CSI Compressco LP
Q1 2016 Earnings Call Transcript

Published: 6 May 2016

[Operator:]

Welcome to the CSI Compressco LP First Quarter 2016 Results Conference Call. The speakers for today’s call are Tim Knox, President and Director of CSI Compressco GP; and Elijio Serrano, Chief Financial Officer for both CCGP and TETRA Technologies Inc., who owns the general partner. 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 Tim Knox. Please go ahead.

[Tim Knox:]

Good morning and thank you for joining the CSI Compressco First quarter 2016 results conference call. I’d 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 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 has posted on our website, our Form 10-Q is planned to be filed with the SEC on or before May 10, 2016. Again, thank you for joining us. We do appreciate your interest in CSI Compressco. I want to start by sharing with some of the results and key financial indicators that we use to measure our business. I’ll discuss changes to our fleet and fleet utilization, equipment sales and backlog, the overall performance of the business and our outlook as we continue in the challenging environment of 2016 and then I’ll turn the call over to Elijio Serrano, Chief Financial Officer of CSI Compressco and also Chief Financial Officer for TETRA Technologies, who owns a general partner to cover more financial details. Total revenue of $82 million for the first quarter of 2016 is a decline of $18 million or 18% from the $99 million reported in the fourth quarter of 2015. With $10 million of the decline attributable to reduced equipment sales, $4.5 million attributable to reduce compression services and $3.5 million attributable to reduced aftermarket services. I want to use this opportunity to point out that we have made a change in where we classify part sales. In this quarter and future quarters, part sales will be included in the aftermarket services line of business for reporting. Adjusted EBITDA at $25.4 million is a $6.4 million or 20% decrease from the $31.8 million in the prior quarter. First quarter distributable cash flow of $14.2 million is a decrease of $5.2 million or 27% compared to the fourth quarter of 2015. As was the case in the fourth quarter of 2015, we were positive on free cash flow with $14 million in the first quarter of 2016 before the quarterly distribution and $1 million free cash flow positive after the quarterly distribution. Our focus on cash flow in the current downturn remains intense. Cash utilized for capital expenditures in the first quarter of 2016 was less than $2 million. Headcount reductions have continued where appropriate with total CSI Compressco headcount dropping by approximately 135 employees, roughly 17% for the company as a whole since the beginning of 2016. Wage reductions and other personal cost control measures have been enacted where appropriate. All employees are engaged in the effort to minimize daily spend and we continue to work with our supplier partners on opportunities for price concessions in the products and services that we consume. Exiting the first quarter of 2016, our compression services fleet consisted of 1,130,674 horsepower with 77.2% utilization or 872,873 horsepower utilized. During the first quarter, we added 8,500 horsepower of new equipment with the majority of those cash expenditures occurring in the prior year and we sold 5,366 horsepower of used equipment from the fleet. Equipment in our largest horsepower segment 800 horsepower and above was 85.9% utilized at the end of the quarter, while equipment below 800 horsepower was 70.7% utilized. Comparing this downturn to the downturn of 2009 and 2010, total fleet utilization at the end of the first quarter of 2016 is very close to where we found the bottom of the prior cycle. Where we continue to have the most success with our large equipment is in the Permian Basin and Delaware Basin where roughly one-third of the total rig count exist and where activity remains comparatively