Good morning and welcome to Archrock Second Quarter 2020 Conference Call. Your host for today's call is Megan Repine, Vice President of Investor Relations at Archrock. I would now like to turn the call over to Mrs. Repine. You may begin.

Thank you, Devon. 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 second quarter of 2020. 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 the information currently available to Archrock's management team. Although management believes that the expectations 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 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 and cash available for dividend. 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 SEC. I'll now turn the call over to Brad to discuss Archrock's second quarter results and provide an update of our business.

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 and Archrock have ever faced. As we've highlighted for some time, Archrock provides critical U.S. natural gas infrastructure. And the company is built by design to endure market cycles. Against the backdrop of a 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 on our cost and capital savings efforts. Among the accomplishments in the quarter, we generated EBITDA of $101 million, flat compared to the prior year period. We improved contract operations gross margin percentage by 400 basis points sequentially and annually to 66%. We reduced SG&A expense by more than 6% from $31 million in Q1 to $29 million in the second quarter. Our second quarter CapEx was down meaningfully year-over-year, but remained somewhat elevated as we took delivery of units to meet orders that were placed by customers in 2019. 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 of the 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 quarter 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 at 4.1x. As a result of our lower CapEx…

Great. Thank you, Brad. Let's look at a summary of our second quarter results and then cover our financial outlook. We maintained flat adjusted EBITDA of $101 million compared to the second quarter of 2019. Lower revenues were more than offset by intense cost management. Our second quarter adjusted EBITDA included $2 million in net losses related to the sale of assets. We recorded a net loss for the second quarter of 2020 of $30 million, which included several onetime charges, the majority of which were noncash. As Brad mentioned, we retired 184,000 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 $188 million in the second quarter, down from $207 million in 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. In 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 our AMS work and as we continue to balance retaining our high-quality technicians with rightsizing the business for activity levels, both resulted in second quarter AMS gross margin that was below…

[Operator Instructions]. Our first question comes from the line of Kyle May with Capital One Securities.

Brad, you mentioned that compression operations 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 at the timing of this, we had an amazing May. I mean it's -- it really hit so quickly. And what we saw for the quarter was a sharp increase in stop activity as customers rightsized for production levels and for economics. Bookings and starts basically came to a strong stop and standby activity hit a record pace, that is the number of units we put on standby, which -- in which we still collect revenue but at a lower rate. What we saw already coming into Q3 is that stop activity is already moving to a more normalized level. I'll remind you that that's 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 positives that we've seen. Bookings, however, continue to lag as would be expected given production expectations. But it's that normalization of stop activity and the return of horsepower of those previous ones on standby to full operations that are some of the indications we've seen. Look on a bright spot, I'd point out that despite the market and 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 brought back on I think to offset some of the decreases that we saw at least partially in the shelf plays. So it wasn't all bad. And those were the highlights and 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 highlighted that 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 about 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 as 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 cost structure, labor, parts as well as lube oil. There was, as you pointed out, Kyle, a contribution from the standby revenue, which has 0 -- almost 0 operating costs associated with it. But our guidance range moved up for contract operations gross margin to 63% to 65%, which is indicating the amount of that improved profitability we expect to hang on to certainly in 2020. We're not going to really comment beyond that, but we're going to be very ambitious about how well 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.

[Operator Instructions]. Our next question comes from the line of Daniel Burke with Johnson Rice.

Brad, just trying to think about the trajectory of the business in the second half of the year in terms of contracted horsepower. Maybe one way to ask this, I don't know if it will work, but would be to ask you what sort of a normal run rate of stop activity, if that's what's going to prevail in the second half of the year? Any way to think about that? I mean there won't be a lot of net adds, but I was wondering how to think about stops.

Yes. So number one, I am going to just express that visibility into the market is not great. And the communications with our customers right now still look at, I think, a flat to slightly declining level of gas production throughout the course of the year. And so we don't see that there's going to be a lot of bookings or growth available in the market. And at the same time, though, we also see a stabilization around the horsepower levels required for current gas production. And finally, our guidance includes our expectations for what's going to happen to revenue in contract operations. And I think that's the -- my commentary in that is the best indication that we have in forecasting horsepower changes for the rest of the year.

Okay. Yes. Clear enough. With just 2 quarters, it gets a little easier to box that in. All right. Maybe a smaller one then on the AMS side. I think you or Doug highlighted there was a sale. It didn't sound like it was particularly sizable. But I was wondering if it did have any impact on gross margin for the full year as we kind of look at the scale and try to balance where in that guidance range you'll fall out for the year.

Yes. Not really. The business we sold was a small portion of that business. By the way, it has a great team. It has a good business. It just so happened, however, that given some changes in that subsection, subset of the market, we had a buyer that was able to value it 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 and debt reduction would be 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 as one of the incremental steps in the context of we're doing all we can do to figure out where we can monetize and reduce debt.

And I just would add, Daniel, that from a modeling perspective because it was, as Brad pointed out, relatively small in the grand scheme that it shouldn't have an impact. And our guidance, again, our range there really more reflects even less visibility in the AMS business for the back half of the year, but we're hopeful we've captured the right range for that in what we put out an updated guidance.

Our next question comes from the line of Ryan Pfingst with B. Riley FBR.

Doug, you mentioned you are maintaining a wider EBITDA guidance spend, understandable with the uncertainty. But what do you think are some of the factors that would get you to the higher end of that range? Is it just activity levels? Or is there more room to actually save on the cost side?

Look, I think activity levels obviously have a big impact. And we are continuing to be hopeful that our sales organization will fill needs where there are. I mean it all really comes down I think to commodity price. And as Brad highlighted, do we start to see drilled but uncompleted wells pick up in activity in the back half? Your 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 AMS business. So I know it varies for each of you on the line as to whether you include that or you don't. In our adjusted EBITDA, we do include it. Including that, we think that we'll be above that midpoint that we described previously. If you don't, it certainly 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 in the wide -- 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. And then on M&A, certainly, this entered 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? And if you would potentially have any appetite at the right price?

Our perspective on M&A and industry consolidation hasn't really changed. On the one end, we need a favor and would like to see consolidation wherever it occurs. We think it brings discipline into the capital of special -- capital side, especially of the industry. And I think that, as with other subsectors, there are certainly some -- there's costs that could come out through consolidation. We are absolutely a willing participant where we can find value and quality combined in the same operation for us. We think that that's always a good path to get some incremental growth. Looking back, we're still completely pleased with the acquisition we had last year of Elite Compression, which was both 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, the 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 and age and standardization of the fleet that we've continued to invest in and grow. And on that point, one 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've gotten to the point where we are operating today the most competitive and youngest fleet we've ever had. And any consolidation or acquisition in which we participate needs to be consistent with that strategy.

[Operator Instructions]. Since there are no further questions, I would like to turn the call back over to Mr. Childers for any final remarks.

Thank you, everyone, for participating in our Q2 call. We believe we have taken and continue to take the right steps to position Archrock to navigate this current cycle and plan to continue to focus on cost and capital management for the remainder of 2020. I look forward to updating you in our third quarter call 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 and have a wonderful day.