Exterran Corporation
Q2 2020 Earnings Call Transcript

Published: 10 Aug 2020

[Operator:]

Greetings, and welcome to the Exterran Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Blake Hancock, Vice President of Investor Relations. Thank you. You may begin.

[Blake Hancock:]

Good morning, and welcome to Exterran Corporation’s second quarter 2020 conference call. With me today are Exterran's President and Chief Executive Officer, Andrew Way; David Barta, Exterran’s Chief Financial Officer; and Girish Saligram, Exterran's Chief Operating Officer. During this conference call, we may make statements regarding future expectations about the company’s business, management’s plans for future operations or similar matters. These statements are considered forward-looking statements within the meaning of U.S. securities laws, and speak only as of the date of this call. The company’s actual results could differ materially due to several important factors, including the risk factors and other trends and uncertainties described in the company’s filings with the Securities and Exchange Commission. Management may refer to non-GAAP financial measures during this call. In accordance with Regulation G, the company provides a reconciliation of these measures in its earnings press release issued earlier today, and a presentation located in the Investor Relations portion of the company’s website. With that, I will now turn the call over to Andrew.

[Andrew Way:]

Thanks, Blake, and good morning, everyone, and thanks for joining the call today. First, I will discuss COVID-19 development since we last checked in and then discuss the second quarter along with how we are progressing on our long-term strategy. COVID-19 continues to challenge in many part of our customers’, vendors’ and employees’ lives. But I am extremely appreciative of all the collaboration and dedication of our employees have shown during these trying times as we continue to work to support our customers. On our last earnings call, we had really only seen the impact of COVID towards the end of the quarter, especially related to closing of offices, global travel restrictions, in most of the parts impacting our AMS business. At the time of the call, most of our office staff were working remotely. Today we're starting to see our Middle East and Asia offices opening back up and the degree of normalcy is beginning to appear. North America and Latin America, however, continues to see elevated COVID levels, making travel and returning to work more challenging, and we continue to monitor local situations very closely. Our global crisis management team continues its daily operating rhythm to ensure the safety of our employees, contractors and customers. But the second quarter came in largely as we'd expected from an EBITDA perspective, as we had guided to the low to mid $20 million range. During the quarter, COVID had an impact across all of our business lines, with the largest impacts coming from ECO and AMS, where we had to manage challenging customer logistics, specifically the inability to move people around parts and equipment all around the globe. We also saw the impact on new bookings, with customers delaying decisions making as they worked to normalize their operations before making additional investments. We've laid out our strategic plan over the past year, as we look to move from a product oriented company to a projects and service related business that resembles more of an energy industrial company. This included our announcement that the U.S. compression fabrication was no longer core to the business. As of today, we expect to be out of the U.S. compression fabrication business in the fourth quarter. We are working closely with all potential parties and the outcome whether fully liquidated or sold to a strategic buyer presents fairly similar outcomes to Exterran and our shareholders. Regardless, we expect to be fully complete with all the current backlog in the fourth quarter. We continue to control the costs in the business as backlog comes down, while ensuring we complete all the work and service commitments for our customers in the way that they have come to know and appreciate from Exterran. For the investment community, while today the CFS business is still in our financials, we have provided revenue, gross margin and backlog information since the beginning of 2019 in the appendix of today's earnings presentation. While compression was part of our legacy, we have spent a lot of time talking about how water will be key to our future success. Obviously the downturn has slowed oil production, including water. We are also seeing our customers cut their produce water budgets, specifically in the U.S. That said, internationally, the high water cuts in conventional fields continues to drive demand. The positive news is that we have not yet seen any projects cancels and are actually seeing a growth in our pipeline. The timing of awards have pushed to the right. With the current market dynamics as well as COVID related communication hurdles, these projects are taking time to go through a normal commercial and tendering process. We have a few large projects that are imminent, and we are well-positioned. These projects will be a significant output for the company, not only helping grow our water business, but also giving water its first large global ECO contract. Looking at the second half of the year, we have been very forthcoming that we didn't foresee any material product orders for 6 to 12 months, as the North American market appeared largely shut down to new CapEx. We've started to see some promising signs in North America and Girish will provide more details in his section. For planning purposes, we're not incorporating any of this activity into our guidance at this time. The international markets continue to show resiliency as we continue to have constructive conversations with our customers in all regions, and show just one of our aspects of differentiation, last quarter when we provided full year guidance. I'm pleased to report that our EBITDA guidance for the year remains between $120 million and $140 million of EBITDA. Let me remind you on the assumptions we incorporated last quarter to achieve this. We assumed no new sizable product orders for the rest of the year, improvements in travel restrictions and supply chain activities during the second half of the year, continued remote collaboration with customers and execution on key project wins as we booked over the last several quarters, slow improvement in macroeconomic conditions as it pertains to the commodity prices and exchange rates. Today, as I reflect on these, the open question still remain around the improvement in travel restrictions, the impact on supply chain, factory product execution that could manifest itself in the timing of key projects, impacting EBITDA linearity and cash inflows and outflows over the build cycle. These challenges are still dependent on country-specific COVID outcomes. On the project execution side, I'd like to remind you all we won a large project in the Middle East during the first quarter. We continue to work closely with our customer to keep this project progressing. For the first two quarters of the year we were largely in the engineering phase for the project and required minimum travel or manufacturing. We've invested heavily in global and local talent over the past few years, and it's just another example of our strategic transformation from a products company to one that can handle complex projects where our engineering and operational expertise differentiate us from where the company was several years ago. Our global engineering teams did an outstanding job of completing the critical milestones of [indiscernible] and 3D modeling of the facility from January through June, all achieved remotely whilst leveraging the technology tools we spoke about last quarter. With that, I'll now turn it over to Girish.