strongest. While the entire compression services industry is subjected to the pressures of low commodity price environment, the smaller horsepower segments, especially the 100 horsepower below category continue to be the most stressed. Low commodity prices such as the sub $2 value for natural gas and variable prices for natural gas liquids that were experienced in the latter half of the first quarter of 2016 and changed economics in marginal wells such as the compression, vapor recovery, and sometimes even the production itself are not economically feasible. We will continue to respond to our customers with competitive rates and excellent service to maximize the utilization of our equipment. Even with this further deterioration in small horsepower utilization, we have seen positive sings recently and is coupon stacked for this equipment. Compression services revenues were $62 million for the quarter, a 7% decline from prior quarter and a 17% decline from same quarter prior year, a result of lower horsepower utilization as well as continuing pressure on compression services pricing. Our customers continue to indicate that sustained commodity prices around $50 per barrel and $2.50 per million Btu are where they need to operate. With current prices having improved into the lower $40 for oil and just above $2 for natural gas, we are cautiously optimistic about the second half of the year, but also believe that we will continue to see pressure on our offerings until the desired level is reached. We continue to address cost issues in the field, seeking price concessions from our suppliers and more effectively controlling labor and overtime in order to minimize the impact that lower revenues have on our profits. As was mentioned in our fourth quarter 2015 earnings call, we have dramatically reduced growth capital for 2016. Total growth CapEx in 2016 is forecasted $8 million to $13 million, which will consist of roughly $5 million invested in our JD Edwards Enterprise One ERP project and up to $8 million spend on other growth opportunities. Additionally, total maintenance capital expenditure of 2016 remain forecasted $12 million. In the equipment sales business, we recorded $10.7 million in revenue for the quarter, of which approximately $2.7 million came from used equipment sales. The continued reduction in new equipment sales has been expected in line with the ongoing decline in equipment sales, bookings and backlog. Our new equipment sales backlog at March 31, 2016 stood a bit above $26 million, an $8 million reduction from the $34 million reported last quarter. Bookings of approximately $1 million occurred in the first quarter. While we will continue to pursue new equipment sales opportunities aggressively in order to improve our book-to-bill ratio, we will also continue to implement cost control initiatives to align our manufacturing capacity with the reduced levels of activity as we have been doing since the onset of the current downturn. In the first quarter of 2016, direct and indirect labor related to the manufacturing operation was reduced by 75 employees with projected cost avoidance of approximately $0.5 million per month moving forward. These reductions and savings are in addition to those previously discussed in prior earnings calls. Before turning the call over to Elijio, I would like to comment on our previously announced first quarter distribution of $37.75 per common unit, which was flat with our distribution from the prior quarter. We continue to believe that this level of distribution combined with the cost initiatives and other actions that we are taking is appropriate for the partnership at this time and is one of several considerations in appropriate management of the balance sheet cash and debt. Please note that this distribution comes with a coverage ratio of 1.11 in the first quarter and as previously mentioned, resulted in $1 million of free cash flow after distribution. With that, I’ll turn the call over to Elijio Serrano.

