CSI Compressco LP
Q1 2018 Earnings Call Transcript

Published: 7 May 2018

[Operator:]

Good morning and welcome to CSI Compressco LP’s First Quarter 2018 Earnings Conference Call. The speakers for today’s call are Owen Serjeant, President and Elijio Serrano, Chief Financial Officer. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I will now turn the conference over to Mr. Serjeant.

[Owen Serjeant:]

Thank you, Phil. Good morning and thank you for joining the CSI Compressco’s first quarter 2018 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 analyses 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 announcement that went out earlier this morning and is posted on our website, our Form 10-Q is planned to be filed with the SEC on or before May the 8th 2018. I will start with an overview of our performance, then turn the call over to Elijio Serrano, our Chief Financial Officer, who will provide more details on our financial results, balance sheet and projections. I joined CSI Compressco on November the 20 of last year. In the 5.5 months since I joined the company, I have had opportunity to visit all of our operations across the US, Argentina and Mexico. I convene the management and sales teams to conduct detailed business reviews, align our clearly designed expectations. I have also had the opportunity to visit with many of our key customers. The management team and I have conducted detailed reviews of our fabrication operations, GasJack fleet, gathering system strategy and gas lift initiatives across Midstream and offstream segments. We've also created a management in several areas, including adding to the publication business, procurement and logistics operations and finance team. In January, we secured our large order in the company’s history, pushing our fabrication backlog to third party sales to over $100 million. I’m very pleased with what I’ve seen as I believe our business model is profitably positioned to generate better margins and returns on capital. In the first quarter, we have taken several steps to position ourselves to participate in this option. Firstly, we completed refinancing of our debt by retiring our revolver and replacing it with a 7-year bond with no maintenance covenants. This bond offering provides us over $100 million of cash to invest into the business. We're also in the process of putting in place a $50 million asset based revolver to provide additional liquidity for working capital needs to keep expanding into this cycle. Second, the management team have clearly defined goals and objectives on how to improve our returns on capital. We have hurdle rates that will be achieved. We have identified the appropriate customers that will properly compensate for us for the services and the equipment we bring. Our future investments are going to be targeted at a select group of existing customers in our core areas of strength. We are increasing prices with a large gathering system asset and with gas lift assets. We are achieving price increases of approximately 15%, and in some cases, closer to 20%. These increases are coming from contracts that are rolling over on existing assets where new equipment will be deploying. As part of this focus on customers that will better compensate us, we are repositioning staff inventory on an infrastructure to achieve better returns. Third, we have increased our 2018 projected growth capital expenditures from $40 million to $55 million communicated during the Q4 earnings conference call. So now between 75 million and 90 million. This will add approximately 115,000 incremental horse power to our fleet. All our orders for engine and compressor to fabricate equipment for our fleet are based on committed orders from existing customers. Those orders are coming in approximately 15% above their previous pricing. Our Midland fabrication operations have a clear mandate that we need to further drive down the cost of fabrication and deployments of equipment. The vast majority of our equipment being fabricated on the fleet are 1,300 and greater in horsepower. The combination of improved pricing and lower cost to fabricate equipment is expected to drive up our return on capital. Fourth, we are focusing on expanding our aftermarket services. This business has been growing significantly over the past two quarters. We're also putting prices in this area to further improve our margins. And important to understand that this business grows with no capital expenditure required, or minimal levels of working capital. As new equipment sales also increase, there is