CSI Compressco LP
Q4 2017 Earnings Call Transcript

Published: 27 Feb 2018

[Operator:]

Good day and welcome to the CSI Compressco LP Fourth Quarter and Full Year 2017 Results Conference Call and Webcast. 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 will now like to turn the conference over to Stuart M. Brightman, TETRA Technologies' CEO and CSI Compressco's Chairman of the Board of. Mr. Brightman, the floor is yours, sir.

[Stuart Brightman:]

Thank you, Mike, and good morning and thanks everyone for joining the CSI Compressco fourth 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 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 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 posted on our website, our Form 10-Q is planned to be filed with the SEC over the next several days. Again, thank you for joining us this morning. We do appreciate your interest in CSI Compressco. First, I'd like to formally introduce Owen Serjeant. Owen has joining us today on the call. Owen joined in November as President of CSI Compressco. I had taken that role for several months. I am very pleased to hand that over to Owen. Prior to that, he was spent about 35 years with Cameron and Cooper Energy Services. With Cameron he spent, a portion of that time running the global subsea and a series of operations engineering and marketing and sales positions. In addition, he was involved in the compression business for the most of the times with the Company. He has degree of Mechanical Engineer with an MBA. He brings a tremendous depth of knowledge of both compression and within the energy service industry with the proven track record of executing at the operating level. Strong knowledge of manufacturing and engineering, solid customer relationships and very strong people skills. He is a strong addition to the team and very timely as we go through this growth market to be able to focus on profitable growth, improved returns on the capital in going forward. I would also add, as you see in our comments today with the increasing activity both for our equipment sales and demand for our compression services, the ability to manage the up cycle both from a fabrication and an outsourcing is a tremendously important asset that Owen brings. When we reconvene in May and go over the results of the first quarter, Owen and Elijio will take the lead on calls. Obviously, I will continue to extremely engage with CSI Compressco in my role as CEO of TETRA as well as Chairman of the Board of CSI Compressco. First, I will start with an overview of our performance then turn the call over to Elijio Serrano, our Chief Financial Officer for both CSI Compressco and TETRA, who will go through the more detailed financial information. During the fourth quarter, we continued to see a market improvement in activity. As the rig count completions activity continued to increase, our customers were dealing with significantly higher volumes of associated gas from the shale play drilling and completion programs. The gas to oil ratio in major oil shale plays continues to change gas needs get to market would be re-injected through production, both of which continued to increase the demand for compression equipment and services. Additionally, during the downturn operators and midstream players rationalized their compression equipment saved cost and eliminated or returned excess compression horsepower. Operators historically have kept some amount of excess horsepower capacity to handle increase volumes as additional wells were brought online. However to reduce cost and manage through the downturn, excess horse powered equipment will return to service providers such as ourselves. With the rig count holding firm over 900 rigs in the U.S. and the high oil to gas ratios, they're experiencing they are cut short of compression in horsepower to handle the volumes. As a result, we and the industry have seen a very strong demand for large horsepower of our gathering systems. We are now operating at over 92% utilization for our large horsepower flee that is focused on the gathering systems. We deployed an incremental 13,667 horsepower during the quarter increasing amount of deployment to over 900,000 horsepower. Compared to the end of 2016 we have put back to work over 49,000 horsepower that was previously idle. None of that was growth investment, all redeployment of idle horsepower. Overall utilization for the fleet is 83.2% up from 81.4% at the end of the third quarter and up from 76.4% at the end of the last year. The vast majority of the increase in the strongest request we are getting at for South and the West Texas, Southeast and New Mexico and Oklahoma. All of which have traditionally been our strongest areas with the greatest concentration of customers and equipment. Our current customer base where we are the provider of their compression equipment is where the demand is coming from as they focus on infill drilling. We are also seeing demand for equipment for the Delaware Basin where the infrastructure is not as matured as the Permian. Our