[Elijio Serrano:]

Thank you, Tim. Compression services gross margins of 49% were 200 basis points lower than the fourth quarter, reflecting market pricing pressures mainly on the lower horsepower equipment. Equipment sales gross margins of $741,000 was $2.9 million below the fourth quarter as revenue declined $10 million on less equipment shipments and part sales. Our backlog, as Tim mentioned dropped from $34 million to $26 million. As a result of the decline in backlog, we initiated a series of staff reductions in our manufacturing and engineering operations that accumulated to a reduction of 75 staff or 40% reduction in staff for this group year-to-date. The first quarter was unfavorably impacted by $790,000 of unabsorbed cost as we went to the staff reductions. These costs will not repeat until the second quarter and beyond. SG&A cost of $10 million declined 9% from the fourth quarter reflecting the impact of several cost reduction actions. This reduction was achieved despite the first quarter incurring a heavy dose of audit and Sarbanes-Oxley related cost. During the first quarter, we recorded a non-cash charge of $100 million to write-off the remaining amount of goodwill and to write-down a portion of our intangible assets. This was done as a result of lower projected earnings and a significant decline in our unit price from December 31 to March 31, but just a key input in determining the appropriate valuation of goodwill and intangible assets. Adjusted EBITDA up $25.4 million, declined $6.4 million sequentially, mainly as a result of lower equipment sales, weaker utilization of our lower horsepower equipment and pricing pressures as a result of this extended and more severe downturn then what we have previously experienced. In our press release, we have included a table that outlines a computation of adjusted EBITDA. Given the market environment and focus on debt metrics, we are publishing adjusted EBITDA to be consistent with EBITDA as defining our revolver agreement. Earnings per share for the first quarter were a loss of $3.11, excluding the non-cash charge on the goodwill and intangible asset impairment charges of $100 million. The EPS loss for the first quarter was a loss of $0.08 per share. Distributable cash flow declined to $14.2 million, while the coverage ratio would remain above 1 times at 1.11. Tim mentioned earlier that given this very challenging environment that we’re going through, which is materially worse than what we’ve experienced or anticipated. We have made free cash flow our primary focus within the organization. Our objective is to ensure that we generate enough free cash flow to cover a distribution and not incur any additional dip. In fact, our goal is to delivering this environment at the current distribution levels. We expect to achieve this by continuing focus on our lower cost structure, minimizing capital expenditures and aggressively managing working capital. In the first quarter, cash flow from operating activities was $15.1 million with almost none of this coming from working capital. Capital expenditure for both growth and maintenance capital was $3.2 million or $1.4 million after the proceeds from the sale of used equipment. As a result, free cash flow was $13.7 million. This was more than sufficient to cover our $13 million of distributions. And this is a second consecutive quarter that free cash flow has been more than sufficient to cover the distribution and allow us to keep debt levels flat. At the end of March, our debt leverage ratio was 4.8 times compared to a leverage ratio covenant of 5.25. The last item I like to address is our credit facility covenants. We are in discussions with our lead bank to modify the leverage ratio on our credit facility that will allow us to remain in compliance with the covenants to do an extended downturn. We expect to complete this amendment by the end of May and expect our leverage ratio covenant amendment to be similar to what others in our sector have achieved with the same lending group. We’ve come in to this downturn laying out a series of actions to ensure that the company’s balance sheet is solid throughout the process. We stop significant capital investments late last year. We initiated a series of cost actions that we are significantly advanced in getting those completed and we also implemented a 25 reduction in our distribution earlier. We believe that the result of those three, plus our amended covenants will allow us to have a solid balance sheet throughout this downturn. With that, let me turn it over to Tim.

[Tim Knox:]

Thank you, Elijio and at this time we’ll go ahead and open the call for questions.

[Operator:]

Thank you. We will now being the question and answer session. [Operator Instructions] And our first question will come from Marshall Adkins of Raymond James.

[Marshall Adkins:]

Good morning guys. So Elijio, it sounds like the distribution for the time being is going to remain intact and also I guess you mentioned in your discussions with the creditors that you expect to get the leverage covenants raise? I know the other two public gas were closer to six times, is that where you are headed right now is that why you think you’re going to keep the distribution intact?

[Elijio Serrano:]

Good question, Marshall. First point is that the distribution decision is obviously a Board decision and management makes recommendations. You’re right; our two publically traded peers have recently announced amendments. They have put their covenant right under six times. Many of the banks in our credit facility are the exact same banks in the credit facilities of our publically traded competitors. So, I think to believe that we achieved something comparable is appropriate. And clearly, we will not mention this on the call, if we were not in advanced discussions and have a confidence level that we can get to something that we’re very comfortable with.

[Marshall Adkins:]

Perfect. Okay, shifting gears, in terms of the exit for the quarter, was it any better than the middle of the quarter when oil prices were down and a lot lower or are you I guess another way of asking that is are you seeing any stabilization or improvement at all from the February crash in oil prices?

[Elijio Serrano:]

Yeah. Marshall, I will speak a bit from memory what’s occurred, but certainly the amount of decline slowed or has slowed as prices have comeback up a bit, definitely in February we were – real low oil prices, real low gas prices in this small equipment was hit pretty hard, and pretty fast and we’ve seen some stability since then and as I mentioned, Washington, Oklahoma and some other places, there are some good things happening for us with our customers and from competitor standpoint on some of the smaller equipment, an ordinance from gas with the applications.

[Marshall Adkins:]

So, you’d phrase it as stability rather than any kind of real improvement broadly speaking?

[Elijio Serrano:]

I would say that yes. In the past, trying to keep into the quarter versus the past additional five weeks a bit straight in my head. It is stabilized, certainly not a dramatic improvement.