a knock-on benefit on aftermarket services as we normally service the equipment that we sell. Over time, I believe we have the opportunity to become one of the largest aftermarket service providers in our industry for compression needs, covering gathering systems, gas lift and gas processing compression requirements. This is a focus area for us to improve on our returns on capital. Fifth, we are trying to keep management rhythm and discipline to focus on key areas like consistently monitoring performance against expectations, challenging ourselves and moving quickly while our progress is slow to materialize. These areas include achieving better pricing, deploying assets at the most effective cost we can, getting better utilization from our fleet mechanics and technicians and expanding our focus on aftermarket services performance. The market is clearly heading in the right direction and each quarter seems to be stronger than the prior one. This is true not only in North America but also in Mexico and Argentina where we are seeing a significant increase in requests for quotes or proposals. The US rig count continues to climb and it is now more than 100 rigs from the fourth quarter average and exceeded 1000 rigs last week. With the rig count growth, our customers have more demand for compression to the higher volumes of associated gas from the oil shale play drilling programs, which bodes very well for our business. The increase in demand in the US is coming from our existing customer base where gas volumes continue to increase. Our large horsepower assets are having them move the associated gas into the Midstream systems. Our customers keep adding more capacity to our existing network. We are their primary service provider. We’re obviously seeing them build on networks in the Delaware Basin [indiscernible] where our Midland fabrication business is based. We are the only fabricator of large horsepower compression equipment of any material scale in the Permian Basin. Our daily locators support the growth in the Permian basin and expansion into the Delaware Basin. This ideal location of engineering knowhow allowed us to secure a $67 million order to fabricate and deploy over 45 large compressors later this year and into next year for our large Midstream Company. In order bases that are high volume of associated gas, gas lift is the preferred method of other alternatives like ASPs for improved oil production. This is accomplished by either wellhead gas lift compression or with [indiscernible] with larger volumes of gas, centralized gas lift. In either process, with the breadth of our fleet, we’re able to offer compression of the wellhead in the 200 to 600 horsepower size range to over 1000 horsepower for more centralized operations. [indiscernible] gas lift gas gathering services required in larger horsepower units. This has driven an increase in the utilization of our greater than 1000 horsepower units and we will continue to be held to support this trend to our growth capital expenditure that are focused on the higher horsepower. With the GasJack fleet, we are seeing improved demand for this application in the Rockies. We are also evolving application on these assets towards gas lift and enhance production for liquids. The combination of stronger demand for gathering systems, increased opportunities of our gas lift and evolving our gas lift to broader applications plays well for our diverse fleet of assets. Our quarter over quarter utilization for 1000 and higher horse power equipment focus on gathering systems that is now at 92.9%. We deployed an incremental 13325 horse power during the first quarter, increasing the amount to deploy the horse power to 913, 962,000. Compared to the end of first quarter 2017, we have put back to work nearly 60,000 horsepower that was previously idle. Overall utilization for the entire fleet is 84.2%, up from 83.2% at the end of the fourth quarter and up from 77% at the end of Q1, 2017. The vast majority of the increase in the areas with the most activity and demand include the Permian and Eagle Ford basins as well as crude stack areas in Oklahoma where around 50% of our operating horsepower is deployed. Our customers are now placing orders and making commitment for equipment, more than a year out as securing new equipment is at a shortage. Today, we are adding capacity on our large equipment but are building more equipment for the recent bond offering. With that, I will turn it over to Elijio to provide some financial details on the quarter. Then, we will open up for questions.

