CSI Compressco LP
Q2 2019 Earnings Call Transcript

Published: 7 Aug 2019

[Operator:]

Good morning and welcome to the CSI Compressco LP's Second Quarter 2019 Earnings Conference Call. The speakers for today's call are Brady Murphy, Interim President of CSI Compressco LP, Roy McNiven, Vice President Operations for CSI Compressco LP; and Elijio Serrano, Chief Financial Officer for CSI Compressco LP and also for TETRA Technologies Incorporated, which is the general partner of CSI Compressco LP. Also in attendance today, is Michael Moscoso, Vice President of Finance for CSI Compressco LP. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.I would now like to turn the conference over to Mr. Brady. Please go ahead.

[Brady Murphy:]

Thank you, Jake. Good morning everyone and thank you for joining CSI Compressco's second quarter 2019 results conference call. I would like to remind you that this conference call may contain statements that are or may be deemed to be forward-looking. These statements are based on certain assumptions and analysis, made by CSI Compressco and are based on a number of factors.These statements are subject to a number of risks and uncertainties, many of which are beyond the control of the partnership. You are cautioned that such statements are not guarantees of future performance and that actual results may differ materially from those projected in the forward-looking statements.In addition, in the course of the call we may refer to EBITDA, adjusted EBITDA, free cash flow, distributable cash flow, distribution coverage ratio, backlog or other non-GAAP financial measures. Please refer to this morning's press release or to our public website for reconciliations of non-GAAP financial measures to the nearest GAAP measure.These reconciliations are not a substitute for financial information prepared in accordance with GAAP and should be considered within the context of our complete financial results for the period. In addition to our press release announcements that went out early this morning and as posted on our website, our Form 10-Q is planned to be filed with the SEC on or before August 08, 2019.So I'll start the call briefly commenting on Owen Serjeant's recent departure from his post as President of CSI Compressco followed by an overview of our performance and then turn the call over to Roy McNiven to provide some on our improvements in our compression services margins, followed by Elijio Serrano, who will provide some more detail on our financial results and updated projections.As most of you seen, we announced that effective July 22, 2019, Owen Serjeant resigned from his position as President of CSI Compressco to address personal matters. We thank Owen for his contributions to CSI Compressco and wish him well. CSI Compressco is a much stronger company today than it was when Owen joined in the fourth quarter of 2017. Thanks in part for his contributions.CSI Compressco continues to be backed by a very strong management team and we continue to be pleased with the performance and outlook for the partnership. We will announce a new President at the appropriate time.Now turning to operations. CSI Compressco had an outstanding second quarter and delivered several record level performances since combining CSI with compressed ago in August of 2014, which is record highs and compression services margins of 52.7% and utilization of 89.1% for our compression services fleet. Compression Services revenue will $64.5 million increased 2.4% sequentially.Gross profits increased to $34 million in the second quarter from $30.4 million in the first quarter, as margins expanded to $52.7 million from $48.2 million in the first quarter of the year. Sequential incremental margins were 248%, which represents incremental gross profits relative to incremental revenue, comparing the second quarter this year for the first quarter of 2019. A little later, Roy will walk us through some of the initiatives that are driving these improvements.Second quarter 2019 adjusted EBITDA of $32.8 million increased 22% over the first quarter of 2019 as revenue and gross margin in all three segments increased sequentially, with the gross margin increases led by compression services and equipment sales. As we indicated in our last call, we expected a meaningful ramp up in both new unit sales and aftermarket services in the second quarter due to the timing of several large projects and that has been realized.In addition to the strong growth, in the new unit sales from the first quarter, our aftermarket services business also experienced a strong rebound sequentially, with revenue improvement by $4.6 million to $18.2 million, and gross margin improving by $385,000.Second quarter 2019 bookings for new equipment totaled $18 million up from $11 million in the first quarter of 2019. Our backlog as of June 30 is $60 million. Although our new equipment pipelines identified opportunities remains strong in excess of $250 million, bookings so far this year have been lowered than last year as customers are delaying some new unit purchasing decisions.However, we expect that orders for new equipment will pick up in the second half of this year as customers plan for their 2020 delivery requirements. We're currently in late stages negotiating some large international orders that we expect to materialize this quarter. More like equipment sales order book, our aftermarket order books strengthen as we progressed in the quarter and the outlook for the second half of the year is very encouraging.We believe our revenue and profitability in the third quarter should increase sequentially. This business requires minimal capital investments and generates very good returns. We continue to deploy new equipment for our core customer, which is required to support their higher gas production levels as well as the increasing trend to use higher horsepower compression for centralized gas lift in the early stages of oil production.Our utilization for the thousand and higher horsepower equipment focused on gathering systems and centralized gas lift was 97.1% at quarter end, up 150 basis points from the end of the first quarter in 2019. Overall, the utilization for the entire fleet is at 89.1% up from the 87.2% at the end of the first quarter and up from 85% at the end of the second quarter 2018.The vast majority of the increase continues to be in the areas with the most activity including the Permian Basin, Eagle Ford and SCOOP/STACK areas in Oklahoma. We have approximately 70% of our operating horsepower deployed to these three areas. We're currently in discussions where our customers on their 2020 requirements for their large horsepower units to address a centralized gas gathering and gas lift.As we previously stated, we do not commit to order new equipment unless it has full customer commitment, and we do not build fleet equipment on speculation. Our disciplined approach, approaching where and whole to deploy new equipment allows us to attain returns on capital of 20% or above and preserve shareholder value.We continue to see price increases as contracts on our existing horsepower equipment rollover. The more we scale up our compression services business in these key markets with key customers, the more we are able to improve our profitability by adding minimal costs with each additional unit deployed.Between our growth plans and TETRA support, we expect to deploy approximately 107,000 horsepower of new equipment into our fleet in 2019. This is approximately 6,000 horsepower more than our prior guidance. Elijio will further elaborate on our projected total year capital expenditure expectations.In summer, we had a very strong quarter, which revenues increasing sequentially across all three business lines and adjusted EBITDA increasing 6 million sequentially. The gas compression business continues to be one of the strongest segments in the energy sector and the long-term outlook for increased gas production continues to be strong. We're excited about the future of this business and its continued growth profile.Now, Roy McNiven, our Vice President of Operations overseeing our field operations on the fleet side and aftermarket services will provide some incremental color on what is driving our improvements and margins. Roy?

