CSI Compressco LP
Q3 2017 Earnings Call Transcript

Published: 11 Nov 2017

[Operator:]

Good morning and welcome to the CSI Compressco Third Quarter 2017 Conference Call. All participants will be in a listen only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today’s event is being recorded. I will now turn the conference over to Stuart Brightman, President and Chairman of the Board of CSI Compressco. Please go ahead, sir.

[Stuart Brightman:]

Thank you, Rocco. Good morning and thank you for joining the CSI Compressco third quarter 2017 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 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 measures. 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 by Thursday, November 9, 2017. Again, thank you for joining us this morning and we do appreciate your interest in CSI Compressco. I will start with an overview of our performance, then turn the call over to Elijio Serrano, our Chief Financial Officer, who will cover more detailed financials. During the third quarter, we saw an acceleration of positive momentum from many of our customers. The number of requests for proposals, quotes increased, asking about availability of equipment increased as the quarter progressed. These are occurring not only in the U.S. but also in international areas we’re participating particularly Latin America. This momentum has converted into stronger activity levels and improved financial results for CSI Compressco. We deployed an incremental 23,414 of horse power during the quarter increasing the amount of deployed horsepower by 2.7% to 886,971. This increased demand is to address customers’ gathering system requirements in West Texas, South Texas, New Mexico and the Oklahoma areas resulting from the higher gas content from new crude oil wells. Customers have changed their focus from acreage acquisition to increased production from their existing fields requiring additional compression capability for their gathering systems. During the downturn, most customers rationalize their gathering systems and eliminated excess compression capacity as incremental wells are being brought online with a higher gas mix than anticipated, they are finding themselves short of compression capacity in reaching out to the industry to meet that demand. Many wells are coming online with the gas, with a higher GOR or Gas to Oil Ratio that requires incremental compression capacity. We are also seeing increased demand for gas lift applications for enhanced oil recovery applications at the well site that impact our smaller and mid-sized compression equipment, with particular areas of strength being the SCOOP/STACK and the Permian Basin. The GasJack units to address late life wells are also seeing an increase in activity, particularly in the Rockies. As a result of the above, utilization increased 250 basis points to 81.4% at the end of the third quarter. Our larger horsepower equipment that is focused on gathering systems is now at a utilization of over 90% at 90.1%, up from 89.6% at the end of the second quarter. 47% of our total deployed fleet is greater than 800 horsepower in size. We have initiated our orders for additional large horsepower equipment to meet the increasing demands from our customers focused on West and South Texas. This additional equipment will begin arriving and be deployed beginning in the fourth quarter and into the third quarter of next year. We are also evaluating opportunities for additional equipment to be ordered, fabricated and deployed. Our 100, 800 horsepower equipment utilization had the most significant increase in utilization going from 73.8% at the end of June to 79% at the end of September. This group of assets were addressing requirements for gathering systems and are also focused on enhanced oil recovery applications. We still have over 90,000 horsepower available in the size of assets to deploy to meet the strong demands we are seeing. The smaller horsepower equipment predominantly the GasJacks increased in utilization to 65.1% from 64.1% from June to September. The higher demands we are seeing for this smaller asset base are in the Rockies in West Texas. The strong demand for equipment is providing us the opportunity to begin increasing prices, we saw a modest impact from better pricing in the third quarter and expect more meaningful impacts beginning in the fourth quarter and going into 2018. New equipment is being deployed at pricing levels above our existing fleet. In addition to the strong environment for the deployed fleet, we saw a meaningful increase in new orders for the fabrication and sale of equipment. Orders received in the quarter were $37 million compared to an average of $12 million per quarter during the prior three quarters. As a result, our backlog increased from $24 million at the end of June to $53.6 million at the end of September. The majority of the orders for large gathering systems from our domestic customer base. We recorded sales of new equipment in the third quarter of $7.5 million and with the $37 million of new orders, our book-to-bill ratio was 4.9x. As a result of the increasing demands to build and deploy equipment for our fleet and to meet the increasing backlog, we have started to significant ramp-up resources in Midland to keep up with the demand to build and deploy compressors. Our industry is seeing turnaround times and new equipment stretch out to a year as many of the fabricators have started to get backlog. Once we receive the engines and compressors that we order, we can quickly fabricate and deploy to our fleet or ship to our customers new equipment. Being vertically integrated in this market provides us a competitive advantage that allows us to quickly deploy assets. Aftermarket services is also seeing an increasing amount of opportunities. Customers are catching up maintenance, rebuilding parts inventory and reconditioning assets that were previously idle. We expect the future quarters to see a nice ramp up of activity to meet these demands. On August 1, we successfully launched our fully integrated ERP system that automates our quote to cash process and streamlines our business processes. Our sales team and field technicians are now connected with real-time visibility to all resources with automatic resource scheduling and improved parts management providing us real-time metrics to support us in managing our business in a rapidly changing environment. We have started to receive the benefit of lower cost and increased efficiencies from this new system and expect to generate more than $4 million of annualized cost savings by mid-2018. We’ve seen to date only about $1 million of our projected savings and expect the balance will take place within the first half. We also expect to see the benefits to working capital by accelerating our invoicing and reducing inventory levels in the field. The timing of the system deployment appears to be ideal as activities are increasing, manpower increases -- manpower requirements are increasing and we can leverage the new system to move effectively to respond to the market. Our capital expenditures for 2017 are projected to be $25 million to $30 million with maintenance capital expenditures between $16 million to $18 million of the $25 million to $30 million previously mentioned. Our coverage ratio in the quarter was very strong at 1.56 times providing us capacity to fund some of the growth capital. With the completion of the system and its previous CapEx requirements, the cost savings coming from the system, better pricing, improved utilization, ramp-up of equipment sales, we believe we have line of sight to better earnings and a good coverage ratio that will support funding growth capital to keep improved earnings and distributable cash flow. Acting as President over the past several months, I have been extremely engaged working with the leadership team. We’ve accelerated growth opportunities and remain very focused on growing all of our businesses, large horsepower, medium, small, domestic, international, equipment sales and aftermarket. The team has performed extremely well during this period, completing the previously mentioned successful deployment of the ERP system and now aggressively responding to the opportunities associated with the improving marketplace. I remain extremely confident in our ability with this team to continue to deliver increasing results. With that, I’ll turn it over to Elijio and then we’ll open up for questions.

