CSI Compressco LP
Q3 2015 Earnings Call Transcript

Published: 9 Nov 2015

[Operator:]

Welcome to the CSI Compressco LP Third Quarter Results Conference Call. The speakers for today’s call are Tim Knox, President and a Director of CSI Compressco GP; and Elijio Serrano, Chief Financial Officer for both CCGP and TETRA Technologies, Inc., who owns a general partner. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Tim Knox. Please go ahead, sir.

[Tim Knox:]

Good morning and thank you for joining the CSI Compressco third quarter 2015 results conference call. I would like to remind you that this conference call may contain statements that are or maybe 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, distributable cash flow, distribution coverage ratio or other non-GAAP financial measures. Please refer to this morning’s press release and to our public website for reconciliations of non-GAAP 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 for our complete financial results for the period. In addition to our press release announcement that went out earlier this morning and is posted on our website, our Form 10-Q is planned to be filed with the SEC on or before November 10, 2015. This morning, I will discuss fleet growth and utilization, equipment sales and backlog and the overall performance of the business. I will then turn the call over to Elijio Serrano, Chief Financial Officer for CSI Compressco and also Chief Financial Officer for TETRA Technologies, who owns our general partner, to cover more financial details. I want to start by sharing with you the sequential improvements that we have experienced in many of the performance metrics that are critical to our business. $129 million of total revenue for the third quarter of 2015 is not only an improvement over the prior quarter, but another record amount. Revenue from equipment sales delayed earlier in the year, a solid quarter of aftermarket services and steady performance from compression services each contributed to this result. Adjusted EBITDA at $32 million is a $0.5 million increase over the second quarter, with improvement in both compression and aftermarket services margins. $21.8 million of distributable cash flow shows 6% sequential improvement and allowed for a $0.25 increase to our distribution to $50.25 per unit, while also improving our distribution coverage ratio to a solid 1.25x distributable cash flow. This is a 9% increase compared to the third quarter 2014 distribution. We continue to invest in our compression services fleet, the most profitable segment of our business, with $16 million in fleet capital expenditures in the third quarter and with almost all of that directed at the over 800-horsepower category, where utilization continues to exceed 90%. At the end of the third quarter 2015, our compression services fleet consists of 6,523 compressor packages, totaling 1,160,976 horsepower. The addition of large compressor packages in the third quarter was partially offset by the sale of several smaller compressor packages, totaling a net 22,320 horsepower addition. As September 30, 2015, 951,268 horsepower were generating revenue, resulting in an operating horsepower utilization of 81.9%. Compared to the second quarter of 2015, our total operating fleet decreased by 1,175 horsepower a 1.7 percentage point decline in total utilization, as we continue to see pressure on utilization of the smaller equipment in the field. Through all of this, compression services revenues held steady in the third quarter, $73 million right in line with prior quarter result. We continue to execute on converting the legacy Compressor Systems Incorporated rental agreements to MLP-compliant services, allowing us to capitalize on tax efficiencies of the MLP structure. For the month of September, over 60% of the legacy CSI fleet was operating in accordance with and invoiced as MLP-qualifying revenue. Exiting the third quarter, over 70% of the legacy CSI fleet business has now been converted to MLP-compliant service contracts. We anticipate continued progress to our goal of 80% contract conversion. I mentioned a moment ago that our total horsepower utilization declined for the prior quarter, a continuation of what we’ve seen since the beginning of 2015 with low oil and natural gas prices impacting this key performance indicator of our business. Please note, the segment hit the hardest has been the small compressor segment, where gross margins are the weakest. As I said, utilization of over 800-horsepower segment remains above 90%. And utilization of our reciprocating compressor fleet above 100-horsepower remains in excess of 86%. This is where we continue to invest, and this is where we find the most attractive returns. As was anticipated, our aftermarket services segment showed strong results in the third quarter, recording $7 million in revenue, a 50% increase over the second quarter. In the equipment and parts sales business, we recorded $49 million in revenue, consistent with the prior quarter. Our equipment sales backlog at September 30, 2015, stands at $46 million, a $41 million reduction from the $87 million reported last quarter. This is the result of very modest $3 million in bookings in the third quarter, a symptom of the pressures in the market and a tendency for our customers to delay investing in new production and new gathering or processing plants during uncertain times. While we continue to pursue equipment and parts sales opportunities aggressively in order to improve our book-to-bill ratio. We’ve also continued to implement cost control initiatives to align our manufacturing operations with the evidenced levels of activity, as we have been doing since the onset of the current downturn. As we enter the final quarter of 2015, we find some customers with funds in the capital expenditure budgets expressing interest and purchasing existing compression equipment. And this may give us the opportunity to execute on used equipment sales in the fourth quarter, with follow-up aftermarket services work in 2016. Conversely, we find that some customers are looking to improve their balance sheets and may consider sale leaseback type transactions of compression assets that they own, which could provide opportunity for CSI Compressco to expand our compression fleet, territory and customer base. We have evaluated the opportunity to purchase certain assets from operators, and we’ll continue to seek out and evaluate these opportunities with the intent of aggressively pursing those situations in which the equipment contract terms are attractive to the partnership. Before turning the call over to Elijio, I’d like to reiterate our previously announced third quarter distribution of $0.5025 per common unit. This is the 12th increase in the past 13 quarters, the ninth consecutive increase a 9% increase to the distribution per unit compared to the third quarter 2014 and was done at a 1.25x distributable cash flow coverage ratio. With that, I will turn it over to Elijio.