customers are making payments to us for equipment to be delivered as far out as EMEA. We are out of capacity as all our large equipment that was previously idled has been deployed. We currently have on order over 57,000 horsepower of large equipment to be deployed in the second and third quarters of this year with commitments for all of this coming from existing customers. The latest trend we are experiencing is the move towards centralized gas lift. The volumes of gas being produced are presenting a challenge to electric submersible pumps. Operators are moving more towards surface gas lift. Historically, this has been one smaller compressor per well, but with the move towards pad drilling and wells been drilled in closer proximity many operators are moving towards centralized gas lift to a larger unit is connected to multiple wells to enhance production. This is causing greater demand for our equipment in the 400 to 1400 horsepower range. To deal with this opportunity, we're now bringing equipment that had been idled to slightly longer periods of times and are catching up maintenance to deploy this equipment. We are also ordering equipment to build and deploy additional capacity into our fleet, and we are aggressively pushing pricing. Pricing and improved returns are our priority at CSI Compressco and it is an initiative that Owen and team are driving. We have solid and proven track record of delivering exceptional levels of service, being very responsive to our customers and now we are being property compensated for this especially as we begin ordering equipment to expand our fleet. Every new capital request is reviewed by customer price levels and profitability to meet these objectives. The timing of this rebound is very fortuitous for us. As previously noted, in August of 2017, we deployed our new ERP system that connects real-time all our field mechanics to our system, provides visibility to all their activities, proactively schedules maintenance and allows us to closely monitor their activities in the work schedules. Additionally, the customer relationship modules of this system gives us sale and management team full visibility to the status of all of our equipment and when contracts are scheduled to end, we can make pricing decisions or decisions on when that equipment can be moved on a real-time basis in advance. As volumes increase and the demand for more field mechanics and technicians increased, our system will represent a competitive advantage that we expect to result in improving margins. Some of these features existed in our legacy ERP systems, but our processes now real time at the field level and are significantly more streamlined. As we noted previously, this project is anticipated to generate over $4 million in savings equally important to me is it allows us to have more efficiency at the field level, as we go through a growth period and the challenges of attracting labor. We also have accelerated the maintenance and make ready process to prepare the mid-range in the gas state even to meet increasing demand. This group of our assets have been last to experience an increasing demand but is gradually coming around. Elijio will talk to the impact of that in fourth quarter results in compression services margins and maintenance CapEx. The demand for deploying additional equipment is also extending in the aftermarket services. We are adding resource to handle increasing volumes of activity with customers, as they also add more equipment to their own fleet and also catch up maintenance for equipment previously idle. Aftermarket services revenue was up 4% sequentially and up 41% from the fourth quarter of last year. This business is typically in and out business, but we have been able to build the backlog as the activity has picked up. Part sales were also seeing increased volumes as our customers rebuild spare parts inventory levels, Revenue from part sales were up 28% sequentially. Again, our new ERP system allows us to handle this more efficiently and give more visibility to our customers. During the fourth quarter, we received orders to fabricate and sell 16 million of equipment when combined with the 37 million of orders we received in the third quarter. This second half run rate was very strong. Nevertheless, the total orders of 53 million that we received in the second half of 2017 was surpassed when we recently received in January a $67 million order to absorb a large compression to an operator in the Permian Basin. This order was the largest in the history of our company increases our backlog at the end of January to approximately $114 million. This new order will be delivered in the second half of 2018 and during the first half of 2019. This further evidence of the industry is preparing to build out, gas processing plants gathering systems to handle to associated gas that is coming from the over 1,000 wells that are being completed each month. With that, I will turn it over to Elijio to provide some financial details and then we will open it up to questions.

