Archrock, Inc. (NYSE:AROC) Q4 2023 Earnings Call Transcript
Archrock, Inc. (NYSE:AROC) Q4 2023 Earnings Call Transcript February 21, 2024
Archrock, Inc. reports earnings inline with expectations. Reported EPS is $0.21 EPS, expectations were $0.21. Archrock, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, good morning. Welcome to the Archrock Fourth Quarter 2023 Conference Call. Your host for today's call is Megan Repine, Vice President of Investor Relations at Archrock. I will now turn the call over to Ms. Repine. You may begin.
Megan Repine: Thank you, Abby. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of Archrock, and Doug Aron, Chief Financial Officer of Archrock. Yesterday, Archrock released its financial and operating results for the Fourth Quarter and full year 2023, as well as annual guidance for 2024. If you have not received a copy, you can find the information on the company's website at www.archrock.com. During this call, we will make forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, based on our current beliefs and expectations, as well as assumptions made by and information currently available to our trust management team.
Although management believes that the expectations reflected in such forward-looking statements are reasonable, it can get no assurance that such expectations will prove to be correct. Please refer to our latest filings with the SEC for a list of factors that may cause actual results to differ materially from those in the forward-looking statements made during this call. In addition, our discussion today will reference certain non-GAAP financial measures, including adjusted EBITDA, gross margin, gross margin percentage, free cash flow, free cash flow after dividend, and cash available for dividend. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see yesterday's press release in our Form 8-K, furnished to the SEC.
I'll now turn the call over to Brad to discuss Archrock’s fourth quarter and full year results and to provide an update of our business.
Bradley Childers: Thank you, Megan, and good morning, everyone. Simply put, 2023 was a tremendous year for Archrock. We exited the year with excellent fourth quarter performance, building significant momentum in utilization, pricing, and profitability. As we wrap up a record-breaking year for our company, I want to extend my congratulations to our dedicated employees on an extensive list of accomplishments. Among the highlights, our teams worked around the clock to meet our customer's sharp increase in demand. We grew our contract compression operating fleet by 214,000 horsepower, excluding sales of non-strategic assets, and we increased our exit fleet utilization by 300 basis points to an all-time high of 96%. As we met this demand, we recorded over 4.4 million man-hours and drove 22 million miles.
In this exceptionally busy environment, and despite a dynamic labor market, we continue to deliver industry-leading safety performance, achieving a total recordable incident rate of 0.05. And for the third consecutive year, we achieved zero lost time incidents. We more than doubled the net income in earnings per share compared to 2022, and we grew our adjusted EBITDA by 24% year over year. This step change in our earnings power enabled us to return more than $105 million in capital to our shareholders through two dividend increases and the initiation of a share buyback program. We also concurrently delivered outstanding dividend coverage of 2.4 times and drove our leverage ratio to an all-time low of 3.5 times. From the separation of the international and fabrication operations at the end of 2015, to the navigation of two significant market disruptions in 2016 and 2020, and our steps to high-grade our fleets, our technology, and our markets, I'm exceptionally proud of the strong market and financial position we've built through multiple years of effort to transform our company.
This transformation not only contributed to record successes across multiple metrics in 2023, but we expect will benefit our operations, financial performance, and investor returns well into the future. We kick off 2024 in an enviable position. Our fleet quality is first-rate. We have a fleet of highly standardized large horsepower units deployed in the most stable infrastructure segment of the market. Our service quality is excellent. We have the talent, technical expertise, and safety processes in place to deliver the high level of service that our customers require. And we've only begun to leverage the capabilities of our innovative technology and process investments to digitize and increasingly automate our operating platform, which will enable us to take our customer service to new heights.
Our customer relationships are deep. We have strategic partnerships with key customers that span multiple decades. And we are an integral part of their critical midstream operations. And we're preparing for a greener economy. The work we're progressing on methane and carbon capture could contribute meaningfully to the industry's efforts to reduce emissions and create long-term value for Archrock and our shareholders. We're encouraged by the early results in field tests and expect to demonstrate commercialization progress for certain products during 2024. We're proud to continue Archrock’s mission to lead our industry in powering a cleaner America. Turning to compression fundamentals, we continue to experience an opportunity-rich market, one that contributes to our ability to grow our earnings and cash flows in the future.
Over the long term, our repositioning and investments in technology and processes should also reduce the volatility and further improve the stability of our operational and financial results. The opportunities we see in the market for compression and for Archrock are driven by several factors. First, growth in natural gas production. In 2023, U.S. natural gas production grew to a new all-time high of 104 billion cubic feet per day, eclipsing the previous record set in 2022. And the natural gas production forecast suite track all continue to show growth in 2024 volumes. Natural gas production growth continues to be led by key Archrock oil-producing markets that have associated gas like the Permian. In the near term, the visible slate of global LNG projects that have already been approved and sanctioned are expected to result in a sustained and secular call on U.S. natural gas production.