[Elijio Serrano:]

Thank you, Tim. Gross margins for the entity of $43 million in the third quarter increased 2.5% from the second quarter on the strong profits coming over from compression services and aftermarket services. Compression services gross profit increased 3.9% sequentially. And as a percent of revenue, compression services gross margins increased 200 basis points from 48.5% in the second quarter of this year to 50.5% in the third quarter. Tim mentioned earlier that our backlog for new equipment sales have declined, given the market environment. However, I would like to remind you and point out the gross profits from compression services represents the vast majority of our total gross profits. For the third quarter, compression services gross profits were 86% of our total gross profit. Gross profits on the equipment sales represented only 10% of our total profits. As the manufacturing and sales of new equipment declines, we have plans in place to adjust the cost structure of our fabrication assembly operations to mitigate this decline. We will reduce our cost structure accordingly to minimize the impact of a declining backlog. As an example, since the beginning of this year, we have already reduced headcount by 50% at our Oklahoma City facility, where we were fabricating and assembling the smaller size horsepower equipment. We have other cost initiatives in place to also reduce field service and G&A cost in addition to the fabrication and assembly cost that I mentioned earlier. So that we are proficient to remain – to maintain a solid distributable cash flow coverage ratio into the future. Third quarter adjusted EBITDA, as defined in our press release, of $32 million was 24.8% of revenue, consistent with the second quarter of this year. Earnings per unit in the third quarter were $0.04, an increase of $0.02 compared to the second quarter of this year. Net income of $1.2 million, an increase of 39% compared to the second quarter of this year. Cash flow from operations in the third quarter were $11 million, our capital expenditure, $18.9 million. Distributable cash flows of $21.8 million increased sequentially by 6% on the higher profits from compression and aftermarket services in addition to an expected tax refund of $1.2 million if we take advantage of our deposition tax deductions following the acquisition of CSI, so that we can reclaim previously paid U.S. income taxes. Day sales outstanding of 41 days reflect the company’s focus on timely invoicing and aggressive pursuit of collections as we manage working capital, debt outstanding on the revolver increased by $10 million in the third quarter from the second quarter of this year. Liquidity available to CSI Compressco at the end of September is very adequate. And from a combination of cash on hand of $18 million and undrawn capacity under our revolver, we believe we have more than adequate liquidity to fund all our growth initiative. Our leverage ratio, as defend by our credit agreement, at the end of September, was 4.41x debt-to-EBITDA compared to a covenant of 5.25x. We remain comfortable that we have the liquidity in the revenue and earning stream from compression services to continue to fund our growth initiative. We are in the process of completing our 2016 plan, and we’ll determine how much capital investments we want to invest from our manufacturing operations, and at the same time, leave adequate capacity available to address some of the opportunities Tim mentioned, of potentially buying assets as they come available in the market. I would also like everybody to remember our cash cycle. As we build equipment, we make payments for the purchase of compressors and the engines. We build over a 4-month to 6-month period, then we deploy the equipment. So cash that we have outlayed early in this year is just now coming to the market, that’s producing revenue. That will represent incremental revenue and cash into the future. So, we have invested for horsepower that’s just now coming on the market. And finally, I would like to empathize Tim’s earlier point that our third quarter coverage ratio was a solid 1.25x, a slight improvement over the second quarter, achieved in a very challenging environment. So with that, let me turn it back to Tim.

