Exterran Corporation
Q2 2018 Earnings Call Transcript

Published: 12 Aug 2018

[Operator:]

Greetings. And welcome to Exterran Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A 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 for today’s call, Mr. Blake Hancock, Vice President, Investor Relations. Thank you. You may begin.

[Blake Hancock:]

Good morning. And welcome to Exterran Corporation’s second quarter 2018 conference call. With me today is Exterran’s President and CEO, Andrew Way; David Barta, Exterran’s Chief Financial Officer; and Girish Saligram, Senior Vice President and President of Global Services. During this 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 meanings of the 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 yesterday, available on the company’s website. With that, I will now turn the call over to Andrew.

[Andrew Way:]

Thanks, Blake. Good morning, everyone. Exterran had another solid quarter on many fronts, with EBITDA as adjusted of $51 million on revenue of $343 million, record product bookings, key ECO wins in Latin America and the Middle East and Africa, continued margin rate expansion in our Product Portfolio segment and continued progress on growing AMF. We noted on our last call that we felt good about the opportunities for products in ECO, and clearly, the pipeline has began to convert to orders during the quarter. Our Q2 bookings were $440 million, a 127% increase from the first quarter 2008 (sic) [2018] bookings, with the international order book contributing significantly to that total. The wins over the past several quarters are a result of our increased focus, capability built-out and a strong execution throughout the globe. In our Contract Operations segment, we recently signed a contract in Latin America for over $150 million of revenue over an eight-year period to build, own, operate and maintain an operation that will go into service in the latter part of 2019. Inclusive of the project awards we announced on our last earnings call, we have now signed over $250 million in Contract Operation projects over the past six months and continue to further develop the long-term pipeline we have indicated on prior calls. In AMS, our topline exceeded our expectations, as overall strength in Latin America continues along with improved part sales in the Middle East-Africa region. We are seeing continued commercial success and are further developing capabilities to deliver expertise to our customers with a high degree of responsiveness. This year, I have talked about three areas we continue to focus the entire organization on, delivering the projects that are in backlog, positioning the business to win and scaling our capabilities in the Middle East. I am pleased with the progress we continue to make in all areas. We are making good progress on the previously announced projects across our engineering, manufacturing and on-site construction teams. We continued to make further progress, optimizing our manufacturing capabilities to ensure that we are generating improved margins and returns while meeting all of our customer needs. Our regional teams, along with our global supply chain organization, continues to make excellent progress, positioning the company to take on more complex projects locally, delivering sharp productivity and faster cycle times, all of which should help us in our margin expansion efforts over the coming years. Our Middle East facility has quickly become a key competitive advantage for Exterran, for both compression, and processing and treating product lines, by providing a full service offering, from application and configuration to detailed design, manufacturing and service support. This will allow us to lower cycle times, with customers providing additional capacity for the opportunities we see ahead. As we look out at the macro, we continue to be very optimistic on what we see ahead. The U.S. is on pace to be one of the largest exporters of gas in the next decade as the EIA expects 2018 natural gas production to grow nearly 10% this year alone. While our production may pause, given the takeaway capacity in the Permian, we remain very positive towards our production growth and associated growth for the Basin in longer term, and how our processing and treating facilities, along with new product developments fit into these projections. Internationally, gas demand continues to be driven by industrial growth in China and in the Middle East, along with Latin America, with gas independence is a goal of many over the coming years. I will now pass the call over to Girish, who will discuss the global markets and demand for our products and services.

[Girish Saligram:]