[Girish Saligram:]

Thanks, Andrew. I'll start with the large Middle East project that Andrew touched upon, and the engineering success we have had year-to-date. I would like to second his comments as this is a huge undertaking and accomplishments of the team to be able to execute up to this point largely working remotely on such a complex project. In addition, we continue to further develop our internal throughput systems so that we can leverage this optimized methodology of global efficiency and productivity as volumes pick up. In addition to the engineering focus, we have also been utilizing the past few months to further enhance and develop our organization. We have used this opportunity to put a significant focus on training and development and have successfully delivered a significant amount of technical training throughout operating teams. This ensures that we remain fully certified and compliant, while also ensuring that we are sharing best practices around the world. We are also making inroads in broader partnerships and greater value addition from our supply base. While the macroeconomic situation has seen many operators and our customers request concessions, we have launched a focused initiative to improve our value equation to better terms and costs from our key suppliers. Yet again, looking to collaborate towards value creation rather than simply sharing the pain. This includes opportunities for consolidating volume purchases across regions, more local sourcing, more cost efficient designs, et cetera. Since our last call, we have made a lot of headway with our customers as we continue to work with them, as we all navigate this pandemic, along with the market itself. The COVID pandemic, along with the pressure that is creating on the supply demand balance of the commodities continues to put tremendous pressure on our customers and their operations. The duration of these impacts is weighing on some our customers, pushing them to assess all of that operations and facilities as everyone in the industry is doing, balancing near them spending and operations with longer term needs. The longer this proceeds, the more pressure our customers are coming under and the greater scrutiny all of their contracts and facilities come under. Our strong contracts and long-term relationships allow us to be collaborative with our customers, but it is important for us to ensure the long-term stability of our customers and lead to future success for both Exterran and them. Collectively this is a well-coordinated and focused effort across our operating functions to ensure that we are getting the maximum efficiencies as we operate in the field and our factories. This in turn provides us the bandwidth to engage our customers in meaningful contract discussions. Now turning to a global overview of market demand dynamics. The North American market continues to be extremely quiet as demand for incremental facility needs for 2020s are limited. That said, compared to our last call, I would say the U.S. market does have a pulse albeit faint. We are beginning to see some signs of life as opportunity slowly arise, which are more unique niche customer needs rather than broad-based demand signals. While I am a bit more optimistic about the U.S. than I was last quarter, our view has not changed that we don't foresee any significant demand in the region for the immediate future. We are progressing well on some initiatives helping us expand potential processing capabilities, along with some unique power generation applications. While these may be small, we have the potential to help us bridge the gap until our more core product lines normalize. In Latin America, the effects of the current environment have been particularly hard on the currencies in several countries. We have explained in prior calls how we manage this and why there is a top-line impact and risk, our margins are significantly protected. Our customers continue to feel pressure from the commodity declines and this region is where we continue to have the most customer discussions around operations and how we can be collaborative to benefit both us and our customers over the near to longer term. The Middle East continues to be the region of the highest activity and we are seeing new project tenders, and inquiries through this period. We continue to see demand from our current customer base, the new customers and additional product line opportunities, including water and oil train needs are growing as well. CapEx spend in the region has been more resilient than most. And while signing of the awards is always difficult, we do see the potential for some later in the year or early 2021. Finally, in Asia Pacific, our AMS business continues to grow as we continue to add new projects into the segment. For the first time in a while, we are also beginning to see some demand for our processing and cleaning facilities in the region. And although the total number of opportunities are smaller than the rest of the world, this can be meaningful to the region and accretive to our overall business. Overall, our team and operations continue to do an outstanding job managing our customers and operations, largely remotely. Our mission critical equipment and facilities have allowed us to have constructive conversations with our customers that are mutually beneficial. While many of our customers remain exposed specifically to oil and largely in North America are struggling at this time, our heavy international weighting and greater tying to natural gas provides us more stability and a strong opportunity set for the quarters to come. With that, I'll now turn it over to Dave.