[Elijio Serrano:]

Thank you, Steve. Good morning, everybody. Third quarter revenue decreased sequentially by 4.9% due to the timing of large new equipment sales. Compression services revenue of $51.7 million increased sequentially by 2.8% reflecting the utilization from equipment previously idle that has been deployed, in addition to the initial impact from better pricing. Compression services margins of 45.1% improved 240 basis points from the second quarter. Total compression services fuel costs declined by 1.6%. We have been incurring significant make ready costs to prepare for deployment equipment that was previously idle. The vast majority of our larger equipment is now deployed and make ready cost going forward are expected to be minimum. In addition, we had a significant amount of internal resources focused on completing and deploying our new ERP system. They are now dedicated and focused on operations adding incremental management support to an expanding business. Aftermarket services revenue of $9.5 million decreased sequentially by 10% and equipment sales of $10.4 million decreased sequentially by 28%, both on timing of significant projects. Aftermarket services margins of 18.8% were down sequentially by 80 basis points and equipment sales margins of 9.5% improved 120 basis points. During the second quarter, we recorded a non-cash fair value adjustment to the Series A Preferred convertibles that improved earnings by $1.3 million. We’ve excluded this from adjusted EBITDA. In the second quarter, this non-cash fair value adjustment to the Series A Preferred was $5.5 million, also favorable. Also during the quarter, we received $3 million of insurance proceeds for equipment damaged in prior quarters. Offsetting some of this gain from the insurance proceeds with the premium from our insurance coverage, the deductible in the policy and the loss margin on these assets, which combined total approximately $1.5 million on an annualized basis. During the quarter, we also incurred $583,000 of expenses to deploy our new system, mainly training related cost that reduced EBITDA in the quarter. These are not expected to repeat into the coming quarters. Maintenance capital expenditures were $3.8 million in the third quarter compared to $5.7 million in the second quarter. The decline, as Steve mentioned, reflects our catch-up of maintenance on equipment that was previously idle. As most of our large and medium horsepower equipment is now back in service, we expect make-ready cost to come down significantly and maintenance capital expenditures to return to the historical rate of $3 million to $4 million per quarter. Adjusted EBITDA for the third quarter was $23.3 million. We expect fourth quarter adjusted EBITDA to be sequentially better than the third quarter when excluding the $3 million favorable impact from the insurance settlement. Distributable cash flow was $10.8 million, a sequential increase of $5 million or 87%. This resulted in a coverage ratio of 1.56 times. Free cash flow, defined as cash flow from operations less all capital expenditures, was $11 million, up from $5.3 million in the second quarter and is 15.3% of revenue. The leverage ratio at the end of September was 6.33 times, safely within the covenant of 6.75. Net debt declined by $5.3 million from $504.7 million at the end of June to $499.4 million at the end of September reflecting the strong free cash flow generation. On October 20, 2017, CSI Compressco announced that the Board of Directors of its general partner declared a cash distribution attributable to the third quarter of 2017 of $0.1875 per share outstanding, which will be paid on November 14, 2017 to common unitholders of record as of the close of business on November 1, 2017. We are very pleased with the quarter, given the positive momentum on utilization, pricing and new equipment orders. We are ramping up manufacturing without the need for CapEx and with only a minor requirement of incremental working capital to meet the strong equipment backlog. We’re also ramping up after-market services, which does not require capital investment. Our compression services fuel cost declined 1.6% when revenue increased 2.8%, demonstrating the leverage available to us as volume [indiscernible] significant benefits from better pricing. Our new ERP system, which we believe to be best-in-class can be leveraged to manage costs in a recovering market and provide our mangers with better tools to make faster and smarter decisions. With that, we’ll open up the call for questions.