Thanks, Andrew. Today I will talk to you about global demand and dynamics. Starting with North America, we continue to have expectations for robust demand, driven by the continued need for additional compression, and processing and treating capacity across the lower 48 in the U.S. The Permian takeaway capacity has been a hot topic of late and while we don’t see any material impact on our compression business, we have seen a slowing in processing and treating orders in the Permian, and would not be surprised to see this continue until early next year, as companies prepare for pipeline capacity to begin to come online in the middle part of the year. This is a recognized issue and we don’t believe there are any long-term impacts. Additionally, the longer lead times for our gas plants means that customers will look beyond the current constraints and take the necessary actions with a long-term view. We are seeing significant activity in multiple basins. In the Permian, SCOOP and STACK, the associated gas from oil production is the main demand driver for our business, and provides incrementally greater returns to operators. In the Utica and Marcellus, power demands, increased pipeline capacity and LNG growth are contributing factors. We saw a very significant portion of our compression orders in the second quarter go into gathering applications, which we expect foreshadows another wave of processing capacity down the line. The final dynamic to mention in North America is the continued impact of long cycle times on engine deliveries. While we are not seeing the supply situation change, we are seeing customers planning significantly ahead in recognition of these cycle times, which is a relatively new phenomenon in the space. In the Middle East and Africa region, we continue to see strong demand as a result of customer investments. However, the cycle times, while getting faster, are still much longer than in North America. We are seeing a resurgence of demand for oil processing capacity and that is typically coupled with associated gas volumes, and the need for produced water treatment solutions. Inquiries for early production facilities that incorporate oil, gas, water and power solutions are on the rise, and fit for solution space that we are focusing on. Our key focus continues to be countries where we have a significant presence and strong customer relationships. The long-term demand signals we are seeing from Kuwait, Oman, Iraq and Bahrain make us feel further confident in our investments in local expertise in the region and building out our Hamriyah facility to serve as the regional manufacturing and engineering hub. Our ability to design, build and provide service expertise locally is becoming more of a competitive differentiator. At the same time, we are also putting in place strategic initiatives to drive greater penetration in the region, in countries such as the Kingdom of Saudi Arabia and parts of Northern and Sub-Saharan Africa. With the need to drive investment to increase gas production and replace declining oil production assets, we believe that our DBOOM, or Design-Build-Own-Operate and Maintain model provides a win-win opportunity. For customers, it is a faster path to monetize their assets, while deploying scalable solutions and for us, it is a mechanism to grow our contract operations base, with long-term contracts at higher returns. Latin America feels like we are at the beginning of a production and midstream up cycle. We’ve talked extensively in the past about Argentina, Bolivia and Brazil as the centers of new gas initiatives driven not solely by economics, but by fundamental demands of the benefits natural gas brings to growing nations. As Andrew discussed, one of the opportunities we were working on has come to fruition and we remain confident of more growth in the future. In Argentina we are seeing the first significant operational investments in the Vaca Muerta play and are expecting to see the first awards soon. In Brazil, the continued reforms and investments for large IOCs foretell the need for significant onshore gas processing capacity. Finally, we are starting to see the earlier signs of recovery activity in the Asia-Pacific region. The region continues to be important for us to drive services volume, but we are starting to see some new projects come up that will hopefully get awarded within this year. We have manufacturing capacity and very strong services expertise in the region that should aid us in delivering competitive customer offerings. I will now pass it over to Dave to discuss our second quarter financial results.

[David Barta:]