[Roy McNiven:]

Thank you, Brady. As Vice President of Operations, I have responsibility for our domestic compression services and our aftermarket teams including the highly skilled group of mechanics and technicians to service our equipment and deliver our aftermarket services.As Brady mentioned, we're experiencing continued sequential improvements in compression services gross margin and in the second quarter reached the high of 52.7%. In addition to a great team responsible for delivering fantastic results, these improvements are being attained from several initiatives that I'll elaborate upon.In mid-2017, we deployed an ERP system that significantly improved the tools available to us to more effectively manage the business. This system provides us real-time P&Ls for each of our units, enabled us to transition from scheduled maintenance towards predictive maintenance and provides a better visibility on utilization of our mechanics and technicians in addition to allowing us to manage back office functions more cost effectively.This system is one of the most advanced that I've seen in my history in the energy services sector, providing the most visibility at a granular level to make real-time decisions. We're utilizing these tools to allow us to determine which customers and geographic areas are seeing the best margins and returns. Our new capital is being deployed to those areas.As a result, we are adding horsepower to our fleet and a much higher rate. And we are adding incremental mechanics and technicians, effectively improving our horsepower per technician ratios. We can also identify individual units that are not achieving the desired margins and quickly pinpoints the source of the issue via the performance of the unit, the application or the effectiveness of how it's being maintained.We can then have clearly defined actions to address it. This in addition to transitioning from regularly scheduled maintenance programs towards the more predictive based maintenance model results in cost efficiencies and improves our equipment runtime. We're also using these tools to drive down overtime and to better manage the cost of parts and components as we optimize restocking levels.In addition to benefiting from deploying equipment in the optimal customers and geographic areas, on top of doing predictive maintenance, we're also seeing the impact of new equipment being deployed at prices much higher than the prior market peak in 2015. This targeted and intentional growth has supported our efforts to create clusters, which creates cost synergies to our ability to more effectively schedule our mechanics and technicians.And finally, given the continued demand for compression services and high utilization of the fleet, we continue to do to achieve price increases as customer contracts rollover. During the second quarter, we also successfully implemented a price increase to the U.S. GasJack fleet.I'll turn the call over to Elijio.