[Tim Knox:]

Thank you, Elijio. I have mentioned in prior calls the relative stability of the compression services sector compared to the larger oilfield services market. While U.S. rig count has declined by almost 58% in the past 12 months and natural gas prices declined by 43% and oil prices by 50%, our fleet utilization’s declined by less than 5% in that same comparative period. The compression services fleet remains the economic engine of CSI Compressco, providing 60% of year-to-date revenues and 87% of year-to-date profit dollars. We will continue to monitor our performance and prudently manage the business with a focus on minimizing cost, protecting profitability and delivering appropriate returns to our investors. With that, we’d like to open the call up for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Praveen Narra of Raymond James. Please go ahead.

[Praveen Narra:]

Hey, good morning guys.

[Tim Knox:]

Good morning, Praveen.

[Praveen Narra:]

I guess, when we think about one of the big growth areas for production has been with the Marcellus, and I think you guys have talked previously about growing your footprint out there, can you give us any update on what you’re seeing over there? And does that continue to be a focus or is it more concentrating on current areas of where you guys are at?

[Tim Knox:]

So Praveen, the Marcellus, again, it is growing 18% of the U.S. gas production and probably more down the road, so it’s obvious place for a big compressor company to be. At the same time, we’ve mentioned that we’ve – we are putting the money into our large horsepower equipment, probably the same thing is needed up in the Northeast, and we keep deploying it in South Texas and West Texas and the Mid-Continent, and other player – other places where we have all our infrastructure existing. So at this point, it hasn’t made sense for us to not serve the markets and the customers in our strong backyard areas. We’re going to continue looking to Marcellus. We’re going to continue pursuing opportunities, but we’re also going to do – make the prudent decisions with the deployment of our assets in the most profitable and in areas that have been consistent for us.

[Elijio Serrano:]

And Praveen, I’ll add. We’re very focused on – we have got a very disciplined capital allocation process. We evaluate all the opportunities where we believe we’ve got the lowest risk with the highest returns is what gets first access to capital. And right now, that is completely being met by South and West Texas and the Mid-Con area, as Tim mentioned. Clearly, Marcellus is still a target, but only after we meet the higher margin opportunities in our backyard.

[Praveen Narra:]

I think that makes a lot of sense. I was a little bit intrigued by the idea of the sale-leaseback programs you were talking about from some midstream companies. I guess, what is the extent of that opportunity? And would there be any differences in normal contract lengths with something like that?

[Tim Knox:]

So, the extent of the opportunity, again, we are – we have had conversations. We are having conversations along those lines. We need to find the deals that make the most sense for us. Contract length, as you get into that negotiation, is tied to the asset value, right? You pay less for it, maybe you can contract it for less. But typically, those deals tend to be 60-month type agreements.

[Praveen Narra:]

Okay, perfect. And then my line cut out, you may have mentioned this. But in terms of covenants, could you give us a frame of reference, with a lot adjustments being made of where you guys were at for 3Q?

[Elijio Serrano:]

Right. So at the – into the third quarter, our covenant is 4.41x debt-to-EBITDA. The covenant that we have is 5.25x, we were actually at 4.41x on actual numbers.

[Praveen Narra:]

Okay, that’s helpful. Thank you very much guys.

[Operator:]

And our next question comes from Gabe Moreen of Bank of America Merrill Lynch. Please go ahead.

[Gabe Moreen:]

Hey, good morning everyone. Sorry, Tim. I jumped on the call a little bit late. In terms of the guidance that you had laid out there for ‘15 previously, on gross CapEx, as well as on EBITDA guidance, did you talk about that at all on the call?

[Tim Knox:]

No, we did not talk about it and no updates necessary. I believe we are tracking that direction.

[Gabe Moreen:]

Okay. So you are tracking in that direction. Okay, fair enough. Then in terms of [indiscernible] you mentioned sort of tax refund potential in subsequent quarters. Can you just talk about, I guess, timing, magnitude and maybe where that shows up on the statement? And then as – will that be counted, I guess, as DCF when and if it shows up?

[Elijio Serrano:]

Correct. In the press release, Gabe, you can see that we’ve got a small benefit that benefited our distributable cash flow. We filed for a refund of $1.6 million, I believe it is, of which, we’ve already received an in the bank $1.2 million a couple of weeks ago. So, we have got the opportunity for previously paid taxes to reclaim some of that, of which we’ve already seen the benefit of that reflected in the third quarter.

