CSI Compressco LP

Thank you, Nick. Good morning and thank you for joining CSI Compressco’s third quarter 2020 results conference call.

I would like to remind you that this conference call may contain statements that are or may be deemed to be forward-looking. These statements are based on certain assumptions and analyses, made by CSI Compressco and are based on a number of factors.

These statements are subject to a number of risks and uncertainties, many of which are beyond the control of the partnership. You are cautioned that such statements are not guarantees of future performance, and that actual results may differ materially from those projected in the forward-looking statements.

In addition, in the course of the call, we may refer to EBITDA, gross margins, adjusted EBITDA, free cash flow, distributable cash flow, distribution coverage ratio, backlog, leverage ratio or other non-GAAP financial measures. Please refer to this morning’s press release or to our public website for reconciliation of non-GAAP financial measures to the nearest GAAP measures.

These reconciliations are not a substitute for financial information prepared in accordance with GAAP, and should be considered within the context of our complete financial results for the period. In addition to our press release announcement that went out earlier this morning, and as posted on our website, our Form 10-Q which are filed with the SEC this morning.

With that, I will turn it over to Brady.

Thank you, Elijio. Good morning everyone.

And thank you for joining CSI Compressco's third quarter of 2020 earnings call. I'll get a recap of our third quarter performance and turn it over to Roy to introduce our new compression telemetry technology, followed by Elijio to provide some commentary on the balance sheet, cash flow and liquidity.

Despite the very difficult macro environment for our industry with US land rig count dropping 36% sequentially, CSI Compressco delivered solid financial results. Adjusted EBITDA margin of 35.1% were the highest since the acquisition of Compressco Systems Inc.

Excluding the new equipment sales business that we've made the decision to exit revenues held up well decreasing by only 1% to $72.3 million from the second quarter. Adjusted EBITDA improved sequentially by $723,000 and adjusted EBITDA margins improved by 700 basis points.

Adjusted EBITDA included the benefit of $5 million from the sale of used equipment as we continue to rationalize the fleet of underutilized smaller units. The CSI Compressco management team has done a great job streamlining our operations and reducing overhead costs.

Corporate SG&A expenses were reduced by another 10% from the second quarter. Despite staff and cost reductions and the exit of the fabrication business, the team has continued to operate safely while supporting our customers as they rationalize the amount of horsepower they require.

Mechanical availability of our equipment and our customers' network continues to be high, with our high horsepower units, operating at over 98% mechanical availability for the quarter to support our customers operations. Compression services revenue decreased 5% sequentially reflecting pricing pressures, equipment on standby and a slight reduction in utilization.

Gross margins remain healthy at 52.9% as pricing pressures and equipment on standby were largely mitigated with lower field operating costs. Utilization declined from 82.1% in the second quarter to 80.3% in the third quarter, and was in line with our expectations.

We are currently above the low point of utilization from the 2015 to 2017 downturn, despite this downturn being much more rapid and severe than the previous one. Our shift towards the higher horsepower units and concentrating on the larger, better capitalist customers is reflected in our results, as gross margins have remained above 50% compared to the low point of 43% in the last downturn in 2017.

The ERP system we developed and have been using now for a couple years has given us the tools, reports, dashboards and KPIs to quickly focus on those areas that are underperforming and our team can quickly address. As a result, operating costs have been reduced by 23% from the peak in the first quarter of 2019.

We will come out of this downturn with a much leaner cost structure and a more efficient organization. Horsepower on standby peaked at 226,000 in May, representing almost 20% of our fleet, and has been improved to 78,000 horsepower on standby at the end of September, representing approximately 8% of our fleet as our customers have been bringing production and units back online.

Our customers are working to maintain their production levels given the significantly lower levels of drilling activity. They are finding that our 1,380 horsepower units perform more efficiently and cost effectively on multi well pads with long laterals when compared to other forms of artificial gas lift, such as electrical submersible pumps.

As a result, more and more of our big units are performing centralized gas lift, particularly in the Midland basin of West Texas. The wells that were brought online in the Delaware basin in 2019 are now seeing production drop off, and we are seeing opportunities to also deploy our big units into the Delaware basin to enhance production on wells drilled from last year and earlier this year.

With improved outlook for natural gas prices and a period of transition as producers focus on maximizing returns and free cash flow. We believe production enhancement strategies on existing and aging wells are becoming a greater priority for a broader group of producers.

And as well pressure to decline compression is a low cost solution for producers to increase base production of liquids and gas. In this new environment, our smaller gas deck compressors are also seeing demand to enhance production on smaller or single well applications.

We expect gas lift to continue to take market share, as it reduces lifting costs and increases reliability of horizontal shale wells. Our fleet is well suited to meet the market of this increasing demand.

Aftermarket services are remains a focus for us as it does not require capital to generate earnings and free cash flow. Aftermarket services revenue declined 12% sequentially while gross margins improved 20 basis points to 14.8%.

Aftermarket services are expected to gain momentum going into 2021 as our customers' deferred required maintenance this year as they work to conserve cash. But this can only be done for a limited period of time before their equipment begins to shut down or operate less efficiently.