[Marshall Adkins:]

Alright. One last one from me, you’re equipment in sales revenues took a pretty big that’s where our model missed a big chunk. What’s going on there and can you give us your outlook on that little sub segment, I know assuming this is a lower margin business, but just help us understand what’s driving that?

[Elijio Serrano:]

Let’s talk about the backlog and we tried to make sure we’ve been very clear on what the backlog was and all the earnings calls, some maybe in modeling it, sometimes people think that backlog runs up quicker than it does. Some of the equipment is when it was ordered, it was 12 plus month delivery. So these things in the backlog that deliver on into the latter part of the year, so that might have been part of the difference there. The solid equipment business is very tight, the mid stream operators for the most part aren’t buying a lot. Some of those companies have excess compression that they know in their own inventories. So that business has definitely been impacted and we’ve seen that and seen a variety of announcements from other people on the industry that have similar backlog declines. When prices turn around, then the market will likely open up quite a bit, but even when commodity prices turn around, there’s still six month roughly lead time to get that equipment billed once it is booked and the orders are in hand.

[Marshall Adkins:]

When you see prices surround, are we thinking more of 50 or 60 before you see a meaningful bond?

[Elijio Serrano:]

50 is a number that I have heard many times talking with a variety of customers and a variety of places around the country. Stable $50 oil prices appears to be the point at which investment is likely to return.

[Marshall Adkins:]

Fair enough. Thanks guys.

[Operator:]

The next question will come from Andrew Burd of JPMorgan.

[Andrew Burd:]

Hi good morning. First is a follow-up on the fabrication business. Is there any operational cost left to be rung out there or have you pretty much rung everything out by this point?

[Elijio Serrano:]

Andy, we have pulled the majority of operational cost out. It’s a matter of continuing to match the labor resource to the work load, but as you see in the shops they are very nice large barns, there is not a big maintenance cost, there is not a big up key, there is not a big electric bill associated with simply owning that equipment - owning those facilities.

[Andrew Burd:]

Great. And then second question on the utilization decline quarter-over-quarter was that just kind of, I appreciate the commentary of Permian strong and some of the other things you mention in the prepared remarks, but was it a kind of widespread return of units that drove that number lower, did you see a handful of customers really represent the bulk of that step down, just trying to get a sense of the drivers there.

[Elijio Serrano:]

It was, I hate to say both. It was widespread with smaller equipment. We also had two or three customers that have elected to shut in or certainly curtail some of their production and we hope that we are able to turn that equipment back on in the coming months. There are places where we have idled equipment that are latching on location in the discussions with the customer, looking forward to that opportunity to quickly turn it back on.

[Andrew Burd:]

Okay that's helpful. And the last question on just back to the coverage, potential coverage waver with the banks, I think the two public peers, it seemed like there was nothing that they had to offer in return for getting the covenant waiver it was just an extension, do you anticipate the TCLP you may have to offer something in return whether it be a lower distribution or higher interest rate or something like that?

[Tim Knox:]

The discussions we've had have not pointed toward any adjustment to our distribution and there might be a modest adjustment on pricing, but we don't think it’s big enough to move the needle.

[Andrew Burd:]

Great. Thanks for taking my questions.

[Operator:]

And our next question comes from Mike Profozich of Nomura.

[Mike Profozich:]

Good morning. My question is on CapEx, looks like 1Q CapEx is kind of running a little bit below what you're guiding for the full year and I know you've narrowed your CapEx guidance down to the lower end, but just curious on the cadence for the year and maybe it comes into low what you're guiding to, any thoughts around that?

[Tim Knox:]

Yes. There’s a couple of points. One thing that I mentioned is that our cash outlay for CapEx in the first quarter was less than $2 million and I need to make sure that I’m clear, some equipment that was in our build cycle, some fleet additions that were in the build cycle, I think I mentioned we added 8,500 horsepower this quarter. That equipment in the build cycle was started October November of 2015, so a lot of the cash, the engines, the compressors the big parts and pieces, some of the labor was spent in the prior year. So in the fourth quarter, our CapEx that’s recognized this place into service is between $8 million and $9 million, but only about $2 million of that was cash spent this quarter. So, maybe that helps to bridge that gap for you.