Thanks Girish. As I discussed our segment results, I will make comparisons to sequential quarterly performance. Starting with the contract operations segment, revenue was $91 million, while gross margin was $59 million, resulting in a gross margin rate increase to 65% compared to 63% in Q1. The sequential changes in revenue and margin were largely due to FX movements in Latin America, as well as the delta and contract recoveries. I’ll talk more about the FX dynamic shortly. In AMS, revenue was up 22% to $32 million and gross margin of $9 million increased 15% from the prior quarter. This resulted in a gross margin percentage of 27%, down compared to 28% posted in Q1. The increase in sales was due to increased part sales and commissioning in Latin America, and increased part sales in Middle East and Africa, while mix was the biggest driver in the slight margin rate decline. Revenue in Product Sales segment was $220 million and gross margin was $28 million, resulting in a gross margin percent of 13%, up from 12% in the first quarter. The sequential revenue decline was primarily a result of the timing of a couple of projects that were pushed into Q3. Another strong quarter for compression and revenue from process and treating orders while down slightly on a sequential basis, was up versus the prior year. As Andrew noted, we hit a record in Product Sales bookings of $440 million. Our Product Sales backlog was $635 million at the end of Q2, compared to $427 million at the end of Q1. I should mention that we’ve been discussing with 1 customer the potential to convert their product order to an ECO contract that we hope to have a decision on this during the quarter. SG&A expenses were flat at $44 million, as we continued to manage costs, while investing in revenue-producing initiatives, such as new product development. We referenced in the press release and earlier in our comments, FX, a topic we haven’t talked about, certainly, as Exterran Corporation. So I wanted to take a few minutes today on the call to discuss FX and the impacts on the company. FX volatility can impact a company in a couple of ways, either a transactional or in a translational standpoint or both. We have many disciplines and approaches here that it’s hard to get significant transactional impacts that would impact margins and EBITDA. Generally, we peg the contract per equipment to the U.S. dollar, even though the equipment is not -- is in a country other than the U.S. Also, our O&M contracts are generally in local currency, but so as a majority of the costs to support the contract, thus isolating us from the FX margin squeeze. Because of business practices like these, our EBITDA exposure to FX pressures is significantly reduced. With regard to translational exposures, there’s really not a way to mitigate the impact of translational foreign currency revenue into U.S. dollars. So while the gross margin might be protected, the translation impact will be a reduction in U.S. dollar reported revenue when the local currency is devaluing vis-à-vis the U.S. dollar. Year-to-date, we have seen a significant devaluation of the Argentine peso and to a lesser degree, Brazilian real. The peso has devalued well over 40% versus the dollar since the beginning of the year. So on a sequential basis, the devaluation of the peso and real is a $4 million reduction of reported sales in Q2. We’ll discuss the impact for Q3 shortly, but we expect the FX rates in these countries to be at a similar level for the remainder of this year. Turning to capital expenditures. In the second quarter, total CapEx was $45 million, driven primarily by investing in growth projects in our Contract Operations segment. Gross CapEx for the full year is expected to be around $240 million, with the growth CapEx currently estimated at $210 million, and maintenance and other to be $30 million. We expect to receive advance payments of $40 million this year, which we account for as deferred revenue. Moving to the balance sheet. Total debt at the end of the second quarter was $402 million with available credit of $566 million. Our leverage ratio, which is debt-to-adjusted-EBITDA as defined in our credit agreement was 1.8 times at the end of Q2, flat with Q1. Our long-term debt less cash or net debt stood at $383 million, up from $369 million at end of Q1, with the increase a result of an investment in growth CapEx. We are positioned well with adequate capital to take advantage of the pipeline of opportunities that we’ve been discussing. With regard to the outlook for the third quarter of 2018, from a high level we would expect to see similar EBITDA levels to what we witnessed in Q2. In Contract Operations, Q3 revenue should be in the high $80 million range with a gross margin percentage somewhere to Q2 levels. In Latin America, we expect similar FX trends to drive the sequential revenue decline. For AMS, revenue should be in the high $20’s million to low $30 million range, and margins for this segment should be in the mid-$20’s million. In our Product Sales segment, revenue should increase around 10% sequentially, with continued focus on productivity and cost out initiatives. I mentioned earlier, the ongoing discussion with one customer for the potential to convert their product to an ECO contract. If the customer elects to convert their order to ECO, our Q3 sales outlook would be flat to up roughly 5% sequentially. SG&A should be between $45 million and $47 million, with slightly higher sequential and year-over-year increase due to the incremental investments in new product initiatives. I’ll now turn the call back over to Andrew.

[Andrew Way:]

Thanks Dave. As we have stated, this will be a year of investment for Exterran as we execute our growth plan. Investment will come in the form of capital expenditures and new product initiatives. We will continue to be good stewards of capital, as we maintain our focus on working capital investing in high-return projects and product lines. The end markets continue to feel cooperative and receptive of our approach and maintain an appetite for midstream equipment and new ideas to efficiently process the increasing demands of gas production. I’ve talked in the past about our renewed focus in R&D and product development, which we believe will be additive to our regional growth strategy. Additionally, we have a corporate business development function that is fully up and running, allowing us to look at inorganic opportunities that would allow us to help continue our evolution into becoming a systems and process company. We feel we are well-positioned within the oil and gas space to capitalize on the continued global build-out and excited of the new developments within our Water business. I would like to spend a little bit of time discussing our Water business with what the addressable market looks like and where we are in the process. For the unconventional space in North America, well over 5 billion of barrels of water is produced annually. Water is a big topic within today’s oilfield service space and is a critical issue with many of our key customers. Additionally, in the conventional space, secondary water treatment is also a challenge that a lot of our international customers face from a practical and a regulatory perspective. We already have existing projects deployed and we’ll look to leverage these as a base to grow. We have a number of patented technologies that are being adapted to deliver a total solution across the water value chain. As of today, we have a series of projects with a select number of customers that are both in pilot and full production phase. With the learnings and collaborative efforts with our customers, we are introducing a total water solution that addresses key problems that the industry faced. We are pursuing multiple projects in the second half of ‘18, and are looking to further commercialize and enhance product capabilities for EWS in the coming quarters. As we look at our customers’ investment plans, we believe we are well-positioned to support them in meeting their objectives and our global footprint is a strong enabler in driving those relationships. With that, I’ll now turn the call back over to the operator for questions.