[Elijio Serrano:]

Thank you, Stu. Fourth quarter revenue increased sequentially by 16% as revenue from newly equipment sales doubled in the third to the fourth quarter reflecting the timing of shipments. Compression services revenue increased by 3.3% sequentially. After market sales increased by 4.4% and parts sales increased by 28%, all reflecting the rebounded activity that Stu mentioned earlier. Stu mentioned that in addition to the $53 million of new equipment order that we received in the second half of last year. Early in January, we secured a $67 million contract to fabricate and sell 45 large compressors to a midstream operator in the Permian Basin. This order is the largest in the Company’s history and points towards incremental profits coming from the sale of new equipment in the second of this year and then into the first half of next year. The long lead commitments from the customer also points towards the confidence from the industry to meet long-term investments to handle the higher gas volumes especially n the Southwestern part of the United States. Gross profit increased 6.3% from $26.1 million in the third quarter, $27.8 million in the fourth quarter driven by the higher new equipment and part sales. Adjusted EBITDA of $21 million was 25.3% of revenue. This compares to $23.3 million of adjusted EBITDA in the third quarter. As a reminder, the third quarter included a non-recurring gain of $3 million from insurance proceeds. Normalizing for this item, adjusted EBITDA was up 3.3% from the third through the fourth quarter. During the fourth quarter we recorded a non-cash fair value adjustment to the Series A preferred convertible that reduced earnings by $1.6 million, we’ve excluded this from adjusted EBITDA. In the third quarter this non-cash fair value adjustment to the Series A preferred unit was $1.3 million favorable. Given the increased strength in the market we accelerated work on preparing and catching up maintenance on the equipment that have been idle for longer periods of time. As a result, maintenance CapEx increased from $3.8 million in the third quarter to $6.9 million in the fourth quarter. Approximately half of the maintenance capital expenditure in the fourth quarter was for equipment already deployed and working in the field going through normal and traditional periodic maintenance that is capitalized. And the other half was reaching into the fleet of the equipment had been idle for a longer period of time to catch up maintenance and prepare to deploy the equipment in the coming weeks given the strong demand we're seeing from our customers. Distributable cash flow was $5.4 million in the fourth quarter versus $10.8 million in the third quarter with the decline reflecting the one-off third quarter insurance proceeds and the higher maintenance capital expenditures that represented investment to participating the up cycle. The coverage ratio in the third quarter of 1.56 times and in the fourth quarter was 0.73 times. We believe both are at opposite against of what we expect going forward. On January 22nd of this year, CSI Compressco announced that the Board of Directors and its general partner declared a cash distribution attributable to the fourth quarter of 2017 of $0.1875 per common unit outstanding. This was paid on February 14 company unitholders of record, as of record of business on February 1, 2018. Projected 2018 capital expenditures are expected to be between $55 million and $75 million. Maintenance capital expenditures are expected to be between $15 million and $20 million. We expect to fund these capital expenditures through our combination of internally generated cash flow as well as borrowings under our credit facility, which we expect to either extend or replace in 2018. Accessing the debt market with covenant friendly structures may also be utilized depending on marketing conditions. We believe our combination of this sources should position us to invest growth capital to take advantage of the recovery occurred in the multiple areas of our operations. Now better utilization of our existing equipment improved pricing, growth in fabrication backlog on top of the increasing volumes from aftermarket services and part sales in addition to the benefit of the recently installed ERP system makes us comfortable that improved earnings are forthcoming. Returns on capital are also improving, giving us the confidence to move towards the lighter covenant capital structure to fund growth. With that, we will open it up to questions.

[Operator:]

Thank you, sir. We will now begin the question-and-answer-session. [Operator Instructions] The first question we have will come from Andrew Burd of JP Morgan. Please go ahead.

[Andrew Burd:]

First question around the fabrication business clearly picking up nicely, so two questions around that. The first is, what type of gross margin should we be assuming for the backlog? And then second is, just more of a big picture corporate strategy question about the fabrication business and how it fits into the long term strategy for CCLP?

[Owen Serjeant:]

Andy, historically, we've seen margins from the fabrication and the equipment to be the mid-teens range in the 12% to 18% range. At the value the market, they came down into the mid-single digit. We see them moving into the high-single digits, low-double digits this year, and into the coming periods moving slightly toward historical margin ranges. And then your second question about fabrication.