Longer term, the EIA forecasts U.S. natural gas production growth through 2050. The second factor is the heightened capital discipline across the energy sector. Customers, peers, and suppliers are balancing growth with returns to shareholders. Industry-wide additional investment in compression, a critical piece of infrastructure needed to move gas to market, is required to meet current and growing demand. For Archrock, this has created a healthy and visible backlog of customer orders. We are sold out of new build equipment for 2024 and have already begun building a meaningful new order book for 2025. Longer term, the increased level of capital discipline we're seeing throughout the oil and gas value chain should support higher returns for investors across the entire sector, including in compression and for Archrock.
This brings me to a third point, the increasingly critical role natural gas can play to decarbonize energy. We now have the opportunity as an industry to further strengthen the case for natural gas by reducing emissions across the value chain, and at Archrock we intend to do our part. Our new ventures team is advancing opportunities to bring methane emissions, detection, measurement, and capture solutions to market. These opportunities are directly adjacent and complementary to our core contract compression services. Currently, we're in the development, pilot, and early marketing phases of these investments, which will make their expected financial contributions minimal in the near term. However, we believe they could contribute meaningfully to the industry's efforts to reduce emissions over time, and thus enabling our core operations to continue to expand while providing exciting new markets for growth opportunities for Archrock.
And despite being still in the early days, we believe the potential impact of our proprietary methane capture device is further enhanced by the final Quad Ob rules published by the EPA last December. If we as an industry succeed in materially reducing emissions associated with natural gas production, and use, we believe we help answer the call on all businesses to reduce carbon emissions. We extend our social license to operate, and we extend the use of our affordable and abundant natural gas resource as a low-emission source of reliable power generation, as well as the value of billions of dollars of existing infrastructure for decades to come. Moving on to our segments, our contract operations business segment is firing on all cylinders. We exited 2023 with a record fleet utilization rate of 96%.
For the full year, our operating horsepower grew by approximately 214,000 excluding the active horsepower we sold as part of our fleet high-grading strategy. The fourth quarter marks our ninth consecutive quarter of sequential increases in our monthly revenue per horsepower. In 2024, we will benefit from a full year's impact of these rate increases, and we expect to capture additional meaningful increments this year. I'm proud to say that we delivered gross margin dollars for the year of $503 million up a $100 million or 26% compared to 2022. This translated into a 300 basis point increase in our gross margin percentage for the year. Notably, we achieved a quarterly high for 2023 of 64% during Q4. Looking ahead, we remain ambitious about driving additional profitability gains in 2024 and long term, especially as we leverage the capabilities of our technology investments to digitize and increasingly automate our operating platform.
Moving to our aftermarket services segment, full year 2023 activity improved meaningfully compared to 2022, and we saw steady activity in the fourth quarter with solid demand for our services. Profitability remains substantially higher than historical levels as we focus on higher quality and higher margin work. We expect healthy levels of activity to continue into 2024. Shifting to our capital allocation framework for 2024, Doug will walk through our capital investment plans in connection with our full year 2024 guidance later in our call, but I'd like first to review our approach to capital allocation and growth. On our third quarter 2023 earnings call, we committed to free cash flow generation in 2024, supported by efficient execution of our operations, price increases, and strategically managed investment in our fleets.
Our 2024 budget reaffirms our free cash flow expectation and our commitment to a prudent and returns-based approach to capital allocation, consistent with the following priorities. First, increasing capital returns to shareholders. As shareholders ourselves, management and the board are committed to maintaining a well-covered dividend that grows along with the profitability increases we are driving in our underlying business. Given our confidence in the outlook for compression, as well as Archrock’s sector-leading financial flexibility, we recently announced a 6.5% sequential increase in our quarterly dividend, and share buybacks remain another value creation tool available to us in 2024. Second, continuing to meet the needs of our customer base through new build investments.
These investments will be funded by operations and supported by attractive returns. And finally, third, maintaining an industry-leading balance sheet and leverage position. As fourth quarter performance shows, we are well on our way to achieving a consistent leverage ratio of three to three and a half times. In summary, we're delivering record performance, reflecting four primary drivers which are also contributing to Archrock's strong outlook. These drivers include, one, our transform platform. Two, our incomparable financial position and capital allocation. Three, a robust market for compression. And four, the future opportunity for natural gas to meet the growing demand for cleaner energy and the prospect for Archrock to leverage technology for a more digitized, automated, and sustainable future.
With that, I'd like to turn the call over to Doug for review of our fourth quarter and full year performance and provide additional color on our 2024 guidance.