[David Barta:]

Thanks, Girish. Despite a challenging quarter managing the impact from commodity price declines and COVID, we delivered results in line with our expectations with EBITDA as adjusted of $24 million on revenue of $172 million. U.S. compression manufacturing attributed revenue of $41 million and gross margin of $2 million. U.S. compression backlog at the end of June was $29 million, and as Andrew said, we expect this to be completed during the fourth quarter. From a segment perspective, revenue for contract operations was $78 million, while gross margin was $54 million, resulting in a gross margin rate of 70%. Revenue declined sequentially primarily due to the impacts of the previously discussed assets sales of contracted equipment that occurred during the first quarter, along with unfavorable FX and COVID-19 impacts. Gross margin percent increased due to continued focus on driving efficiencies through our operations. The ECO backlog at the end of the quarter stood at $1.25 billion. For AMS, revenue was $25 million and gross margin was $6 million, which resulted in a gross margin rate of 24%. The revenue decline was driven largely by the COVID-19 impacts, limiting the company's ability to move people and equipment around countries and to sites and reduced customer and maintenance activities. Revenue in the Product segment was $69 million and gross margin was a loss of $2.1 million, resulting in gross margin rate of negative 3%. Margin declined due to the continued fixed costs under absorption at our manufacturing facilities, which was roughly $4 million. Product mix and customer negotiations, which resulted in [scale] changes and incremental associated costs. We're beginning to see the under absorption abate as we ramp up on projects as June was less than $1 million. Our product sales backlog was $576 million at the end of the second quarter, compared to $648 million at the end of the first quarter. SG&A expenses were $34 million, down from the $38 million in the first quarter. Moving to the balance sheet, net debt at the end of the second quarter was [$457 million]. Our leverage ratio was 3 times, compared to 2.4 times at the end of the first quarter. This increase was expected with the year-over-year reduction in EBITDA. We had total available liquidity of over $266 million. I’d also remind you that we have no near-term maturities. Our next maturity is our resolver in 2023. Even in the current environment, our capital allocation strategy hasn't changed. We will be responsible with the balance sheet and leverage levels, while prioritizing funding organic growth opportunities. During the quarter, we also bought back roughly 19 million of our bonds at a roughly 14% discount after accrued interest and fees. We will continue to be opportunistic to put capital to work regarding potential ECO deals, as well as buybacks with a focus on maintaining a strong balance sheet. Our leverage moved on lower EBITDA. We continue to have ample liquidity available on our revolver with no near-term maturities. Andrew touched on our unchanged EBITDA outlook for 2020, which does include the U.S. compression fabrication business. However, the exclusion of the U.S. fabrication business does not change the EBITDA rate as presented for 2020, and even EBITDA should be in the range of $120 million to $140 million. SG&A for the year is still forecasted to be between $130 million and $140 million. As a reminder, our SG&A includes roughly $20 million of revenue-based taxes associated with our South America business. Cash taxes should be around $20 million and interest expense between $35 million and $40 million. Company's growth CapEx for 2020 is expected to be between $65 million and $75 million with reimbursable CapEx around $7 million. Maintenance and other CapEx should be approximately $20 million. During the first half of 2020 reimbursable CapEx was $6.7 million with no real reimburses planned for the second half of the year. Turning to the third quarter, we expect adjusted EBITDA to be around $30 million. There are no new product bookings included in the third quarter outlook or for that matter in the full year guidance. With all the moving parts we have discussed between COVID and customer conversations, we won’t be giving EBITDA guidance for the quarter. But we -- as we expect the second half should be much better than what we saw during the second quarter annualized as business activity has started to open up, and execution will continue on our Middle East project. Andrew talked about COVID related logistical challenges resulting in tiny changes on key projects that we continue to work through with our customers and these are all baked into our full-year guidance. While there remains a great deal of uncertainty and variability in the business environment, we're also beginning the 2021 planning process. While we're certainly not in a position to provide quantitative guidance today, as Andrew mentioned on our prior quarterly call, we are set up to grow in terms of revenue and EBITDA in 2021. This is largely due to the Middle East project awarded in Q1. We continue to work with the customer on the project schedule given the logistical challenges. We feel confident we will make significant progress on the project as we move forward recognizing the revenue and gross margin on a POC basis. I will mention that the project will result in the use of working capital in 2021 given the size and structure. And with that, I'll turn the call back over to Andrew for closing remarks.