[Stuart Brightman:]

Yes, let me take that one. We view this fabrication is having a couple of benefits to us. One is as we get the margins into the double digits we think it's an attractive return given that we have progress billings on that work. So we’re working capital positive through the full project. In fact, part of the benefit of the large project we have is at positive cash flow over the next couple of quarters, will also be part of that funding of the growth capital. In addition to that, as you start to see us grow the fleet, having that internal capability is important to us. And I would also add as we build through the backlog, increase on the equipment sale as well as building out our fleet for the growing compression services market, the team with Owen’s leadership are expanding our subcontract capabilities. So we are going to have a combined supply chain capability of internal as well as outsourced. And I suspect our outsource capability will be higher than we had in prior times. So I think that’s another strategic area for us to participate in the growth and not be constrained by the supply side.

[Andrew Burd:]

That’s great. Thanks, Stu. And moving on to gas checkout, which I think you've noted was certainly improving in the press release in the Delaware and the Rockies. Can you talk a little bit more about the opportunity on the really small side? And how much of the expected recovery in those basins depends on the recent move in commodity prices and sustaining that?

[Stuart Brightman:]

Yes, I think it continues to be a big focus of ours to kind of get that small horsepower utilization up in the mid 60s back to it some of the higher levels, and I think it’s a big focus to both the operations and service. Clearly, the natural gas side pricing will help us. Enhanced focus will help us. We are getting gas checks ready for redeployment, part of our margin profile as well as maintenance CapEx in the fourth quarter tied to that. We also -- we also talk about gas check, don’t want to get the VJack because that plays into the liquid side. So that’s part of what we’ve been able to focus on as well. So the message from all on to the team is the large horsepower that 92% we’re deploying growth capital to grow that. To meet our objectives we need to react to the underutilized fleet and we are very cognizant of that.

[Andrew Burd:]

And then final question is just a housekeeping one. At the time of the CSI acquisition I think there was some expectation that CCLP would one day be a tax payer just given some of the non-clubbed smaller amount qualifying businesses like international fabrication. Can you just update us on the tax yields since it's been OpEx?

[Elijio Serrano:]

Yes Andy good question. Internationally, we pay taxes in the countries we operate such as Argentina and Mexico, and those are the cash taxes that you see reflect in the financial statements. In the United States, when we did the acquisition, we fragmented a majority of the purchase price of the CSI assets to the assets for tax purposes, and we are taking that depreciation that offset any profit coming over from items such as equipment sales, new or used, aftermarket sales or part sale. We don't expect that in the near future we're going to be paying in U.S. income taxes from those non-qualifying income streams.

[Operator:]

Next, we will have Mike Gyure with Janney.

[Mike Gyure:]

Could you talk a little bit more on the projected capital expenditure sort of 55 million to 75 million range? It seemed most of that is large equipment and I guess how should we think about how much horsepower you could potentially add to the fleet?

[Stuart Brightman:]

Yes, I think as we delineated the range, we split it out between growth and maintenance. And again, I think the maintenance is probably going to be more first half for the year low to given we're still deploying idle assets. And so, I think for the modeling point of view, you'll see that. The gross capital is very much focused on existing companies, existing geographies predominantly out of the Permian Delaware and with specific customers at specific price levels. So, when the capital request come through, it's very easy to make those determinations. So it's very risk free investment at point of decision. We think that's going to aggregate to somewhere in the 40 to 55 horsepower. And we also have on an ongoing basis additional opportunities you guys looking at that will be evaluating as well. I feel very confident when that equipment is deployed over the course of the next several quarters, it goes to work immediately and generates the kind of returns that folks would anticipate. So, we feel very good about that. And Owen and the team are focused on those opportunities and leaving to Elijio and I to figure out additional sources of funding for that growth capital.

[Operator:]

The next question we have will come from Selman Akyol of Stifel.

[Selman Akyol:]

Can you expand on your comments on pricing power out there what's you're seeing hoping to get et cetera?