[Elijio Serrano:]

Thank you, Roy. Brady and Roy touched on the key areas we needed to our operating results. I'll spend a couple of minutes on non-recurring charges, cash flow, the balance sheet, capital expenditures, guidance and our capital allocation strategies.Now recurring charges in the quarter were $3.6 million of which $997,000 were cash expenses and $2.6 million were non-cash charges. The non-cash charges included $2.5 million write-off of 441 small horsepower GasJack units, or 20,286 horsepower which we deem unlikely to in terms of service.As a reminder our gross margin participation statistics reflect this write-off. We have a positive 250 items to domestic GasJack units of about 30,000 horsepower, it can be put as market conditions warrants. We also incurred a $1.2 million non-cash expense related to the firm market valuation from the seriously preferred unit and the cash redemption premium.Cash flow from operating activities were $8.7 million. Capital expenditures in the quarter were $11.5 million for growth capital, net of cash received for the sales of use equipment to deploy approximately 13,400 horsepower in the second quarter. In the quarter we also invested $4.9 million maintenance capital expenditures.Distributable cash flow of $15.7 million improved 150% from the first quarter of this year, and 200% from the second quarter of last year. Our coverage ratio was 33 times compared to 13 times in the first quarter. Discovered reflects our decision in December of last year to reduce the distribution to cash redeemed the significant prefer unit.The final cash redemption of Series A preferred units will be on August 8, which is tomorrow, after which all Series A preferred unit will be fully redeemed. Distributions sustained in the quarter were $477,000.At the end of June, total gross debt outstanding was $646 million up which $350 million of the secured note that mature in the year 2025 and $296 million for the unsecured note that mature in August of 2022. No amounts were drawn on our ABL revolver. Cash on hand was about $4 million. And as a reminder, we do not have any maintenance covenants to comply with.Our growth leverage ratio at the end of June was 5.55 times. When annualizing our second quarter adjusted EBITDA, our gross leverage ratio would be 4.98 times. We are well our way towards a 4.5 times target we communicated in our investor conference in May last year in New York City and also announced a reduction in our distribution in December of last year.With respect to capital expenditures, we expect 2019 capital expenditures will be between $65 million and $70 million inclusive of $18 million to $20 million for maintenance capital expenditures. Our growth capital expenditures are estimated to be between $47 million and $50 million. We expect to sell fund with cash on hand or cash flow from operations.And as previously mentioned, TETRA Technologies as our general partner has agreed to purchase $15 million, 1-5 or 20,700 horsepower of compression equipment that will be deployed to our need to meet customer demand. This 20,700 will be leased from TETRA with CSI Compressco having the right to buy the equipment anytime over the next five years at CSI Compressco's sole discretion.Through the end of the second quarter more than two-thirds of that investment in equipment by TETRA has been made. Between TETRA's commitments to support us and our own capital growth plans, we believe will satisfy our current customers demand and at the same time grow within our cash flow.Total horsepower expected to be added this year from all this initiative is approximately 107,000 horsepower, an increase of approximately 9.4% to our fleet. All targeting 20% returns on capital with high fall through margin and taking advantage of margins in the initiatives that we mentioned earlier.We expect total year guidance -- with respect total year guidance, we are revising 2019 adjusted EBITDA to be between $125 million and $130 million. This compares to $99 million of adjusted EBITDA in 2018 and represents a year-over-year growth of between 26% and 31%. This compares to our prior guidance for between $125 million and $140 million. On revenue, we expect 2019 to be between 475 million to 490 million. This is an increase of between $35 million and $50 million from 2018 and compares to our prior guidance of 490 million and 520 million.The tightening up of the adjusted EBITDA guidance and adjustments to the revenue guidance reflects a slowdown in orders for new equipment sales in the first half of this year. We are very encouraged with the price increases we continue to see on our fleet as contracts rollover. New equipment going out a record high prices and continued improvements in compression services margins everyone elaborated upon earlier in the call.In the second quarter, the improvements in compression services margin. Gross profit was greater than the sequential revenue increase. Given fall through gross margins of 248% or said differently for every incremental dollar of compression revenue generated. In the second quarter over the first quarter, we delivered $2.40 of gross profit from among other things cost reductions and efficiently.At the midpoint of our full year adjusted EBITDA guidance of $127.5 million in after accounting for cash interest expense, maintenance capital expenditures and cash taxes. We expect to generate approximately $60 million of free cash flow. This year $30 million of that was directed towards cash redeemed in a Series A Preferred unit and the rest of growth capital in a small amount for distribution.We previously communicated our plans to direct 50% of our future cash flows towards growth capital. On the assumption that the market reports the higher margins that we're achieving, which reflect 20% returns on capital. The other 50% will be targeted to returning cash to our stakeholders in debt holders and equity holders.We are committed to improving our leverage ratio to 4.5 times or better. We expect to be at the target at the 4.5 times target by the end of 2020 to a combination of continued improvements in adjusted EBITDA, it's open markets purchases of the unsecured bonds. The timing of debt retirement was dependent on generating the targeted of free cash flow and monitoring the market to see with unsecured bonds are trading at.Currently, the unsecured bonds are trading at around $1.90 with a yield to maturity above 10%, which compares to the coupon of 7.25%. We'll be capital disciplined with our 50-50 approach toward reinvesting back into the business and improving stakeholder value. Our focus is on returns, margin improvements and having a very disciplined approach to capital allocation. We'll be prudent in answering our customer's demands and focus only on those opportunities, which provide the highest returns and best pricing. We will grow and deliver.Jake, with that, we'll now open the call to questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Kyle May with Capital One Securities. Please go ahead.