[Elijio Serrano:]

And Mike I’ll add that our expectation is maintenance capital to be for the full year, somewhere between $10 million and $12 million and then Tim also mentioned that we've initiated an initiative to implement an ERP system in Midland that allows to take down cost significantly. That will invest about $5 million on that one, which puts you somewhere between the 17 and 18. There’s a little bit of a growth capital, nothing significant that will you potentially right above $20 million.

[Tim Knox:]

So let me add, where we have bracketed total CapEx of $20 million to $25 million as our forecast for the year that includes about $7 million that was actually cash spent in late 2015. Again the build for the fleet, those units where in the shop for eight weeks, the process from start to finish. So the $20 million to $25 million does include about $7 million in cash spent prior year.

[Mike Profozich:]

Okay great, thanks for the help there.

[Operator:]

The next question will come from Mike Gyure of Janney.

[Mike Gyure:]

Yes, quick question guys, what was the inventory level, I guess exiting the quarter and then I guess do you see any opportunity there for working capital benefits that help the free cash flow for the remainder of the year.

[Elijio Serrano:]

Good question Mike, working capital for the first quarter didn't really contribute much toward our free cash flow, it was primarily cash earnings that went through the process, our inventory at the end of March was $43 million, which is about $6 million, $7 million lower than the end of the year, and we expect that as we continue to deliver some of the shipments currently being worked on that that will come down some, but also keep in mind that the way that we handle equipment sales, new equipment sales we get progressive payments. We normally get a significant down payment at the time that we take an order and as we’re building the equipment we’re getting cash proceeds. So, we've collected quite a bit of the cash as we’re building the equipment that we’re selling.

[Mike Gyure:]

Great. Thank you.

[Operator:]

Next, we have Brian Taddeo of Baird.

[Brian Taddeo:]

Hi, good morning guys. Couple of things, when you talk about your expectation or started deliver this year, can you talk a little bit about what capacity you had to deal with the bonds at this part of that process and as you negotiate with the banks, do you think that the size of the capacity to be able to deal with those increases or not?

[Elijio Serrano:]

We believe that in this environment leaving as much of the availability on your revolver is a prudent thing to do, and we would not be using our revolver to retire bonds in this environment.

[Brian Taddeo:]

Got it. Can you run us what the availability was under the revolver at the end of the month, given the covenants and do you expect to have a pond and amendment have full availability under the revolver?

[Elijio Serrano:]

So the revolver's $400 million upwards. At the end of March, we were $234 million into the revolver. So clearly that gives us quite a bit of capacity. However, realize that your capacity to borrow in the revolver is lesser of availability or a multiple of EBITDA. And right now our covenant is 5.25 times. As I mentioned earlier, we expect to modify that one up as we complete our negotiations toward the end of May, which creates incremental capacity, but not beyond the delta between 400 million and 234 million.

[Brian Taddeo:]

Got it, okay. And then last one, I apologies if I missed this. Can you, if pricing trends if you look over the last couple of months, have the declines in pricing or what customers have been asking for, has the decline is picking up, slowing down, how has the trend done if you look over the last couple of months?

[Tim Knox:]

Well, over the last quarter for sure, couple of quarters, it kind of depends on what horsepower group you look at in the small equipment, 0 to 100. The pricing pressures remain intense and probably have come down a bit further. There are a lot of small competitors outside of the public realm and even outside of kind of the major people in the compression business. There are a lot of small regional competitors that are participating in the market and those prices have come down. As it gets further up in horsepower, the pricing pressure has declined some. Actually, it has declined - the pressure for additional discount appears to be slowing, fairly dramatically. Now there was a lot of discounting done over the past 18 months at this point, but which always seems stability in the higher horsepower and some continued need to go further on prices in the small horsepower.

[Brian Taddeo:]

Can you quantify that on from this point forward, is it another double-digit decline you are seeing in the lower and real higher…

[Tim Knox:]

We do not expect double-digit declines. In aggregate, we expect it to be in lower single-digits.

[Brian Taddeo:]

That’s it. Okay, thank you.