[Stuart Brightman:]

Yes, I mean I'd say over -- for the fourth quarter, we've seen very favorable trends in pricing and that's continued through the first half of the current quarter, and we kind a look at it from two elements. There's agreements that come up for renewal, a lot of our agreements for 12 months, so the sales team is very focused that looking at which ones are rolling, who the customer is, what the utilization of that equipment is, what the alternative set it, who's going to be busy going forward, what's our confidence level to keep that in place multiple years and making those pricing decisions? Every week, the team is looking at what that outcome is and what that's going to be? And that is certainly been a set a scoreboard, scorecard that's been very favorable internally the last several months and accelerating. Separate from that when there is growth capital is being approved, the same process goes through, as the customer with the price point how that compares to what's in place last transaction et cetera and that's trending up. So we feel very good that some of the rapid pricing deterioration we saw in the down cycle is getting reverse quickly as we move through a tighter market out there with everybody's utilization of the large equipment in the 90s. And it's a very visible metric that as I said we're looking at every week.

[Owen Serjeant:]

And Selmon, I'll also add that during the downturn a lot of our customers who are not shy customers to adjust pricing down in the middle of one or two year contract. And now that the market is bounding very strongly and the industry is short of horsepower we're also increasing customers in the middle of agreement and asking them to adjust pricing just like we did a forward adjustment during the downturn.

[Selman Akyol:]

Got it, I appreciate. And is there any way to say 0% to 5%, 5% to 10% anything any color there?

[Stuart Brightman:]

Yes, I don’t want to get into a specific interval, but it stats and aggregates pretty good. I'd say it starts to go both the topper end -- higher end of that range than the bottom as we go into the next few quarters.

[Selman Akyol:]

You guys talked about your starting pull equipments from inventory refurbishing. Can you just say, how much you’ve had or how much additional horsepower you could still from that?

[Elijio Serrano:]

Yes we still believe that we’ve got somewhere in the 30,000 to 40,000 horsepower range of the traditional equipment and for traditional anything over 100 to 1,000 horsepower. And that excludes for example the GasJack fleet that is marched into a different cadence. That we’re working on getting ready to taking that into the market.

[Selman Akyol:]

And then just kind of going back to the GasJacks and you said you are seeing more deployment there. Is there any lengthening to the contract at all or there’s just typically about a year still?

[Stuart Brightman:]

In general, we are still -- most we've stayed at 12 months, as the market continues to revolve, there may be some opportunities. But right now, we are focused on getting the highest return with the biggest customers where we have existing footprint for 12 months.

[Selman Akyol:]

And then the last question from me. Are you guys seeing in inflationary pressures out there?

[Stuart Brightman:]

The primitive, the large -- the overall fighting is the labor out in West Texas where certainly like everybody in this space normally feel service dealing with higher turnover than typical, and right now we’re doing everything we can to move folks around, bring folks from other areas, deal with it as we meant to. And it’s certainly higher than it was a year ago but that’s also baked into our pricing philosophy as well. So I think we are going to use pricing to cover those types of pressures, but labor is certainly an area that we are seeing pressure on.

[Selman Akyol:]

Okay and I am sorry, if I can just follow up on that anything on transportation at all?

[Stuart Brightman:]

Nothing significant, they are top in other verticals on transportation, but to-date that hasn’t been a factor.

[Operator:]

[Operator Instructions] Next, we have Luca Manera of Mirabaud.

[Luca Manera:]

In terms of your capital structure for the year and refinancing your bank debt, I was just wondering if you could give a little bit more color on how you foresee the covenant structure moving forward and probably the mix between secured insurance or secured debt or any other form of capital integrative?

[Elijio Serrano:]

We are constantly checking the capital markets and debt markets to see what options and alternative are available to us. In the recent month, the debt markets have been very attractive. I think opportunities for us to refinance are revolver and if you probably aware, revolver matures August of next year. And this year, we will work on renewing that. So I would say that today we continue to evaluate all options opportunities where we want to extend the existing revolver or whether we want to go towards something that is more covenant friendly. So, that was the excess capacity and as we progress with our decision, we'll communicate to the market that direction we're going.