[Andrew Way:]

Thanks, Dave. The organization responded exceptionally well in the first half of the year for managing customers to working remotely for over five months thus far. We were early to respond with cost out initiatives we put in place in 2019, which is reaping its benefits today in our ability to handle the current macro environment. We continue to focus on managing cash flow and our balance sheet while working hard -- and working hand-in-hand with our customers on project execution and operations. Our strong balance sheet with no near-term maturities allow us plenty of flexibility to manage through the coming quarters. While all of this is important to protect the core of the business, we're spending significant time on the company we plan to be post the U.S. compression fabrication exit. You all know the financial transformation we are progressing towards. As I've laid out, a company where we have a strong backlog, 20% or greater EBITDA as adjusted margins, would improve returns over the coming years. Our business continues to transition to one from a short cycle products with less than desirable margins to one tied to a larger facilities and projects where we can bring our engineering supply chain and operational expertise to the table to create real value. Our portfolio which can require internal capital for projects will have longer build cycles, lowering backlog churn giving us greater visibility through the quarters ahead. And while order book is likely to be lumpier given the larger scale and project focus, the overall company margin profile should continue to improve as the world normalizes in the quarters and years ahead. While we don’t foresee meaningful orders for the remainder of this year, the strong backlog and characteristics I just spoke about continue to give me confidence that 2021 will be a growth year for the company. And with that, I'd now like to turn the call back to the operator. Thank you.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator instructions] Our first question has come from the line of Kyle May of Capital One Securities. Please proceed with your question.

[Kyle May:]

Want to start with the third quarter guidance. And I realized there's still a lot of uncertainty ahead, but just wondering if you could give us any drivers or things to consider that could put you north or south of the $30 million watermark?

[Andrew Way:]

So, Kyle, I think as Dave laid out, we have a pretty good visibility to the backlog. And as we do every quarter, we take into consideration what we have booked in the pipeline from an AMS perspective and clearly the ECO, which is far more predictable. I'd say two things. I really outlined a couple of points in my prepared remarks, but really the two things that will have an impact on that exact question is, how our customers are continuing to operate, will we have the ability to people moving in certain locations, will our factories continue to be operating at the rate that we see coming out of the second quarter? As we already indicated, we had some challenges in certain locations. But our assumptions is that the Asia location and our Middle East operations will be back to normality, and that will allow us to have greater visibility. So really it's more COVID-related and just physical operations than it is going to win, booking new orders, converting that activity. We have the backlog. We just need to have good feet to get through the quarter.