Douglas Aron: Thank you, Brad. Good morning and thanks to all of you for joining us. Let's look at a summary of our fourth quarter and full year results and then cover our financial outlook. Net income for the fourth quarter of 2023 was $33 million. This included a non-cash $4 million long-lived asset impairment as well as a non-cash $1 million increase in the fair value of our investment in ECOTECH. We reported adjusted EBITDA of $120 million for the fourth quarter 2023. Underlying business performance was strong in the fourth quarter as we delivered higher total gross margin dollars for both segments on a sequential basis. Results further benefited from $2 million in net asset sale gains related to non-strategic horsepower sales.
Included in our quarterly results was a $4 million increase in selling general and administrative expenses during the fourth quarter. We do not anticipate this level of expense will continue as it was largely related to the increase in performance-based short-term and long-term incentive compensation expense given the outstanding year our employees delivered and the dramatic outperformance relative to earlier expectations in 2023. Turning to our business segments, contract operations revenue came in at $213 million in the fourth quarter, up 3% compared to the third quarter. This increase was primarily driven by higher pricing. Compared to the third quarter, we grew our gross margin dollars by 4%. This resulted in a gross margin percentage of 64% for the second straight quarter.
In our aftermarket services segment, we reported fourth quarter 2023 revenue of $47 million, up slightly compared to the third quarter despite typical seasonal softness, and up 12% on a year-over-year basis. Fourth quarter AMS gross margin of 22% compared to the third quarter of 20% and 17% versus the prior year period. We exited the year with total debt of $1.6 billion and strong available liquidity of $458 million. Variable rate debt continues to represent less than 20% of our total debt. Our leverage ratio at year-end was three and a half times calculated as year-end 2023 total debt divided by our trailing 12-month EBITDA. This was down significantly compared to 4.4 times in the fourth quarter of 2022, as Brad mentioned earlier while we initially targeted a leverage ratio range of 3 to 3.5x by the end of 2024.
Stronger than expected earnings performance and continued capital discipline has allowed us to achieve this industry-leading milestone earlier than anticipated and we are focused on maintaining a consistent leverage ratio of three to three and a half times through cycles. The strong financial flexibility I just described continue to support increased capital returns to shareholders following two dividend increases during 2023 we recently declared an increased fourth quarter dividend of $0.165 per share or $0.66 on an annualized basis. This is up 6.5% from the third quarter dividend level and 10% versus the year ago period. Cash available for dividend for the fourth quarter of 2023 totaled $71 million leading to impressive quarterly dividend coverage on the increased dividend of 2.8 times.
In addition to increasing the dividend this quarter we were purchased approximately 174,000 shares for $2.4 million at an average price of $13.58 per share. This leaves $41.1 million and remaining capacity for additional share repurchases. Archrock introduced 2024 annual guidance with our earnings released yesterday. All of the customary detail can be found in the materials published last night and for the purposes of this call I will keep my comments high level. We announced a 2024 adjusted EBITDA guidance range of $500 million to $530 million. At the midpoint this represents an increase of $65 million compared to the $450 million in 2023 or 14%. In contract operations we expect full year revenue to be in the range of $890 million to $915 million a year-over-year increase of 11% at the midpoint driven by continued tight utilization and higher pricing, we expect gross margin percentage to a range between 64% and 65.5% for the year.
This reflects not only top-line growth but also continued efforts to maximize our profitability by leveraging technology and focus in focusing on controlling expenses even during this up cycle. In our AMS business we forecast full year revenue of a $170 million to a $185 million consistent with the healthy activity we experienced in 2023. We also expect to defend the profitability gains we've worked hard to achieve with an expectation for gross margin percentage between 19% and 20.5%. Turning to capital on a full year basis we expect total 2024 capital expenditures to be approximately $275 million to $290 million. Of that we expect growth CapEx to total between a $175 million and $180 million to support investment and new build horsepower and repackage CapEx to meet continued strong customer demand.
This compares to growth CapEx of $190 million in 2023 and preliminary growth capital expenditure of approximately $160 million that we provided last November. The change reflects growth CapEx underspend and carry forward from 2023 due to some supplier equipment delays as well as incremental new build horsepower investment supported by multi-year contracts to satisfy key customer demand. Maintenance CapEx is forecasted to be approximately $80 million to $85 million down from $92 million compared to 2023 due to reduced make ready activity. We also anticipate approximately $20 million to $25 million and other CapEx primarily for new vehicles. Total capital expenditures are expected to be fully funded by operations with the potential for additional support from modest non-strategic asset sale proceeds as we continue to high-grade our fleet.
Before we open up the line for questions I will conclude by saying we believe a durable up cycle for our business has arrived and we are focused on maintaining our position at Archrock the premier compression company in America for our Employees, Customers and Investors. We expect 2024 performance to benefit from a full year of record high utilization and pricing and we look forward to delivering on our promise of consistent execution earnings growth and free cash flow generation. With that Abby would now like to open up the line for questions.
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