[Gabe Moreen:]

Okay. So that will continue, it sounds like, into the fourth quarter?

[Elijio Serrano:]

We will have a small amount of cash coming in, in the fourth quarter.

[Gabe Moreen:]

As well. Okay, great. And then last question, I know, Tim, you talked about the M&A question, previous one was well. But two follow-ups, one is just I want to just make sure, are you focused here in terms of the sale leasebacks on larger horsepower per se? And then also as much as I think your customers that you’re probably talking about doesn’t need cast any thoughts or possibilities to using your own units or currency as a way to fund some of that?

[Tim Knox:]

The first question certainly focused on larger units. The market’s proving that’s where the stickiness is, and that is where we have validated that we can have the greater returns on the investment. As for utilizing units, you look at the current yield, right? Issuing equity is a bit expensive, but we will certainly look into a variety of financing options to do those things.

[Elijio Serrano:]

Gabe, I would add that capacity on our revolver in addition to acquiring an asset that are going to bring EBITDA stream would allow us to expand our revolver, so that we’ve got incremental capacity to look at transactions like that. So first source would be use the revolver. Our second source, look for alternative debt. And then the last option will be to use equity if we believe our equity is under-priced at this time.

[Gabe Moreen:]

Got it. No, that’s fairly – I guess my follow-up to that would just be how close do you want to go to those covenants that you’ve gotten? And now much could use that revolver, otherwise, where you – that felt comfortable on or is that something where you think you can get an amendment even to the covenant if you did some M&A?

[Elijio Serrano:]

Any incremental debt to secure more assets in such a transaction would be done below today’s level of debt-to-EBITDA.

[Gabe Moreen:]

Okay, alright. Thanks very much guys.

[Operator:]

And our next question comes from Jeremy Tonet of JPMorgan. Please go ahead.

[Andrew Burd:]

Hi, guys. It’s actually Andy. Elijio, you touched on this, but can you – is there any way to quantify the cash flow benefit that you expect in the fourth quarter from recent investment that didn’t hit a full run rate and wasn’t fully manifested in the third quarter numbers?

[Elijio Serrano:]

A very good question. Let me walk you through an example. So we’re buying compressors and engines to build for our own fleet. If from day 1, you’re laying out the funds to order and by the compressors and engines, then over a 5-month to 6-month period, you’re building the equipment. Then you’re expending labor cost and related manufacturing cost. So that by month six, all the cash is out the door to build your equipment. Then over the next two months, you’re going through quality control of the equipment, you’re deploying the equipment, you’re setting up the equipment. And really, you’re only generating cash with it beginning on month 8 or 9. So at that point, all the cash has gone out the door without yet a revenue and profit stream coming. So on the capital expenditures that we’ve been outlaying funds for in Q1 is just now coming online. And as you guys have see from our quarterly results, we’ve been investing anywhere around $20 million per quarter for the last several quarters on growth equipment. So you’ve got this wave of cash revenue and profits coming, that is coming online as we’ve been investing early in the year. So you go back and look at our quarterly CapEx and amount of horsepower we’ve been deploying, that’s where we’re now getting a full year benefit of from here into the future. That’s why we have a conference and a belief that, even though manufacture and sales of used equipment is declining and under pressure, that the compression fleet that represents the gross – the vast majority of our profit is a driver to our company.

[Andrew Burd:]

No, that’s helpful color and certainly a nice tailwind. And I guess second question is also for you, Elijio, and kind of from your role as CFO of TETRA. Perhaps you could comment on how important CCLP distribution stability is to TETRA. An even if we were to get, someday, to a worst-case scenario, where coverage and leverage where potentially tight and deteriorated beyond your expectations, what are some levers that could be pulled by TETRA in support of the partnership to maintain that distribution?

[Elijio Serrano:]

So we completed this transaction is little over a year ago. And when we did the acquisition, we laid out some financial parameters and targets. A little over a year later, we’re quite pleased that everything as been executed consistent with the due diligence and the economics that we’ve laid out. The predictability of the cash stream has been solid. The rental fleet has remained very consistent with our expectations. Seen a little bit of pressure in the smaller horsepower equipment, but we’re seeing very high utilization on the high horsepower equipment. When we went into this transition, we had leverage of slightly under 4x. And we communicated that we were comfortable going anywhere up to 4.6, 4.7 type range as we invest to take advantage of the opportunities. We’re trending very consistent with what we thought was going to happen. If we believe the market’s going to get difficult and pricing pressure and demand slows down, the obvious action is

[Andrew Burd:]

Great. That’s also helpful color. And then last question for me is kind of follow up on the Marcellus opportunity. Can you quantify the type of upfront commitment that CSI would need to make in order to make a major deployment with scale in the Marcellus?