[Elijio Serrano:]

Thank you, Owen. First quarter revenue increased sequentially by 2.8% on continued stronger activity from aftermarket services. Compared to the year ago revenues, up 30% with aftermarket services improving 49% to $14 million and equipment sales increasing by 2.1 times to $17.7 million. Compression services revenue increased 1% to $53.7 million. Total horsepower increased by 3169 from December to March from bills that we initiated in the fourth quarter of last year. Active horsepower increased sequentially by 13324 with the utilization improving 100 basis points from 83.2% to 84.2%. Equipment over 1000 horsepower was 92.9% utilized. To better reflect the composition of our fleet and to allow for better industry comparisons, we are measuring and publishing the utilization of our equipment in three sizes, zero to 100 horsepower, 101 to 1000 horsepower and 1001 and higher horsepower. This better aligns with how the industry reports categories of equipment. Historical trends for this three categories will be published on our website. We define the fleet utilization as the aggregate compressor package horsepower in service divided by the aggregate compressor fleet horsepower as of the given date. We do not exclude the idle horsepower under repair or horsepower that is otherwise impaired from our utilization rate. Compression services margins in the first quarter were 41.6% and were impacted by approximately $2 million of fuel costs we consider to be non-recurring. 1 million was incurred in general for labor and parts as we deploy technicians across various regions in Texas to unlock equipment that [indiscernible] freezing cold weather conditions over a prolonged period of time. We expended almost 9000 labor hours during this period, either to unlock equipment or to proactively address potential issues from equipment locking up. The other one at Midland was for inventory adjustments and for fuel cost that we don't expect to repeat into the future quarters. After market services revenue was $14 million with gross margins of 20.4%. We continue to see strong demand and growth in this area, if customers prepare equipment previously idle to deploy, catch up maintenance previously delayed and we build our inventory stocks in anticipation of higher activity levels. Equipment sales were $17.7 million with gross margins of 12.5%. This reflected the delivery of equipment for the backlog that we started building in the third quarter of last year. We expect to see continued increases in equipment sale as a result of the $102.5 million backlog. In the first quarter, we incurred a non-cash charge of $3.2 million to write off deferred financing costs associated with the revolver that we retired and replaced with the bond offering. Additionally, in the first quarter, we incurred $101.5 million non-cash charge to adjust the carrying value of the Series A units. Adjusted EBITDA for the first quarter was $19.2 million and was impacted by the $2 million of fuel cost I previously mentioned. From a guidance perspective, we are increasing our prior guidance on capital expenditures by $35 million as we are adding to our build schedule to meet customers’ demands. We are projecting total year growth CapEx to be between $75 million and $90 million. This is expected to deliver approximately 115,000 incremental horsepower to our fleet by the end of the year. We expect maintenance capital to remain at between $15 million and $20 million for the year. In the first quarter, maintenance capital was $4.3 million. We have seen momentum from several areas that give us confidence in providing total year guidance. These items include the following. First, total utilization is at 84.2% and continues to improve. Large horsepower equipment over 1000 horsepower per unit is at 92.9%. Second, we have had success in increasing prices from contracts that are rolling over. Many of these increases started mid to late in the first quarter and didn’t have a material impact on the first quarter, but are expected to have an impact in the second quarter and beyond. As Owen mentioned, the increases are averaging 15% with a few cases where the increases have been at 20% or slightly higher. Third, we are building and adding by year end approximately 115000 horsepower to our fleet, mainly of large horsepower equipment for gathering systems. These are being delivered to our existing customers in existing fields at prices approximately 50% above what they had last year. Our new equipment being build is on commitments from our customers. And the vast majority of this equipment is in our core areas where we have mechanics and technicians will a support infrastructure where the fall through will be higher than the overall margins. Fourth, we have accumulated a backlog of over $100 million of equipment to fabricate and sell. Most of this is expected to be delivered by the end of this year. And fifth, the aftermarket services business continues to increase. The backlog of orders, commitments from our customers in this area is stronger than the last upcycle. On the back of these five data points, we are projecting total year revenue to be between $385 million and $400 million. This implies a significant step up from the first quarter run rate that we're seeing. Adjusted EBITDA is projected to be between $95 million and $100 million, also reflecting the five previously mentioned data points. From a balance sheet perspective, we successfully completed a $350 million 7-year term secured bond offering with a 7.5% coupon that provided us over $100 million of cash to invest at rates higher than in contract. Their current debt structure of $296 million of unsecured notes is for 2022 maturity. And $350 million secured bond with a 2025 maturing, neither of which have maintenance covenants, will allow us to invest in these opportunities that Owen mentioned that meet our hurdle rates of return. Owen mentioned that we are also working to put in place a $50 million asset base revolver also when pricing these covenants. [Technical Difficulty] And finally, on April 20, we announced that the Board of Directors of this general partner declared a cash distribution attributable to the first quarter of 2018 of 18.75 cents per outstanding common unit, which will be paid on May 15 to common unit holders on record as of the close of business on May 1. With that, we will now open it up to question.

[Operator:]

[Operator Instructions] The first question comes from Marshall Adkins with Raymond James.

[Marshall Adkins:]

Good morning, gentlemen. Thank you for the comments on pricing and it’s good to see you’re focusing on returns going forward. Couple of things for me. How long is it going to take these contracts to roll over to this 15 plus percent higher pricing you’re seeing?

[Elijio Serrano:]

Good morning, Marshall. We expect that the vast majority of all the contracts we roll over during this year.

[Marshall Adkins:]

Perfect. And then on utilization, you’re on the large horsepower, you’re right at 93%. How high can that go?

[Owen Serjeant:]

Hi, Marshall. It’s Owen here. We’re pretty much capped out at that number. There still is a little bit that will come back, but pretty much, I think in the industry, obviously, we’ve improved that. You only have that level in the 90s. You’re pretty much capped out.

[Marshall Adkins:]

Right. Okay. So you build new equipment, you talked about returns, what do you think your returns are going to be on that new equipment that you’re adding?

[Elijio Serrano:]

Yeah. Marshall, we prefer not to give target recurrence. Otherwise, it will lead toward our pricing philosophy and in a competitive market environment, I prefer to keep that in house. However, I would say that we expect the majority of the pricing to have a significant fall through to the bottom line.

[Marshall Adkins:]

How about this? Can you give me a range, I mean, are we talking like 15% to 20% IRRs, is that – can you just give us the ballpark?