[Operator:]

[Operator Instructions] Our first question comes from Tim Monachello with AltaCorp Capital. Please proceed with your question.

[Tim Monachello:]

Hey. Good morning.

[Andrew Way:]

Good morning, Tim.

[Girish Saligram:]

Good morning.

[Tim Monachello:]

I was just hoping that you guys can give a little bit of a regional breakdown on where you saw the Product Sales bookings coming from this quarter?

[Andrew Way:]

Yeah. Sure. So this is Andrew. First of all, we saw a similar trend as we saw in the first quarter in relation to the North America markets. Permian continued to be strong. The SCOOP/STACK and kind of the regions that we’ve been talking through all year, we did have some international orders as we described on the phone that came from our Middle Eastern -- Middle East region. So the closure of the bookings that we saw in the second quarter was somewhat similar to what we saw in the first, inbound inquiries was also very similar to what we saw also in the first quarter.

[Tim Monachello:]

Would you be able to quantify at all how much you saw outside of North America?

[Andrew Way:]

Outside, we saw -- about half of the orders that we saw in the second quarter came from our international markets, both Latin America and Middle East, with the Middle East being the largest part of that percentage.

[Tim Monachello:]

Okay. Great. And are you guys willing to talk at all the which country the $150 million Contract Operations project was landed in?

[Andrew Way:]

Yeah. We’ve talked quite extensively about the various countries that we’ve seen over the past six months in terms of activity. This particular order was from Bolivia and so it further supports the region. We already have a good team in the region overall and this is an exciting project that we’re really looking forward to delivering for our customer.

[Tim Monachello:]

Great. Thank you very much.

[Andrew Way:]

Thanks.

[Operator:]

Our next question is from Samantha Hoh with Evercore ISI. Please proceed with your question.

[Samantha Hoh:]

Yeah. Hi. Andrew, could you…

[Andrew Way:]

Good morning.

[Samantha Hoh:]

… maybe tell us a little bit more about this Water business? How are these contracts structured? Is it going to hit the books on the product side or in the ECO side?

[Andrew Way:]

Yeah. So, Samantha, we’ve got two segments to the Water Solutions business that we’ve been developing. First is, what I would describe the conventional water space, and the second is the unconventional, which we have both technologies that are somewhat similar but scalable. So, first of all, for our conventional business, in the past, typically we’ve seen that come through as a Product Sale in various sizes and disguises and we are currently testing that market to really understand the appetite for a conversion to ECO or whether there’s a different model that we can operate inside that framework. And so it’s a projects business today, that certainly has the characteristics to have a long life, have the ability to generate revenue over a longer period of time and so we’re exploring that right now. And we have a number of projects that we have in the pipeline and we hope to have some positive activity here in the next several quarters. On the unconventional, the core technology is really around micro bubble flotation that really facilitate the deoiling and solids removal, in many cases, it is less than 5 PPM, and so we have a number of different applications that we are applying it. We have about nine patented technologies that we cover today in that space, and right now, the key differentiator that we feel is that, for the unconventional, it’s the scalable smaller footprint mandate unit, what we call a mobile solution that does both primary to a secondary and tertiary, all in one go. And so we are excited about the technology there and we’re really testing the business model as we speak. We have a number of pilots today in play with a number of key players in the industry, and we’re just testing the commercial side of things to really ascertain whether this is more of an ECO product or a Product Sale, if you like, and right now, we’re testing as we speak. But are very encouraged with the initial results and we hope to have more updates for you over the coming quarters.