[Kyle May:]

Got it, got it. That makes sense. And as we think about the business going forward without U.S. compression fabrication, how should we be thinking about the segment margins in that piece of the business in the back half of the year, and then what does that mean for EBITDA margins going forward?

[David Barta:]

Yes. I think you'll see in the presentation that's posted some historic information on compression. So you can certainly go back in time and take the U.S. compression piece out of the product results. But as we look forward and this somewhat is based on current volume levels, we would see gross margins in that segment in the low to mid-teens. And again, that also is -- certainly right now I'll call the volume penalty as our process of treating in water businesses certainly aren't operating at a high utilization level. So, over time, if we see volume coming back in P&T business, we would see those margins move up into the high teens and I’d take EBITDA margins into the high teens as well. And as Andrew said, we see this business on a kind of pro forma basis without that our U.S. manufacturing -- compression manufacturing business EBITDA margins north of 20% in a more normalized point in the cycle, for the total company.

[Kyle May:]

Okay. Got it. That's helpful. And then maybe just one more, you've kind of mentioned some of your comments around starting to see the beginning of global improvements and better ability to move employees and equipment around. Just wondering if there's any additional color or insight on what you're seeing more recently and how this compares to your expectations when you provided revised guidance last quarter?

[Girish Saligram:]

Sure. Kyle, I think when we started out this, especially last quarter, it was still at the very beginning of the process. And a lot of countries were in a lot of flux in terms of the specific shutdowns and what their arrangements were vis-à-vis other countries. I think today we've got, on the one hand, a little bit more clarity and stability, and we're starting to see a reopening. So, it's a lot of different contrasts. So, for example, you've got the UAE where people are now allowed to move in and out and you've got a lot more movement. On the other hand, you've got Oman, which is still fairly restricted, you've got Nigeria that is starting to open up but you still don't have the ability to move people into international flights, et cetera. Whereas in the U.S., we still have this have the ability to move people around. So, it's a very mixed bag on a global basis. What has been encouraging though is to see the industry as a whole adopt to the remote work from home type of concept and a lot of customers adapting and working with us collaboratively. We've seen tender activity, especially in the Middle East be very strong and all of that has been done through a remote fashion. So, we have definitely seen an overall improvement, but all of it is kind of dependent on how the pandemic pans out.

[Operator:]

Thank you. Our next question is coming from the line of Tim Monachello with ATB Capital Markets. Please proceed with your question.

[Tim Monachello:]

Curious that the reimbursable CapEx for the year and the guidance there changed from 29 million to 7 million. Just maybe, if you can provide a little bit more detail on that change?

[David Barta:]

Yes, so the reimbursable CapEx is always highly likely to be dependent upon progress on a project. So, we've got a project that's there's potential reimbursable CapEx in the fourth quarter, late fourth quarter and that's why we see based on schedule some of these difficulties of getting the sites and so forth that are probably falling into next year, there's still possibility that could get pulled back. It’s regulated to one particular ECO project.

[Tim Monachello:]

And then the ECO backlog came down a little bit in the quarter about $100 million. I guess I'm just curious if that had more to do with deferrals on renewals, or if it's timing, or if anything has materially changed in regards to how you view that backlog progressing?

[Girish Saligram:]

Sure. Tim, it was a few different factors that groove it. We did have a number of extensions that did happen. But one of the phenomena that we saw was given the nature of customer operations getting disrupted that customers chose, in many cases, they didn't really have the ability to do otherwise short-term extensions versus sign-up for the longer term extensions that we still fully expect to get the third quarter and then subsequent quarters. So, we saw extensions in the range of two months to even 6 or 7 months versus the natural one which we would expect to get a multiyear type of extension. We're still very much on track for that and expect to get more significant extensions in the second half of the year. But that's really what drove it. In addition to that, we had a couple of other things happen like FX and some of the contract changes as customers are relooking at their overall operations and deciding how much capability and how much fleet they want to deploy. But a lot of short-term dynamics versus any real fundamental long-term change.