[Kyle May:]

So I wan tot just start with the contract operations segment. You mentioned overall service fleet utilization increased about 89% in the second quarter. How much farther can you continue to increase this? Or are you getting close to hitting?

[Elijio Serrano:]

So, the amount of equipment that we're deploying is primarily on the large horsepower, and Brady mentioned that we're up in the high 90s already. Anything that's not deployed is in transition between a customer jobsite for down the maintenance. I'm not sure that there's much more to go on the large horsepower equipment. From the mid size equipment, we're running into high 80s. And there's an opportunity to get into the low 90s. And then, I also mentioned that we've got almost 30,000 of small horsepower equipment or any increases that we are going to be on the smaller and midsized, I would suggest that the large horsepower equipment pretty much maxed out.

[Kyle May:]

And the next one for me, Elijio, you talked about, I believe, you reference, the leverage ratio reaching 4.5 times by the end of 2020. How do you think about balancing the, I guess the difference between paying down debt and increasing the dividend?

[Elijio Serrano:]

Good question Kyle. That's a discussion that we've had among the management team and the board. And what we want to do is as soon as we get into the free cash flow available beyond the immediate growth capital commitment that we've made, we're going to take a look at what the unit price is trading at. We're going to take a look at what the bonds are trading at. Yes, the bonds straighten near par then we probably will look at something toward equity. If the equity remains very depressed, in the bond, our trading near part, then I think there's an opportunity to do something more on the equity side. So it's really going to be a function as to what those two securities are trading that when we're ready to make the decision.

[Kyle May:]

Okay, got it. And one more, if I may. When we're thinking about the start when we're thinking about equipment sales and the back half of the year, I realized you gave us a little bit of color on the, that should define a little bit but still be about 1Q level. Can you help us dial that in a little bit more?

[Elijio Serrano:]

Right. So anything that we've got scheduled to occur this year is pretty much already in the manufacturing cycle. We've either got the equipment in order, or it's already been fabricated. We went from a high of $50 million that in Q4, we dropped the $25 million of equipment sales in Q1. And then we jump back up to $50 million in Q2, I would expect that we're going to stay between those two ranges, Q3 and Q4.

[Operator:]

The next question comes from Marshall Adkins with Raymond James.

[Marshall Adkins:]

Could you give us a little more insight into the, you had a big jump and equipment orders this quarter and you're kind of points of a modest slowdown in the next couple of quarters. What's driving that and is there any read through to trends and pricing for your compression fleet or leading edge pricing for the compression fleet as well?