[Operator:]

[Operator Instructions] Today’s first question comes from Praveen Narra of Raymond James. Please go ahead.

[Praveen Narra:]

When we think about -- certainly orders came in well above expectations at least on our end. Can you talk about how you expect to realize that, over what kind of timeframe and then can you talk about how many inquiries are still outstanding or what the call volume is kind of like?

[Stuart Brightman:]

Yes. Specifically related to the equipment sales metrics that we talked about, the flow of inquiries continues to be very strong. That backlog will start executing a portion of it that we had from earlier this year during December and we should begin to see it ramp up sequentially as we go to ‘18 and I think the revenue element will pick up second quarter and beyond as we start to deliver major components of that backlog. As I said, the sales pipeline for that continues to be strong, the activity for the compression services continues to be strong. We are very, very focused on our new capital for the fleet to make certain it’s tied to specific customers at specific price points, as I referenced, increasing price points. So when the teams bring in the capital requests through to Elijio and I, we’re going through that level of detail. And that’s the basis that we’ve increased the capital commitments going forward.

[Praveen Narra:]

When we think about those price increases, that’s across all horsepower I assume, each subset is getting price increases.

[Stuart Brightman:]

It is and I would give you a bit more color, as you would expect it’s kind of correlated to where we have the highest utilization such as the areas where we’ve seen the most price effectiveness, it would be on the largest, and then kind of come down through to zero to 100. But we are starting to see indications even in the smaller horsepower of that. But again, we still have a long way to go on that smaller range before we have a respectable utilization. The other two classes one over 90, the other one going up in magnitude, we feel very comfortable with.

[Praveen Narra:]

Okay. And then one more from me just on the ERP systems, Stu, I think you mentioned $1 million, was that $1 million realized in the quarter or was that kind of an annualized run rate or..

[Stuart Brightman:]

Yes that’s an annualized run rate. We started to realize the benefit of some back-office synergy, we’ve started to realize the benefit of moving off to legacy system and having some of that support associated with that no longer needed. And I’ll tell you Elijio may want to expand it. The leadership team of CSI Compressco at our recent Board meetings did a great job laying out to the Board the opportunity set associated with not just the cost but to be more important, the enhanced functionality, the line of sight visibility that our operations managers have to planning out the preventive maintenance, scheduling that, moving people around, visibility of the field inventory, measuring the time sequences on the maintenance is very, very much real-time. And I’m confident will drive down the fuel cost associated with that.

[Operator:]

And our next question comes from Andrew Burd of JP Morgan.

[Unidentified Analyst:]

This is Bill on for Andy. In the press release, you mentioned gas lift is starting to improve. What are some of the factors driving that now as opposed to, say, six months ago?

[Stuart Brightman:]

I think in the areas we’re seeing it, we referenced in the SCCOP/STACK in the Midcon, there’s a lot of activity and it’s just a way to help them with the initial oil production. So that area down the Panhandle has been very solid for us.

