CSI Compressco LP
Q4 2018 Earnings Call Transcript

Published: 27 Feb 2019

[Operator:]

Good morning and welcome to the CSI Compressco LP's Fourth Quarter Full Year 2018 Results Conference Call. The speakers for today are Owen Serjeant, President; and Elijio Serrano, Chief Financial Officer. 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. Sergeant, please go ahead.

[Owen Serjeant:]

Thank you, Danielle. Good morning and thank you for joining CSI Compressco's fourth 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 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-K is planned to be filed with the SEC on or before March the 1, 2019. 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 and projections. I'm once again pleased to report significant sequential improvement in revenue, adjusted EBITDA and distributable cash flow. We improved sequentially in every quarter this year, starting with the second quarter of 2018, coming out of the 2015 through 2017 downturn. Our fourth quarter revenue was the highest in the history of the company, since the acquisition of CSI in August of 2014. Throughout the year, we made progress growing all of our business lines improved or balance sheet, by eliminating maintenance governance, deployed new large horsepower equipment at high returns, made strong additions to the management team on reaping the operational and financial benefits from the fully integrated ERP system we deployed in 2017. 2018 has been a great success and we are looking forward towards continuing to improve the business in 2019 as the compression market remains very strong across all of our business lines. We expect all of our business lines to improve year-over-year, as we continue to focus on additional efficiency improvements with our field, fabrication, aftermarket network and backup as functions to capture additional margin. We have a strong demand for additional field compression, while carrying a backlog for new equipment sales of $105 million and have a variable demand for our aftermarket services. As a result, we will continue to push price increase into the market to improve our cash flow and returns on capital. While some of the industry struggles with Permian Basin takeaway constraints, we continue to see our business as part of the solution. Demand for our compression services to address the issues impacting demand for some well-sized service companies remains strong, and all of the additions to our fleet are backed by customer commitments. Demand for new unit sales also continues to stay strong as can be seen by our backlog of $105 million at the end of 2018, and an additional $12 million of all this so far this year, all of which we expect to deliver in 2019. Outside of the Permian, the rest of the North American compression market is also holding up strong. Today, we are in the position across all basins to direct capital to those customers and those projects which offer the highest returns. I'll now spend a few minutes on each of the individual lines of business, and provide some perspective on how they are performing. Our compression services business segment continues to be robust and growing. We've increased revenues for seven consecutive quarters, and continue to project sequential improvements into 2019. These improvements are driven by the high horsepower units we are deploying to our existing customers, and at rates above the current fleet. 2019 capital expenditures that we expect to fund from cash on hand or from cash flow from operations are expected to be between $60 million and $65 million, inclusive of $18 million to $20 million for maintenance capital expenditures. In addition, and as Elijio will elaborate, we have an agreement with our general partner that TETRA will buy, and lease towards an additional $15 million of high horsepower equipment that equates to approximately 20,700 horsepower. CSI will then have an option to buy this equipment from TETRA anytime over the next five years. TETRA is supporting us in this manner, so we can continue to focus on generating free cash flow to reduce our leverage ratio, and so we do not have to issue equity at low unit prices. TETRA's commitment is very important to us as we fulfill our customers' demand. From the self funding we are doing plus the support from TETRA, we expect to deploy approximately 99,000 of new horsepower into our fleet in 2019, all with customer commitments. This compares to the 92,000 horsepower we deployed in 2018, mainly in the Permian Basin, South Texas and SCOOP/STACK and almost excessively high horsepower units focused on gathering system and centralized gas lift. Since the end of the downturn in 2017, we have placed orders for approximately 196,000 additional horsepower to be added to our fleet, again with approximately 99,000 scheduled to be delivered in 2019, inclusive of the TETRA commitment. The vast majority of additions are for or have been large gathering systems or centralized gas lift units, each over 1,000 horsepower, for which demand continues to be very robust. All of the orders we deployed have specific client commitments. We are focused on our customers with the strongest balance sheets in the shale basins with flexible gas production and on concentrations of equipment that give us the best returns. The new units we are deploying