[Elijio Serrano:]

Marshall, let me start and then I'll turn it over to Brady. Timing on the equipment sales is simply when we receive the orders. Knowing that it's taken us anywhere from 4 to 6 months to buy the engines, the compressors and coolers, get them delivered, then assemble them and deliver most of those are going into gas processing plants, either in Permian and Delaware basins or being shipped internationally.Last year, we received some significant orders, if you would go back and look at our press releases in the middle of last year and up what we delivered in Q4, or early last year orders. And that's what we did deliver in Q2 for summer orders that we receive last year. So it's really all about the timing of release orders are coming in. You can see from the margin that we're putting that we're achieving low-double-digit margins from those orders. And we also mentioned that we've got almost $250 million list of opportunities that were in discussions with customers.We have seen some of those slow down in terms of being converted to purchase orders. But they're not dropping off, I believe our customers are being a bit more cautious about went ahead in placing orders wanted to look at volumes with gas and pricing indicators out there. So the volume of opportunities is not slowing down the customer's decision to pull the trigger initiative deal as slowing down.

[Brady Murphy:]

Good morning, Marshall. The earlier comments, I would say, I think we showed $11 million bookings in the first quarter '18 and the second quarter. We do expect that to continue to increase and back half of the year from those run rates. But Elijio said, the pipeline hasn't changed, there's still a lot of opportunities out there for decision making, you compare last year to live this year. I think is what is slowdown pushing them further out to the right and then executing orders through the course.

[Elijio Serrano:]

And Marshall just of your question is how does that lead over to pricing on our fleet. And I would suggest that it's two completely different buyers, our buyers of the equipment for a gas processing plants are primarily midstream operators. The people that are taking our equipment for the gas centralized gas lift and gathering systems are the operators, who continue to build and have volumes of gas. That is a way in excess of what your expectations are. So I would suggest that there's not a direct connection between what we're seeing on the orders for building and selling equipment versus a rates for the equipment that we're deploying into the field.

[Marshall Adkins:]

So you're not seeing the same hesitation on the compression side is least at flows through to leading edge pricing. Is that a fair statement?

[Elijio Serrano:]

Yes.

[Brady Murphy:]

That's fair. And again as Elijio said, the customers that we have in the key basins where we operate, I think the strength of our compression services activity that we're seeing.

[Marshall Adkins:]

Right, Elijio, I know it's early, but things seem to be moving the right direction. You're starting to get visibility going into 2020. Any thoughts on your growth CapEx, next year?

[Elijio Serrano:]

So, we have had discussions with our core customers. They've given primarily indications in terms of their planning for next year. And we're going to commit to the 50-50 strategy that we laid out. Our growth capital for next year will be approximately half of the cash flow that we generate that what we're looking forward. I think the opportunities are above and beyond that that will evaluate, but the right now that's our strategy.

[Marshall Adkins:]

Okay, last one, from a utilization bumped up across the board. How much of that should we associate with the right down in the equipment? It doesn't seem like a whole lot but I just want to make sure.

[Elijio Serrano:]

It's only about 150 basis points.

[Operator:]

The next question comes from Selman Akyol with Stifel. Please go ahead.

[Selman Akyol:]

Thank you. I'm delighted you're strong margins this quarter and thinking about you guidance, on a go forward basis, can you talk about kind of gross margins, you going to assumed and your future guidance for the rest of the year?

[Elijio Serrano:]

So, we don't want to be that granular in terms of guidance, I think that it is baked into our projections. We would challenge Roy to keep those margins in the equation, given that the vast majority of equipments coming in, or through our core customers that are well capitalized with strong drilling programs in place. And also, the key to making good progress in this business is to deploy equipment into clusters.Roy touched on this issue, that we've got customers out there that have two or three units in little fields, and they're asking for three or four or to go up to three or four units. And so, we deploy those units into those clusters, we don't have to add incremental technicians and mechanics.That is one of the big items that is driving our margins and if that's where our future capital is going, I would suggest that that there is upside, but it will be dependent on the amount of capital we deploy, plus the price increases, we keep achieving.

[Selman Akyol:]

Great. And then, I guess that was going to lead my next question. Can you just talk in terms of maybe the size of the fleet? How much you've run your prices through? And how much opportunity still may be there, if you realize through price increases?

