020 is certainly.
A higher level of asset sols than we've had in prior years, but in all prior years, we've had it.
We're going to continue to be very disciplined in looking at our fleet hard and moving out assets that we think are not.
Strategic for our operations in our business, so a level of asset sales will be ongoing.
Thank you kindly for <unk>.
Yeah. This is Doug I'd like to maybe top up Brad's answer too on on 2021 demand and outlook.
And I think it's it's one of our caution is well heated and we're simply saying that the market is opaque.
But I think longer term and I don't want this to be lost in today's message.
It is really the longer term impacts of natural gas on.
Greenhouse gases on on what's transpired as as Brad mentioned in his prepared remarks.
On a major reduction in that area and we do very much see natural gas as a fuel of the future and we see demand being great. Our question just at this point is that back half of 21.
Is it later in the year as it earlier in the year and I think that's where we feel.
A little more reticent to get over our skis on trying to predict that.
Understood. Thanks again.
Our next question comes from the line of Thomas Curran with B. Riley Securities. Please proceed with your question.
Good morning.
Good morning.
I'm trying to understand how demand is tracking the trending completions relative to the typical lag we've seen in past recoveries.
Your operating horsepower sequentially declined each month through Threeq, which which Mike was the lowest and then get operating horsepower declined from September to October.
So what we're seeing right now is a fairly steady and that includes month over month and includes quarter to quarter.
Decline in horsepower stop activity is higher than start activity.
And it's it's pretty ratable to.
For the quarter and so to the midpoint of.
The second quarter.
Two.
Give us the exit utilization rate X horsepower rate that we had that we announced today.
Okay, so still not.
Not quite at a at a clear bottom yet.
Well I think what Weve said, so far would indicate that we think the bottom is ahead of us as we still see softness for a couple of quarters.
And then we do expect to see candidly some outpaced the opportunity for growth in the back half of 2021.
And so it's a great Yeah Britain just again further for fair further clarification the rate of decline has slowed significantly but still in our view decline in horsepower ahead.
That all makes sense, Doug, Yes, Q2 guidance follow ups for you.
For aftermarket is 2020 revenue guidance range when it comes to the 5% reduction at the midpoint does that cut solely reflect the disposal of the turbocharger business and then could you give me the split between parts and services for Threeq you.
On the on the guidance, yes, it's almost all the turbo Charger Q4 also tends to be seasonally one of the weaker quarters. So that's that's a piece and then.
Was the question I guess historical on parts versus service.
Just what it was for Threeq you split here, yes Q3.
Percent of revenue services was 59 parts 41.
And that was like 17 nine on service and 12 for on on parts.
Great and then on X gene a.
Okay.
Nice reduction there in the guidance range from a 113 to 116, new one if I don't want to wait.
What are the factors behind this latest step down in <unk> and <unk>.
Do you think of this current quarterly run rate is sustainable into 2021.
I think look yes on on part of that I think we do see.
The gross margin improvements as being sustainable longer term.
Ill be candid and tell you that salary reductions while some of the head count reductions are permanent and we have cut SGN a at all levels of the organization.
I would see less permanency at those overall lower levels into perpetuity.
Because we do want to get our salary levels back at some point to be able to attract and retain high quality talent.
Great. Thanks for taking my questions.
Thank you Tom VIX.
Our next question comes from the line of TJ Schultz with RBC capital markets. Please proceed with your question.
Oh, great. Thanks so.
What are the major things you you need to spend money on to bring some that idle capacity back to market. It.
She hunger and larger horsepower.
Horsepower is it just costs and moving around the units are mobilization costs and.
What do you think maybe you are moving those units to more gas directed or different basins, whereas maybe the next one as large there before or are there other.
Meaningful modification that need to be made to redeploy the idle units.
Sure the primary expense in putting units back to work is just make ready that is if they sat idle or if they've been on location than we do take the time to go through the units and make sure that the maintenance is up to date and since it's been idle for a period of time gives us that opportunity to do so without interrupting our customer's gas production.
So the make ready expenses and part of it is making the unit ready second is yet shipping sarna and so those are the main costs associated with that if we have units that need some additional changes to their configuration, whether it's to the signs towards the controls.
To move to that next application then we would potentially engage in some repackage activity. Some of that shows up in growth Capex and that shows up in opex, but those are the primary expenses that are required to reactivate and I'll point out that that's in our guidance and that's a level of India.
Investment or spend that is.
Always and in our business either gross margin or in our Capex.
Okay, but make ready costs are our opex.
Yes, okay.
Okay. Appreciate it thank you.
Yep. Thank you.
There are no further questions in the queue I'd like to hand, the call back to Mr. Mr. Kildairs for closing remarks.
Great. Thank you. Thank you everyone for participating in our call today as a results demonstrate we continue to take the right steps to differentiate archrock deliver value for our shareholders I.
I look forward to updating you on our fourth quarter call early next year. Thanks.
Thanks, everyone.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.