[Tim Monachello:]

And then I was also curious, if you had any more details, I understand that negotiations are probably ongoing, but the comments around the two imminent in large water projects. I'm just curious if you expect that to be 2020 event and how material could that be to business, the two projects?

[Andrew Way:]

Well, as I said in my prepared remarks, we continue to see really a good pipeline and opportunity and activity, the majority of which is in the Middle East. Our team has been doing a great job during the last few months, really working again remotely with our customers, laying out the plans for the actual projects themselves. And so, if I was to answer the question, which I think I heard in terms of timing, the second half of this year is when we would expect the award to be made, and they’re all sizeable and they will have a meaningful impact on the company. So, we're working through the finer detail of those projects as we speak, a lot of the technical alignment has already been addressed. The technology that we have in-country has already been proven with this particular customer. They're very happy with the outcome of the overall designs and we're kind of working through right now the finalization on timing and the specific applications. So, we would hope that in the second half of this year, late third quarter, maybe early fourth quarter, we should see some activity.

[Tim Monachello:]

Okay, great. So, I guess just follow up there. Is the uncertainty around that contract just due to finalizing some final details, it sounds like that might be the case, or are there other parties bidding on the work as well?

[Andrew Way:]

I'd say, it's just timing in general. I mean, just purely on the operational front end of what we've been doing with, what we read on the news and what we've seen globally in terms of COVID, when you put that into practical terms, I mean, the world has been turned upside down from an operations standpoint. And so, just being able to get uphold of people and make sure that you have alignment on both ends has been an incredible task in itself. And so, when your customers’ operations aren’t functioning as normal, people are still working remotely in many locations. It's just timing. And so, as we work through the implications of these projects, we're always checking and making sure that, is the project going to go ahead and are we going to be successful? On those two, when you combine those, we feel fairly confident that the second half is when the projects will be awarded.

[Tim Monachello:]

Got it. Okay. That's helpful. And then last one for me, just regarding the U.S. fabrication backlog that you still have and maybe just comment around the broader market. It looks like the margin has come down pretty substantially at about 5% on that backlog through the second quarter from 10% last year. Is that a result of just fixed costs absorption on lower revenue, or is that has to do with the actual margin implied in that backlog changing?

[David Barta:]

No. The margin has been in the backlog since we sold the projects and haven't seen a material change in how that market looks. We haven't been seeing a significant new build opportunity for other customers. And as we've said for many months, we're running the business down and we've been liquidating inventory and being dealing with that in a very careful contract-by-contract and a customer-by-customer perspective. So, we have held a certain amount of costs during that period to finish the projects, probably a little more than what we would normally and that's been our intent to make sure that we do the right thing for our customers and make sure the product leaves with the right quality, that tends to come with a cost structure in some areas that's been a little higher than what we have in the past. We have taken out a significant amount of cost this year in that business, but just not at the pacing which the volume has come down. So, we have a good line of sight now unit-by-unit, customer-by-customer to run off that backlog here over the next few months. We're working with our customers on that. And in parallel, we're working to liquidate the assets as we talked about with a potential strategic sale we're also working through. So that will come to light here in the next few months, which will be good and will be through that process by the time we get through fourth quarter and being able to communicate more clearly once we’re through that.

[Operator:]

There are no further questions at this time. I will now hand the call back over to management for any closing remarks.

[Andrew Way:]

So, thanks. Thanks, everyone for dialing-in and listening today. As I said in the prepared remarks and Girish also highlighted, we wanted to thank all of our employees that have really done an outstanding job the past few months working through very difficult conditions, spending time making sure that they’re focusing on the customer and it's been really appreciative. So, with that, I'd like to say thank you and we look forward to updating you after next quarter. Thank you.

[Operator:]

This does conclude today's call. You may disconnect your lines at this time. Thank you for your participation and have a great day.