[Elijio Serrano:]

So, we've been achieving price increases as contracts roll over into high single digits, low double digits, and that is on the existing fleet. Now, I'll say that all new equipment going out, is going out, going out that rates higher than what our average fleets is out there. So anything that we're deploying this new, I would suggest it's getting premium pricing and anything that's been on contract and has been deployed overtime is rolling over with single digit to low double digit price increases.

[Operator:]

Next question comes from Darren McCammon with Cash Flow Kingdom. Please go ahead.

[Darren McCammon:]

Hey, guys, thanks for the answer on the previous capital allocation question, I just had a one little new nuance there. Given the high cash flow ROI that you guys are enjoying, I understand that emphasis of buybacks over distribution. That's pretty clear. I also understand that you're getting higher ROIs replacing units, but it sounds like you're going to emphasize placing units at least for the next quarter over buybacks. Could you talk a little bit about the decision between those two and why that?

[Brady Murphy:]

Yes, this is Brad, Darren. We have a good relationship with our key clients, and we're in discussions with them for their 2020 requirements for capital. So, we may be a little bit frontend loaded on that for 50-50 distributions between meetings their requirements for 2020 and deploying capital in the first half of the year, but we're committed to that 50-50 split that Elijio talked about for the second half of the year for the shareholder returns, a stakeholder returns.

[Darren McCammon:]

Okay. So it's customer demand, that's correct?

[Brady Murphy:]

Yes, it's related to the timing of our customers 2020 deployments for compression.

[Darren McCammon:]

Okay. Does that mean that once that's done, you didn't catch up to the 50-50? Or is it go to 50-50 after that?

[Brady Murphy:]

No, no. We catch up the 50-50.

[Elijio Serrano:]

Our commitment to Darren is that over a relevant time period. We're going to be a 50-50. Every quarter, it's not going to be a 50-50. It might be skewed one way or the other, depending on timing of capital expenditures. But over the relevant time period, we're going to be a 50-50.

[Darren McCammon:]

Help me understand that this is an operations question more. There's a lot of ducts out there especially in the Permian. When our duct comes online, is that when they placed your compressors? Or is it afterwards? In other attempt, when the 4,000 plus ducts in the Permian comes online? Is that extra business for you or you already replaced those units?

[Elijio Serrano:]

So the ducts are drilled but uncompleted, which means that they're not yet producing any gas. As soon as they start getting into a production mode, the equipment has been deployed to either enhance production by doing gas lift or once during a production mode together the gas and push it into a pipeline. So, if a well is drilled, but not completed, it is not yet tied to any compression equipment. Once it's completed, that's when we're tying it to compression equipment. So all those duct opportunities are future opportunities to deploy compression unit.

[Brady Murphy:]

The only thing I would add, I'm not sure we can speak for every operator as it relates to their duct planning and compression planning. I think some of them probably a little bit ahead of the game. Some of them may not be, if they had planned on building up a duct inventory before completing them so. So although I'd like to know all the answers for every operator on duct side, I don't think we can speak to that granularity.

[Darren McCammon:]

That's what I was getting and we gave already pre-ordered these units or I guess we would have to, right? They would have already pre-ordered the units because they're going to bring the thing online?

[Brady Murphy:]

Again, it's hard for us to speak to an operator's plans as it relates to their duct inventory and planning. I wouldn't want to speak for them.

[Darren McCammon:]

The last thing we're seeing a number of E&P firms that are cutting back on CapEx for next year. Is -- how that affecting you?

[Brady Murphy:]

I think it's still pretty early for us to know what the operators capital plans are going to be for 2020. I think that that normally sheds up, in the fourth quarter. I think it's pretty early for that to determine what that's going to be at this point. At least for our customer base, which so far we've seen very little cut back at all from our customers. Again, the bigger operators have continued to drill and complete through this current fluctuation in commodity prices.

[Operator:]

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over for any closing remarks.

[Brady Murphy:]

Okay, this is Brady. We thank you for your interest in CSI Compressco and taking the time to join us this morning. That concludes our call.

[Operator:]

We appreciate your interest in CSI Compressco and thank you for taking the time to join us this morning. This concludes our call.