[Elijio Serrano:]

I would say that that’s on the lower end of our expectations.

[Marshall Adkins:]

Last one for me, small horsepower, it looks like demand is picking up there, just give me your overview. I know that’s not the focus going forward, but give us a kind of overview of market conditions there and what should we expect?

[Owen Serjeant:]

On the smaller horsepower units, on the reset side, we have sort of wellhead type of gas lift applications. There is still quite a lot of activity there, maybe not in the Permian, because of the gas volumes, but fairly up in the Midcontinent, we still see a lot of activity there and those reship units continue to be highly utilized and is improving. And on the GasJacks, that’s a slow recovery because it’s more focused on conventional applications, however, we are looking at unconventional, where we can apply in unconventional areas. So we expect that to start creeping up towards, that can go through the course of the year.

[Operator:]

The next question comes from Andrew Burd with JP Morgan.

[Andrew Burd:]

Mostly housekeeping questions. On the revenue guidance you provided, what portion of that is from the core compression services business?

[Elijio Serrano:]

I would say that equipment sales -- we've got a backlog of $100 million and I would expect that we're going to have slightly over 100 million -- right at the $100 million range on equipment. I would expect that aftermarket services will continue to increase modestly and the rest of it will come from the fleet that we're deploying.

[Andrew Burd:]

And what terms -- what types of term are you getting on new contracts that you're signing today, whether they be for a new customer, new equipment or raising prices on existing contracts and how do you philosophically think about term versus price?

[Owen Serjeant:]

I think in this market, both of them are important, especially what you see on the higher horsepower units, the length of the term tends to be longer and that’s not all traditional, that will be sort of historical parts as well. So larger units, you'll see those three year contracts, smaller ones, we bought them a year or two year type period and I don't think one has to be in conflict between term and price here in this market.

[Andrew Burd:]

And then turning to equipment sales and fabrication, outside of the sizable order you announced from January, the backlog additions have been good, but fairly modest. Can you just comment on competition in that business and industry capacity, especially for customers local to your West Texas footprint?

[Owen Serjeant:]

Yeah. I think about – I’ll answer the capacity one. Generally speaking, the supply chain is moving towards a capacitized position based on, not particularly based on roof line, perhaps based on sort of resources and the strong focus in the industry support supplying to fleet companies as well as trying to sell to Fed policy. So you will see lead time start to extend. There is no doubt about that. From our standpoint, we still see quite a lot of activity. You've got this sort of Midstream companies who are looking to go through a compression services model for a period of time because of economics, but will look to buy equipment as we got the 67 million of order. And there are some large E&P people who are looking at growing their own sort of midstream infrastructure, but might be looking to buy. So, it’s a little bit of a mixed model at the moment, but suffice to say that there is still a lot of activity on the horizon.

[Andrew Burd:]

Great. And final question for me and it's more big picture about the opportunity in West Texas. As producers face issues with constrained takeaway and flaring, are there any opportunities that this could open up for you, particularly in your wellhead compression business?

[Owen Serjeant:]

Yeah. I'm not sure how much of a solution flaring will be over time, but certainly the conferences we’re being to and people looking at alternate, but there's a big push on the infrastructure, so that those constraints can be alleviated, but certainly where we see, wellhead compression for gas left to utilize some of that gas and that's where we’re looking at for the gas lift applications with plunged pumps, there might be an opportunity for us. So yes, there is opportunity out there. We're looking after every day, but the industry has to resolve this situation about what to do with gas. And I know there is a lot of focus on that, but it’s got to your end markets or it goes back down the well to help with our recovery.

[Operator:]

The next question comes from Michael Gyure with Janney.

[Michael Gyure:]

Yeah. I think in your comments you guys talked about the backlog and the expectation that most of that's going to roll off at the end of this year, is that consistent with what we were talking about last quarter? Is that -- for some reason, it seems to me to be a little bit faster than you were talking? I guess if that’s so, maybe can you talk about the drivers of what's happening, why it’s moving forward.

[Elijio Serrano:]

So Michael one of the benefits of being vertically integrated is that you can control the volume of activity through your operations and you don't have to wait in a queue behind others. So we're ramping up our Midland fabrication facilities. We're adding incremental staff to not only build for our own fleet on the incremental capacity we're adding, but also to be able to deliver the backlog that we have. The lead times on some of the cat engines and compressors pushing up into the 9, 10 month period, but we believe that most of the backlog that we've got can be delivered by the end of this year.