[Tim Knox:]

Andy, the – we have a footprint with the legacy Compressco business. We do have some gas shacks in the area. TETRA, the owner of the GP, has a footprint in the Marcellus. And so we’re fortunate from that infrastructure standpoint. It’s bringing the appropriate number of mechanics and some of the higher horsepower, the different technology on the engine. From the equipment investment, as I have said, with – most of the large equipment we’re building right now, we’re deploying it, it is in the key areas where things are remaining the most stable for us. We will look at pulling equipment from our fleet as it comes idle and we’ll keep chasing opportunities. I think there’s a reality that less than perhaps 10,000 horsepower in somewhat are they concentrated, not one in each state, but maybe 10,000 horsepower in a given area. It’s kind of that point at which you can keep a couple people profitably utilized on some of the larger equipment. So that’s kind of a toe in the water at that point, it’s not a big needle mover for us, but somewhere down in that area. To be a major player up there would be up in 100,000 horsepower range.

[Andrew Burd:]

Great. Thanks for that and look forward to the Analyst Day next week. Thanks.

[Operator:]

[Operator Instructions] Our next question comes from Selman Akyol of Stifel. Please go ahead.

[Selman Akyol:]

Thank you. It looks like you guys are doing a good job trying to manage through the downturn. Just a couple of follow-up questions if I may. In terms of just sort of evaluating packages of compression to buy and leaseback, can you guys put some bookends around what we should be thinking about? Are these 0 to $15 million opportunities, $15 million to $30 million or $30 million or above? Is there any way for us to sort of think about that? And then also, can you put in terms of when sort of discussions or thinking about kind of what returns in terms of EBITDA or multiples of EBITDA we could be expecting this?

[Tim Knox:]

For book-ending in the process, I’m going to – I will just use kind of the numbers you bracketed, less than $15 million is not going to be a big – a huge swing for us. We will certainly look at it in a growth area or a growth area for us. If we had that opportunity, for instance, up in the Marcellus, we would look fairly seriously at it. If we were trying to target what would be ideal for us, something in the $50 million range would probably be ideal from the ease of execution, but we would also be happy to consider things $100 million and above. So, it’s a bit of a loose question and I am not sure that I can really nail it down.

[Elijio Serrano:]

And I would add in terms of returns, depending on the risk that we associate with any opportunity, either concentration of assets, creditworthiness of the seller, longevity of the contracts we would expect turns and margins consistent with our existing business.

[Selman Akyol:]

Alright. And then – and I know you guys have discussed this opportunity for a while and I guess since you are bringing it back to the forefront again, should we assume we are closer to something? Is it just the longer we go through the downturn, the more opportunities you are seeing out there?

[Elijio Serrano:]

Imagine that we have had the opportunity to go more than just the surface on more than one item out there.

[Selman Akyol:]

Alright, thanks very much.

[Operator:]

Showing no further questions, I would like to turn the conference back over to Tim Knox for any closing remarks.

[Tim Knox:]

Well, thank you. We do appreciate the questions. The year ahead is shaping out to be one of challenges for the energy services sector. And our management team is working to develop a strategy and business plan for 2016 that will best navigate those challenges, to position CSI Compressco for ongoing success as the market does eventually recover. We will continue to aggressively attack revenue opportunities, while at the same time, questioning all expenditures. We are committed to diligently managing our business for the well being of our shareholders, customers and employees alike and are confident that we will continue to demonstrate success throughout this down-cycle. I would like to take a moment to highlight a couple of key dates. Next Thursday, November 12, at the TETRA facility in Houston, we are hosting an Analyst Day and CCLP will be presenting. We would like to see any of you here that can join us. And then on December 8, on Tuesday, December 8, we will be presenting at the Wells Fargo MLP Conference in Manhattan. And we would certainly enjoy visiting with you there as well. Thank you for taking the time to join us. Thank you for your interest in CSI Compressco. And this concludes the call.

[Operator:]

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