[Owen Serjeant:]

Yes, I am going to add to that, we do think those markets have become more available recently and that we do have -- we will have a range of options. So, as I said earlier, the operating team is focused on growing the business, finding the highest return opportunities then Elijio and I are charged with making sure that we got the proper capital structure balance sheet to support that. And obviously, for us to make some of the comments on the growth that we see in front of us, we feel good about that opportunities set on the financing.

[Elijio Serrano:]

Very interesting, over the last four years, the business model that we have has been tested in the period for oil was at $100 and then oil dropped all the way down to $26 to $27. As the value of that market, our EBITDA bottomed out at the mid-$80 million range, more than sufficient to cover the interest expense of about $33 million $34 million, more than sufficient to cover the related maintenance capital and the limited amount of cash taxes. All those cash obligations were in the low-50s when EBITDA bottomed out in the mid-$80 million range. Then as part of our bank facility, we provide twice a year a value of the assets. And the value of those assets has significantly exceeded the total debt outstanding of $525 million and also exceeded the value of that plus the here we say units out there that leaves the significant amount of equity value out there. So I think our lenders and I think the management team has gotten very comfortable that the business model that we have holds firm, the asset value holds firm. The earnings cash stream holds firm. So, there we now make decisions as to how to structure the balance sheet into the future, our lenders and potential lenders get comfortable that we stress that model and it holds quite firm.

[Luca Manera:]

And in terms of appropriate leverage and question between secured debt and unsecured debt, do you have a long term view of where you should well ASP and also can you just talk a little bit about M&A? I think there was a bigger transaction this year. And what are the opportunities out? Is there any appetite that you're just focusing on organic growth as well?

[Elijio Serrano:]

So, the question about secured versus unsecured. Clearly, the amount of pricing associated with that will come into play. The requirements for any type of covenants will come into play. And as we get ready to look at our balance sheet on a go forward basis, we'll look at all of those the decrement -- the mix that we want. At this point, we don't have any fit internal parameters at that we're working towards. Then with respect to M&A, clearly to-date, the best opportunities are available to us or with an existing customer base and existing basins. So at that point we can in that equipment and leverage our network of mechanics, technician support facility that we think those returned to an incremental margins will be stronger than what we've seen in the recent history. Now at the same time, if we believe that there is opportunity out there to expand our footprint and leverage not only our infrastructure but also our ERP system, we will clearly take a look at those. So for the immediate future, we think the opportunities are to grow with our existing customers and the existing field, leveraging the network and resources that we have what's we believe to be dominant position in the Permian Basin, Delaware Basin and South Texas, Mid Cont markets.

[Operator:]

So, no further at this time and this will conclude our question-and-answer session. I would now like to turn the conference call back over to Mr. Stuart Brightman, TETRA Technologies’ CEO and CSI Compressco’s Chairman of the Board for the closing remarks, sir?

[Stuart Brightman:]

Thank you, Mike, and great questions. I appreciate all the tough questions, the positive questions. And I’ll leave the audience with a couple of summary comments. I mean clearly all the market indicators for all of our pieces of this business are trending up. Our utilization and pricing on compression services, the ERP system that continued to drive down costs, backlog in equipment sales, backlog in after market, all positive. I think Elijio did a good job of articulating some of the financing options that are out there and hopefully leaves investment side with feeling comfortable that we will be able to access that, participate in the growth, the brand name is great , the leadership with Owen is strong. And we are extremely confident that we are going to grow this year and we continue to grow. And we look forward to update the group on first quarter in May and we will let Owen take the lead in going through that. So, thank you very much.

[Operator:]

And we thank you sir and to the rest of the management team for your time also today. The conference call is now concluded. At this time, you may disconnect your lines. We thank you again everyone for joining. Take care and have a great day.