[Michael Gyure:]

And then in the aftermarket business, you talked about a focus on growing that business. Can you talk about maybe some of the initiatives you have going on there to grow that business?

[Owen Serjeant:]

We're looking at -- one of the things about the aftermarket business in this segment is having good distribution network, good systems that support velocity parts going out to a customer. So we're looking out where the footprint is to support that as well as having the right roof line because there's a lot of overhaul on reapplication of selling through our shops, a little bit of a pent up demand, but folks have not invested in over the past few years. So those areas of parts supply, parts distribution, having the roof line to do the larger overhauls of equipment that’s on third parties, having the engineering resource that can do some reapplication work. So those three areas certainly are starting to see the activity start to grow.

[Elijio Serrano:]

And Michael one of the things when we implemented our ERP system back in August was to drive internal operating efficiencies, but we also recognize that it would allow us to better process part orders, connect suppliers and turnaround orders very quickly and we're starting to see the benefit of that. Owen mentioned that part of this initiative is to add incremental management bandwidth and we added a procurement manager that’s helping us drive that. So we believe the combination of stronger demand plus our ERP system allowing faster turnaround on parts plus the dedicated resources is going to be a big driver to this. So the system is helping us not only on the cost side in the future, but it's also now starting to help us on the revenue side.

[Operator:]

The next question comes from Tim Howard with Stifel.

[Tim Howard:]

First off, on the 15% increase. Is that across your horsepower chain or is it focused are the higher horsepower units. And then, so should we -- hearing from your earlier comments, should we see that fully roll in in kind of the 1Q ’19 timeframe?

[Owen Serjeant:]

I think, yeah, I mean these are never binary thing because there's obviously a lot of differences in the horsepower, the equipment with the supply, but generally speaking, the higher price increases that we're seeing in our 15 to 20 horsepower range, so sorry, 20% range tends to be in the higher horsepower block, smaller units tend to be less so. I wouldn’t apply that 50 to 20 across the whole of the million horsepower fleet, but it pretty much applies to the larger horsepower range.

[Tim Howard:]

Got it. And then kind of the 1Q 19 timing as all those contracts reset, is that kind of fair for that higher horsepower fleet to realize that?

[Elijio Serrano:]

Yeah. So Tim, what happens is every month, a certain number of contracts roll over and in anticipation of those contracts rolling over, our sales organization is out there engaging in dialog with the customer. On the magnitude of the price adjustment, they will need to put in place. Once we agree the building for that equipment, the next month goes up at the higher rate. So each month, there's a certain number of assets and contracts that roll over, those are negotiated and new price is set and then we get the benefit from that month forward. As I mentioned in, I think, the very first question that was asked today, we expect that the vast majority of all our contracts will roll over between now and the year, we will have an opportunity to put the new pricing in place for those.

[Tim Howard:]

And then just shifting to expenses, are there any more non-recurring field expenses that we should anticipate in 2Q?

[Elijio Serrano:]

None.

[Tim Howard:]

And then SG&A, seems like it was year-over-year, after you back out kind of equity compensation, any one time items there, anything to be aware of?

[Elijio Serrano:]

Nothing of significance, expect that the run rate that we saw in Q1 is probably going to be flat from here forward.

[Tim Howard:]

And then with the kind of -- shifting to the balance sheet and coverage as well, with the kind of covenant out of the way now, you don't have those restraints, just kind of what your guys’ long term philosophy on where you kind of want to get the balance sheet too? And I understand you’re kind of ramping up spending now. So more of a transition year in 2018, but if you could just speak to kind of goals for leverage and distribution coverage?

[Elijio Serrano:]

[Technical Difficulty] Historically, we've targeted 1.1 times, but I think that as we go through an investment period, I think that you will see us move up from the 0.65 that we see in the last couple of quarters up to 1 and above in the back end of this year. Longer term, we're going to be more comfortable being closer to 4 times. I think where we currently have been and I think the combination of the improved earnings from the capital being invested will be a big impact on driving us in that direction. From an investment philosophy, we intend to use the capital that we raised from the revolver, I mean, from the bond offering to fund our growth capital. We expect working capital to be minimal and we’ll cover that through the ABL that we’ll put in place and we think that the combination of all those will allow us to meet the demands of our customers, while driving up returns on capital.

[Tim Howard:]

Just to be -- you said four times, is that right?

[Elijio Serrano:]

Over a longer time period.

[Operator:]

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

[Owen Serjeant:]

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

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.