[Elijio Serrano:]

The more the commodity price pick up, probably the more we helped out there.

[Brian Taddeo:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Our next question will come from Selman Akyol of Stifel.

[Selman Akyol:]

Thank you, good morning. Just couple of quick ones from me, can you just talk about what you’re seeing in the Eagle Ford?

[Tim Knox:]

Eagle Ford has I would say stabilized for us. As I mentioned earlier, there have been releases that have come throughout our territories and smaller equipment kind of small mid-sized part, but we certainly at this time are working to make sure we stay stable and consistent Eagle Ford not seeing a lot of growth opportunity right now.

[Selman Akyol:]

Okay. And then, as you think about your large horsepower fleet, can you just kind of remind us where the major concentration is by basins?

[Tim Knox:]

Yeah. I mean our 50%, 50% roughly of our revenues are South Texas and West Texas. So, certainly Permian and Eagle Ford, I don’t have the chart in front of me and don’t want to mis-speak, midcontinent probably picked up 20% of our total horsepower.

[Selman Akyol:]

Okay. Thanks.

[Operator:]

And the next question comes from Michael Mallardi of Wells Capital.

[Michael Mallardi:]

Yeah. I saw on your presentation, Marcellus or the East is only 10% of your fleet. Can you just give us some background on the competitive dynamics there and maybe it’s - should they grow over time, those are more internally owned fleets there? Just what the outlook is?

[Tim Knox:]

Yeah. So the history of that, just I’ll take the extra minute here, the history of that compressors systems is CSI part of CSI Compressco, which was acquired 21 months ago now, did not operate its fleet in the Northeast. So the equipment that is up in the Northeast is from the Compressco or the gas jack side of the business with smaller equipment. It has been a remainder intention to begin to have a presence in that area. The correct market isn’t very conducive to entry, fairly slow there at this point. As far as owned fleets and leased fleets, there are a couple of significant competitors that have a lions’ share of the business of the compression services. I believe in larger horsepower it is just a couple of companies that do that not a lot of small local companies with large horsepower. On the small horsepower end of it again there are many local companies throughout the country. It does remain an initiative of ours to increase that presence.

[Michael Mallardi:]

Great. Thank you.

[Operator:]

And this concludes our question and answer session. I would like to turn the conference back over to Tim Knox for any closing remarks.

[Tim Knox:]

As discussed with those questions, we do continue to see challenges as we navigate through 2016. Well, West Texas intermediate was $25 to $30 per barrel throughout the first quarter. We’ve been encouraged by the run up into the $40 range that’s occurred the past 8 to 10 weeks. Natural gas has also seen improvement since the close of the quarter, but only into the $2 range where our customers are still challenged to operate profitably. Total U.S. rig count dropped 36% in the first quarter and is down 40% year-do-date with almost 300 fewer rigs operating. Our management team is committed to diligently managing our business for the well being of our shareholders, customer employees alike and has developed and implemented a business plan designed to navigate these challenges with specific revenue and cost initiatives for the remainder of 2016. We will measure, reinforce and adjust our business plan as necessary to match its changing market. We will continue to press towards completion and implementation of our enterprise one ERP project, which we believe will offer many opportunities for additional cost reductions. We’ll support improvement in processes from employees, improved service to our customers and returns for shareholders. As stated earlier, we anticipate that we will incur $5 million in capital expenditures on this project to 2016 with many features coming online later this year. Once fully implemented in 2017, we are targeting annual savings available from the improved system to be in access of $4 million annually. We will remain focused on generating positive free cash flow, minimizing cash out lays, and investing only in opportunities to present a high rate of return. I would like to mention in closing that on June, 7 and 8 we will participate in the Bank of America, Merrill Lynch Energy Credit Conference in New York City, and June 21 and 22 we’ll be back in New York to participate in the Credit Suisse MLP, Energy Logistics Conference. I hope to see some of you there and will of course make ourselves available to you at or outside of these events. Material presented there will be made available on our website. Thank you for interest in CSI Compressco, and thank you for taking the time to join us this morning. This concludes our call.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You many now disconnect.