[Unidentified Analyst:]

And then it seems like the larger horsepower equipment, it’s very nice to utilize that over 90%. At what point do you need to build new equipment to satisfy incremental orders as opposed to utilizing idle equipment?

[Stuart Brightman:]

We’ve already started reinvesting, I mean, we’re at a stage where we kind of have two variables going on, the ability to use idle equipment is much less, so we have placed capital commitments to deal with that and then the reactivation cost associated with those idle assets is decreasing as they become unavailable. As I said on the prior question, we’re very, very focused on the customers, the region, the price points for those areas where we want to make certain we’re responding aggressively to the market activities.

[Unidentified Analyst:]

And then just one last one. It seems like the steady trickle of free pruning continued this quarter, are these asset sales mostly idle equipment or are they equipment that was in service just prior to being sold.

[Elijio Serrano:]

That majority of it was equipment that was idle.

[Operator:]

Next question comes from Stephen Gengaro, Loop Capital.

[Stephen Gengaro:]

Two things, if you don’t mind. The first is when I kind of do a quick calculation to kind of revenue, rental revenue per horsepower that’s being utilized. It flattish sequentially but I imagine that’s because of the utilization uptick of the smaller units. Is that fair?

[Elijio Serrano:]

Yes. Stephen, the large equipment has a lower poor horsepower dollar value but more concentrated at the job site. So as we deploy more larger equipment, the average of the fleet is going TO come down. But if you were to look at the individual segments, which you don’t have access to, for example, 800 and above, 100, 300 and under 100, you will see all of them are moving up.

[Stephen Gengaro:]

And then as you think about that impact to gross margin line, how should we think about that as we kind of roll forward here?

[Elijio Serrano:]

So I think that the price increases are going to start benefiting us, improve gross margins, I believe that the system savings will start benefiting us. I believe that as we add incremental horsepower to the field, we’re not going to have to add a corresponding number of technicians and mechanics to support the fleet, there’s going to be a opportunity to leverage the infrastructure network of resources that we have out there. Those three will be partially offset by some labor inflation that we’re already seeing given the demand for mechanics and technicians in the field. The sum of all that is the reason we see improving margins into the future.

[Stephen Gengaro:]

Just two other quick ones on the sales side, I know you mentioned some of the orders, and you mentioned kind of what looks like a pretty positive outlook going forward as you deliver. I think Steve mentioned kind of a second quarterish revenue pick-up from that as far as deliveries. Is that when you’ll start to see some of the higher price impact from the recent orders or will it be later than that on the equipment sales side?

[Elijio Serrano:]

The equipment there we’re delivering, for example, in the fourth quarter are orders that were received in Q1 and Q2 of this year. The orders that came across in the third quarter will be delivered in Q1 and Q2 of next year. And Q1 and Q2 of next year will reflect those margins.

[Stephen Gengaro:]

Thanks and then just 1 final one. As we think about the progression here, I mean it seems like the consensus is looking for EBITDA levels of kind of in the mid 90s next year, but it sounds like your commentary maybe a little more optimistic than that, am I reading that wrong?

[Elijio Serrano:]

So we want to refrain from providing guidance beyond maybe a quarter and we indicated that the immediate quarter we think we’ll see a sequential improvement over the $23.3 million that we reported when you exclude the $3 million of [interest]. But right now, we’re seeing a lot of positive indicators with utilization up, pricing coming up, system benefits working in our favor. We are very optimistic about next year.

[Operator:]

And our next question comes from Selman Akyol of Stifel.

[Selman Akyol:]

Congratulations on a very nice quarter. You went through sort of this increasing price points, I know you did by horsepower, but could you put that to [basis] by any chance?.

[Stuart Brightman:]

I don’t want to try to quantify it. I think the message is we’re slowly starting to see opportunities with -- the most impactful in the short term being on the largest. Secondly, as I referenced earlier, we’re very focused on new capital demands being very black and white internally of what those returns look like and what those commitments look like and we’re progressing nicely. We think that will continue, we still think third quarter was the beginning of kind of that evidence that we’re starting to get that average up across that larger range.

[Selman Akyol:]

Got you. And then next question, you guys talked a little bit about Latin America but can you just expand on that?