are priced higher than other selling units in our fleet, and the incremental margins we are achieving on those units are materially higher than our existing deployed units. As a result, the new units are generating returns on capital of approximately 20%. The incremental margins from recent fleet additions and contemplated, new 2019 fleet additions are materially higher as we deploy those units into existing networks and where we already have clusters of equipment allowing our mechanics and technicians to service those units, without making incremental subsidy locations. Our deployment of new fleet horsepower is working and we expect to continue to leverage our footprint to increase fleet size and improve margins. Pricing cuts continued to increase through 2018 for our compression services business as contracts rolled over or new contracts were put in place. We expect to deploy the new equipment at pricing significantly above our legacy fleet and expect price increases in mid-single digits for equipment that is rolling over on year-to-year contracts. We have already had some of these discussions with our customers and identified several opportunities to increase pricing especially for the higher horsepower equipment's which continuous to be in high demand and which in turn provide us with an opportunity to get leading-edge prices for fleet additions and contract rollovers. Lead times for new units continue to be between nine and 12 months. Our equipment sales activity especially for new units was extremely strong in the fourth quarter and was the highest since the August 2014 CSI acquisition benefiting from extremely strong bookings at the beginning of 2018. We have record bookings in the second and third quarters of 2018, and more traditional booking levels in the fourth quarter of 2018. Fourth quarter bookings were $18 million for new equipment orders and are $12 million for January and February of 2019. We ended the year with a healthy backlog of $105 million all of which is expected to be delivered in 2019. We completed the 2018 with orders of almost $190 million a record for us. Our 2019 delivery book is nearly filled due to lead time of key components. Our new equipment quotation pipeline is extremely robust and we anticipate stronger incoming orders as the year progresses and customers continue with their investment plans. Most of these orders are scheduled to be delivered into the Permian Basin, Delaware Basins and South Texas to midstream operators that are investing to address takeaway constraints and to build reasonable gas processing facilities. As we mentioned in the past when selling new equipment we also potentially benefit in the future for selling parts and services through our aftermarket networks to support customers, who purchase from us through the life of the equipment. Many customers choose us to help maintain their equipment after the initial sale. Our new equipment sales in 2018 were very strong and we expect to increase that on a year-over-year basis leading us to believe our aftermarket business is also getting stronger. Given the record fourth quarter, new equipment sales are $53 million. We anticipate the first and second quarters of 2019 will return to normal levels of $30 million to $35 million before increasing in the second half of the year reflecting timing of when the orders were received and timing on receiving the engines and compressors. With aftermarket services we enjoyed another very good quarter growing 10% sequentially to $21.9 million. In revenue as customers accelerated projects into the fourth quarter. We more than doubled our revenue since the fourth quarter of 2017. Our margins for the quarter also increased sequentially by 60 basis points. We expect this business to continue to stay strong in 2019 as the industry adds horsepower to the market and is in need of equipment overhauls of part sales. And as previously mentioned, some of our customers accelerated their aftermarket spending in December and therefore we expect the first quarter to fall off a bit all due to timing of major overhauls but then expect the remainder of the year to be stronger. In summary, the compression industry is in great shape and demand is strong. Our customers continue to have more demand for compression to deal with high volumes of associated gas from the shale play drilling programs and our business is directly benefiting from this across all of our business lines. Our utilization for 1,000 and higher horsepower equipment, focused on gathering systems and centralized gas lift was 95% at year-end. We are essentially at full utilization for large horsepower equipment. We deployed an incremental 20,134 of active horsepower during the fourth quarter, increasing the amount of deployed horsepower to 983,848. Overall utilization of the entire fleet is at 86.6%, up from 86.3% at the end of the third quarter and up from 83.2% at the end of fourth quarter 2017. The vast majority of the increase continues to be deployed in the areas with the most activity and demand including the Permian, Eagle Ford, SCOOP/STACK areas in Oklahoma and in South Texas where approximately 70% of our operating horsepower is deployed. With that, I'll turn it over to Elijio to provide some financial details on the quarter then we'll open us up for questions.