[Samantha Hoh:]

And it sounds like there’s an aftermarket component regardless of if you do Product Sales or ECO. I mean, it sounds like it’s -- there’s like real long life to this type of equipment that you’re putting out on the field. Can -- is there anything you can tell me in terms of like what kind of margins you would envision? Is there seasonality in terms of when those maintenance would be for these type of equipment?

[Andrew Way:]

I think it depends on the model that we ultimately work through, Samantha. I think, if you can picture a Product Sale and you put a unit at a customer location, there’s an element of service that’s required for sure, and that asset has a useful life over a period of time and there are various parts of that application that the customer would want interaction with Exterran. I think until we finalize whether it’s an asset that we serve through the ECO model or product sales, it’s hard to define. So we’ll have a better feeling on that as we trial some of these units and bring it to the full completions to the commercial cycle. We hope to have a better update on that here in the next quarter or so.

[Samantha Hoh:]

Okay. Great. Thanks so much.

[Andrew Way:]

Thanks, Samantha.

[Operator:]

[Operator Instructions] Our next question comes from Joe Gibney with Capital One. Please proceed with your question.

[Joe Gibney:]

Yeah. Thanks. Good morning. Just wanted to circle back a little bit on the order indicator side. So it sounds like pretty constructive broad-based view on both P&T and compression lifts internationally. I understand the Permian air pocket, that’s very well advertised. But just trying to get a sense of sort of what coalesced in 2Q on the international side? Was it a situation where you had order indicators that were in queue for a while or it just all came together at once? I’m just trying to get a sense of the extent of momentum on the international order side as we look into the back half of the year, I appreciate any color there.

[Girish Saligram:]

Hey, Joe. This is Girish. I think on the international side, a lot of it really is, as I mentioned earlier in the prepared remarks, these cycle times tend to be a lot longer. So it’s tough, deals that have been in the pipeline for quite a while that we’ve been working and planning through with the customers on how to bring it to fruition. So that was really the main driver. And again, the majority of deals in the international side tend to be ones that go through a fairly rigorous tender process. So the timing on that tends to be a little susceptible to change over several months and quarters. So we expect to see there will be further orders, there will be further contracts, but spread over time in the next several months. So this particular set of orders were spread geographically, as Andrew mentioned, between Latin America, as well as the Middle East and some of them are orders that come with options for subsequent trains as well that we would hope in the next several quarters will come to fruition.

[Joe Gibney:]

Okay. Understood. And Andrew, just a question on aftermarket, that’s certainly has been a focus for a while, on seeing this lift a little bit more in the portfolio. Sounds like a nice step up, certainly in results in 2Q, sounds like some continued momentum into 3Q. Maybe if you could touch on some initiatives there? You have sort of rejigged the team a little bit there and you certainly tried to engender more of a focus here, with an aftermarket within the company. So appreciate any comments there. It was a nice step up in 2Q.

[Andrew Way:]

Yeah. I think you hit the -- you hit it, right. I think we’ve kind of gone back to basics in some areas and put together a real solid team and we’re very proud of what the teams are looking through right now. We’re just seeing more opportunities with the -- this notion of availability and reliability, and try to move this needle from just a fewer parts supply to more of a unit that focuses on productivity for our customers. And so we spend a lot of time internally, really leveraging the success that we’ve had internationally with our own ECO business and really understanding what it takes to run those facilities at the level of efficiency that our customers have been enjoying from our experienced team in the field and just really try to replicate that in the various regions. I think there is definitely some momentum that’s built-in in Latin America. There’s no question we’re seeing more inbound opportunities. We’ve got better coverage today. So we’re seeing more opportunities that perhaps before we were not and we just continue to be pleased with the level of success and win rate that we’re seeing in the various locations. So it’s -- the results of a lot of hard work, and hopefully, it will continue throughout the balance of this year and into next year.

[Joe Gibney:]

All right. I appreciated guys. Thank you.

[Operator:]

Ladies and gentlemen, we’ve reached the end of the question-and-answer session. At this time, I’d like to turn the call back to Andrew Way for closing comments.

[Andrew Way:]

Yeah. So I’d like to thank everyone for dialing in today. We appreciate your continued support and look forward to updating you at the end of the third quarter. Thanks very much.

[Operator:]

This concludes today’s conference. You may disconnect your lines at this time and we thank you for your participation.