[Stuart Brightman:]

For us, our two biggest footprints in Latin America have been Mexico, LatAm [ph] and Argentina and there’s some opportunities we’re seeing in Mexico, just to refresh, TETRA has been in Mexico for over 20 years. Compressco was in Mexico after the acquisition back in time when that came through the TETRA Group and CSI has had a capability down there historically on the larger horsepower. So kind of looking at that overall opportunity set that we have with the expanded compression asset fleet combined with our local management and some opportunities with the end users, we think we see opportunities there. Argentina, we’ve been in there a little bit shorter period, probably 5 plus years in leveraging the TETRA opportunity set down there. We’re finding opportunities to continue to grow the GasJack. We are finding opportunities to leverage the higher horsepower CSI down there and I would add probably equally importantly, we’re finding an environment where it’s much easier to repatriate the cash, so we now think the risk return down there is very, very healthy. So I think that’s an area you’ll see us continue to grow very profitably.

[Selman Akyol:]

And then are you guys having any trouble hiring people or seeing just wage pressures pick up?

[Stuart Brightman:]

We’re certainly dealing with the same labor challenges both in terms of recruiting retention and underlying wage rates predominantly in areas like the Permian both at the field level because that’s where a lot of the new horsepower is being deployed. And at the fabrication facility in Midland, given the ramp up of the inbound orders have been three times what they were, the average of the three quarters, we’ve got a pretty good hockey stick that our manufacturing folks are having to deal with. So we’re working through that. There’s a lot of focus. Our HR and ops guys are working very closely, will deal with the labor rates as appropriate. But I think we’re facing similar challenges to a lot of the folks we compete with out there.

[Operator:]

And our next question comes from Mike Gyure of Janney. Please go ahead.

[Mike Gyure:]

I was wondering if you could touch a little bit for the backlog of the equipment orders, what are you seeing as far as you being able to source the components and the working capital requirements associated with building backlog, if you are seeing any constraints there?

[Stuart Brightman:]

Michael, let me first address the working capital requirements, when we receive orders to build and sell new equipment, we do progressive billing to the customer upon receipt of an order, we require certain amount of payment to be made to cover the cost of the compressor and the engines as we order them, as we’re building and adding components such as the kit and other components. We’re also progressively billing the client, so that by the time the equipment is ready to ship, we have pretty much recovered all our cost and the only thing waiting to be invoiced is the margin. So it’s pretty much working capital neutral, which is one of the benefits of having a manufacturing operation facility to sell to third party in addition to simply also absorbing overhead when we’re building for our own fleet. Right now, we’re seeing turnaround times start to get pushed up a bit as everyone is seeing with the delay in receiving engines and compressors due to the strong demand of the market, lot of turnaround time in maintaining work from five to eight months in the process.

[Operator:]

And our next question comes from TJ Schultz of RBC. Please go ahead.

[TJ Schultz:]

Just one question from me, early on the distribution you’re not getting credit for the payout in the market given your yields, so what’s your view on letting the fundamentals just play out, which are clearly improving and then trying to get more credit or is there any view of cutting further on the distribution if you think just delevering quicker would be more beneficial?

[Stuart Brightman:]

Yes, as you saw we maintained the distribution at the previous rate, we announced that several weeks ago, and as always we have the Board dialog associated with all the variables of strength of the balance sheet, outlook, forecast, growth capital, yield on the stock. We every quarter kind of do that fresh based on our view of where we are in the cycle and, obviously, we felt it appropriate to leave it flat. And as we look forward, we’ll go through the same process every quarter. I don’t think there is a clear view of what that looks like as we go forward. I don’t think I want to kind of get ahead of myself, we’re focused on the fundamentals of the business, of growing the earnings and funding it and then having the flexibility to discuss the various levers we have. But I would stay lock step on the fundamentals of the business because that’s where the value creation will come from.

[Elijio Serrano:]

And TJ, I’ll add that the distribution that we’re paying out on a quarterly basis is not a significant number at $7 million a quarter.

[Operator:]

And this concludes our question-answer session. I’d like to turn the conference back over to the management team for any final remarks.

[Stuart Brightman:]

Thank you very much. And as always, we appreciate the continued interest in CSI Compressco. Thank you for taking the time to join us and looking forward to the year-end update in February. Thanks again.

[Operator:]

And thank you, sir. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.