[Elijio Serrano:]

Thank you, Owen. Fourth quarter revenue increased sequentially by 20%, primarily due to the continued strong activity from aftermarket services and a record high in new unit sales. Compared to a year ago revenue is up 66% with equipment sales improving 194% to $55.6 million. Aftermarket services revenue increased 102% from last year to $21.9 million. And Compression Service revenue increased 14% to $60.6 million. All three of our business lines increased sequentially as well. Our new unit sales activity, which complements our compression services business, had an extremely strong quarter as we delivered the highest sales quarter since the acquisition of CSI in 2014. Compression services gross margins was 43.6% in the fourth quarter, which includes the impact of $2.1 million of non-income tax contingencies. Excluding this item Compression Service gross margins would have been 47.1%, a decrease of 10 basis points from the quarter due to slightly higher labor and inventory-related costs. However, we continue to see the benefit from better pricing and other efficiencies as contracts roll over as additional large horsepower units are deployed at higher rates and from the benefits of our ERP system, which improves operational efficiencies. As Owen mentioned, we continue to deploy new equipment with returns on capital of approximately 20% driven by the higher pricing on the new equipment and by deploying new units to existing clusters with our strongest customers. Aftermarket Service revenue was $21.9 million with gross margins of 19.2%. We continue to see strong demand and growth in this area as documented by our 10% sequential revenue growth and improved margins. We saw a big push of some of our customers to complete projects in the fourth quarter as well as buy additional spare parts to exhaust their 2018 budgets. As a result of this year-end push, we believe the first quarter will be a bit softer but don't see the demand stopping as the year progresses. Equipment sales of $55.6 million were with gross margins of 9.4%, which is 100 basis points improvement over the third quarter margins. This reflects the delivery of equipment from the backlog that we started building in the third quarter of 2017. We continue to look for further efficiencies in our equipment sales business to improve margins in the future and expect that future margins will be above 10% going forward. The 2018 margin reflects orders that were placed in 2017 and early 2018, which were at lower prices before demand fully picked up. And as mentioned in our press release this morning and as Owen mentioned earlier, we don't expect fourth quarter 2019 to be at the fourth quarter levels, but rather to be more in line with our results from the middle quarters of 2018 for equipment sales. Our backlog at the end of 2018 stood at $105 million after receiving $18 million of orders in the fourth quarter. Since year-end, we have received an additional $12 million of new orders that we expect to deliver all the current backlog in 2019. Orders placed after the first quarter of 2019 will most likely be delivered in 2020 due to the lead times as the key components for our equipment. In the fourth quarter, we recorded a $2.4 million non-cash benefit to adjust the carrying value of our Series A convertible preferred units. We also recorded a $2.1 million non-income tax contingency in our field compression segment. Adjusted EBITDA in the fourth quarter was $30.2 million, a $3.6 million improvement from the third quarter. Our coverage ratio was 28 times, up from 1.07 times in the third quarter due to the stronger earnings and the distribution reduction we announced on December 20. It is interesting to note that our coverage ratio would have been 1.5 times, if we had left a distribution at $0.1875 per unit. This give you a -- this gives you a sense as to how strong the quarter was. As a reminder on December 20, we announced plans to reduce the quarterly common unit distribution from the fourth quarter from $0.1875 per unit or $0.75 per unit per year that was previously in place to $0.01 per unit per quarter or $0.04 per unit per year. Our intention is to review this reduction in the -- of the distribution in the second half of 2019 and determine the best use of cash after redeeming the $30 million of Series A preferred units that are currently outstanding, so that we can determine the deployment of cash from operations that will create the most value to our unitholders. This year, we intend to use savings from the reduced distribution to cash redeem the remaining Series A preferred units in order to avoid issuing common units that might further dilute our existing unitholders. With respect to the balance sheet, our goal as communicated on May 31 at the Investor Conference that we held continues to be to improve EBITDA leverage ratio from the current levels to 4.5 times or better. And we believe we are making progress with that goal without issue in diluted equity. Our press release provided guidance for 2019, which is consistent with the guidance we provided on December 20. We continue to see a strong market across all our business lines and have seen little impact from the drop in oil prices in the fourth quarter or the Permian takeaway constraints. We believe year-over-year all of our business lines will improve and increase over 2018 despite the slower start in the first quarter from equipment sales and aftermarket services. The key points of our guidance are the following

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Praveen Narra of Raymond James. Please go ahead.

[Praveen Narra:]

Hey good morning guys. I guess when we think about the large horsepower side of things, obviously, you guys talked about getting pricing and that legacy contracts rolling on to better pricing and better margins. So, how do we think about the cadence of contract rollovers for the -- ones that are strong on legacy contracts as we go through in 2019 what percentage?

[Owen Serjeant:]

Hi Praveen, it's Owen here. So, if you look through -- a lot of the contracts like on a year basis from a pricing review standpoint, so we look at a lot of those contracts through the second half of this year are going to go back through a pricing review process. Now, bear in mind that's going from the low of the market, so that's sort of the back end of 2016 and into 2017. 2018 was a lot of recovery in terms of going through that first pricing review with customers. And we've talked before on the larger horsepower units that we were in the sort of mid to high teens on rollover contracts. I wouldn't expect to be that high going into 2019 and we indicated in this -- in the narrative where we feel it will be. But we do have a lot of contracts again that will be going through reviews in the second part of the year on a rollover basis. The new equipment again that's 92,000 horsepower last year, 99,000 this year, so a bit of a rollover of 5,000 horsepower goes into the first quarter 2020. But again, they all have higher prices than what the existing legacy fleets. It is not the brand new units. Emission standards configured at this stage for gas lift operations, so you can generate a higher price of that equipment.

[Praveen Narra:]

Right. Okay. If we can move to the equipment sales side, obviously, you guys still have a pretty significant backlog. How should we think about margins for that going forward? Or can we still see margins improve from here or how do we think about it?

[Owen Serjeant:]

Yes, we've posted a number there in the narrative there of about 10% which is higher than what we see in our 2018 and 2017 before. And a lot will depend on the general activity, but we do see quite a robust pipeline of opportunities. So, the market indicates that there's a great deal of activity out there. And what we'll be doing we'll be pushing that pricing level because of the constraints in the industry. We're using the same cost suppliers for new units for the most part as we do for fleet and that's why we recognize how we price our equipment. So, again, we'll continue to be aggressive and we still have a healthy backlog. And we've got line of sight on some good opportunities in Q1. I've got -- I can't control timing. I mean there's still a bit of volatility there on the units side, but I think that's just going to be short-term as people turn the corner into 2019 and resolve their own project timing issues. Well, again, a lot of opportunity out there that should be -- we should realize some increased price on there. And again, on the cost side we continue to drive efficiencies in the operation where we can.

[Elijio Serrano:]

And Praveen let me add also I think two important points and remind our investor community of our fabrication business. So we do fabrication in the same location that we also build for our own fleet. And the other thing as we receive orders, we get deposits and progressive payments such that we're working capital positive through the entire cycle. So this is more than a 10% margin that we're recognizing from equipment sales. It's also a business that is cash flow positive throughout the cycle and actually creates positive working capital for us in the process.

[Praveen Narra:]

Right, right. If we can move on -- if I can just want to ask one more question just on the TETRA leaseback agreement. I guess, can we talk about -- sorry, can we talk about how that profitability split works between the two companies? Is it a 50-50 share? And then can we also kind of touch on what the capacity to do more of these deals are?

[Elijio Serrano:]

So, a couple of responses. We'll evaluate this as opportunities come up. We mentioned that we want CSI Compressco to be self-funded. We don't want CSI Compressco to issue equity. We don't want to incur additional debts. So we'll carefully evaluate any other opportunities that they have and see whether we self fund with better profits or whether TETRA continues to support in the current capacity that we've mentioned we're doing right now. The second item is that TETRA is investing the capital. TETRA is taking the risk on the equipment. So they're going to make the majority of the returns. But CSI Compressco will make a margin on this equipment, as they put in service to customers.

[Praveen Narra:]

Okay. That makes sense. Thank you very much, guys.

[Operator:]

The next question comes from Jeremy Tonet of JPMorgan.

[Charlie Barber:]

Good morning, guys. It's actually Charlie on. On 2019 guidance you gave us a little color and apologies if missed it. But can you talk about the gross margin expectations for compression services, how that is relative to 2018 and what might cause that to maybe move a bit high or low versus expectations?

[Elijio Serrano:]

A couple of items, Charlie. The first is that we've mentioned that all the new equipment being deployed is going at much higher pricing, and we're also deploying that equipment in two existing clusters of equipment so that the fall-through or the incremental margins are significantly better than the existing margins. So we expect that it will average up all the margins. Then Owen mentioned also that we continue to focus on operational efficiencies, use our ERP system to schedule and preplan a lot of the maintenance. So we expect our gross margins on the compression services to increase year-over-year. We also talked earlier about fabrication that we expected to increase to the 10% and slightly above range. And we also expect the aftermarket services to continue to operate in the 20% plus type range.

[Charlie Barber:]

Great. And then on your distribution. So, later this year, you'll reevaluate the distribution policy. Can you talk a little bit more about that? Maybe how that might work? Do you anticipate kind of reversing the step-down gradually? Or do you think that maybe you might implement maybe a bit more cushion a higher coverage to give yourself more room there?

[Elijio Serrano:]

So, very good question, Charlie. If you look at the information that we've put out in our guidance and take the midpoint of our EBITDA which is about $123 million, interest expense is -- cash interest expense is about $48 million, maintenance capital is $18 million to $20 million and cash taxes are $3 million to $5 million. That gives you $60 million that we have a decision is to how do we utilize that $60 million? This year we've made the commitment that that $60 million -- $30 million of it will go to redeem the Series A for the balance of this year. And we've also mentioned that we're going to self fund our growth capital. So the other $30 million is spoken for growth capital. Now we're talking about how do we take that same $60 million and take advantage of that cash being generated from the business in 2020 and whether we increase the distribution and reinstate it into what level whether we do a new unit or we purchase units on the open market whether we reduce debt and buy debt on the open market or whether we continue to invest in growth capital at 20% opportunities. That is the review that we're going to go through discuss with our board and lay out a strategy at the upcoming earnings call that we'll have after Q1. So we'll make those decisions as we see the year progress. But we're in a position to where we think that we've got a business generating a solid $60 million-type free cash flow that we can determine how to best create shareholder value.

[Charlie Barber:]

That’s helpful. Thank you.

[Operator:]

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

[Owen Serjeant:]

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