We recently secured a major account with a large midstream provider on advanced stages of security another one to provide parts and services to their fleet of compressors on their networks. This is expected to have a meaningful impact on our revenues going into 2021 and beyond.

Overall, I want to again commend our management team and employees on safely and efficiently delivering a good third quarter and an incredibly difficult environment. I'll turn the call over to Roy McNiven to introduce our new compression to limit your system that we are branding Helix.

Roy runs our compression services and aftermarket service business has been focused on our next generation technology deployments to further enhance profitability and improve our customer service ROI.

Thanks, Brady. We've previously highlighted the investments we are making and updating our telemetry solution.

Having already completed the ERP implementation and back office integration, we're now looking to modernize our telemetry solutions as a means of driving incremental performance improvements, customer service and creating meaningful differentiation. Today, we're excited to introduce Helix digitally enhanced compression.

Helix is the brand name for our new telemetry solution and is a product of a significant amount of time and effort spent scoping and gathering requirements to produce a unique digital solution that delivers significant value to our customers differentiating our customer progression services solution. A common theme across our customer base when it comes to priorities is reliability.

Reliability is a key to maximizing and maintaining 24x7 productions. In compression, we measure reliability in terms of runtime, and mechanical availability, and it's common for contracts to call out guarantees of between 95% and 98% mechanical availability.

Brady mentioned that in the third quarter, we operated our large compression fleet with a mechanical availability of 98% which sounds pretty good and is very competitive in today's compression industry. However, could you imagine if an airline engine operated at only 98% mechanical availability, with the introduction of Helix, we can do much better and customers will reward better performance?

A big part of compression runtime performance is predictive maintenance and anticipating failure modes well in advance of catastrophic failure. This in addition to identifying and rectifying operating conditions that are not in support of optimized production.

The key to predictive maintenance is really receiving highly reliable, high fidelity data and using that data along with machine learning to constantly improve runtime performance and reduce costs from expensive failures. Predictive maintenance is more cost effective than scheduled and reactive maintenance.

So what is Helix? Helix is not a typical out of the box telemetry system.

Helix is a hybrid solution that incorporates some of the most advanced leading edge technologies forcing a step change in compression and reliability. With a seamless and reliable flow of high fidelity, real time data through a secure and robust connection from our compressor packages to our Azure Event Hub in the Azure Cloud, our customers, sales team management and technicians will have access to real time information and compression package performance metrics 24x7.

The user interface creates an enhanced user experience through the availability of real time analytics; performance reporting, diagnostics, and troubleshooting that support a more reliable higher performing compression solution. Using our in-house custom front end application and CSI Compressco's Data Lake, our team of telemetry analysts who collectively possess over 240 years of industry experience, perform runtime and reliability analytics.

This is in addition to supporting our highly skilled team of technicians and customers remotely from our reliability center. Here, Helix leverages the decade of compressor analytics and data we have collected as baseline data, accelerating efforts and creating and implementing effective machine learning algorithms to enhance our predictive maintenance programs and compressor performance and reliability.

In our press release, we mentioned our partnership with Houston's Rice University D2K team, a program dedicated to addressing Big Data solutions. D2K is our acronym for Data to Knowledge.

In our front end, our front end application is also seamlessly integrated with ERP system, which has been instrumental in the automation of numerous processes, and is driving cost reductions through efficiency gains since its introduction in 2017. In summary, Helix will deliver the modern look and feel when it comes to protection today's age, along with the high fidelity required by customers and required to facilitate enhanced predictive maintenance programs, leveraging machine learning while tying into customers Big Data strategies.

Helix will further advance CSI Compressco and their use of technology and enabler to deliver higher levels of performance, customer service and value. The Big Data will allow us to more cost effectively and proactively maintain our equipment.

As for a timeline, we're currently in the process of deploying our updated IoT gateways and expect to have approximately 25% of our fleet upgraded by the end of the fourth quarter of this year. We're also upgrading our front end application with the target of go live date at the end of the first quarter 2021.

Starting today we're launching our Helix solution and communicating how we leverage technology to further enhance our compression services solution. We will do this in the coming 10 to 12 weeks through various media initiatives.

The feedback we have received from previews we have done with some of our super major customers has been very positive and they have indicated this will leapfrog anything out in the industry today. I'll now turn the call over to Elijio.

Thank you, Roy. Brady mentioned that we generated $27.8 million of adjusted EBITDA in the third quarter and included the benefit of $5 million from the sale of used and valuable assets.

We count the sale of used asset as EBITDA given that there is no current year cash costs associated with those revenues. Without the $5 million of sale of used assets, adjusted EBITDA was $22.8 million in the third quarter.

We expect another $8 million of used unit sales in the fourth quarter, as we continue to monetize assets that are under sized or not adequately utilized. Cash on hand at the end of September was $16.7 million, which is up $2.4 million from the beginning of the year.

At the end of September, there are no amounts outstanding on our revolver, compared to $2.6 million that was outstanding at the beginning of the year. The reduction in the outstanding amount on the revolver plus the increase in cash represents almost a $17 million improvement from the beginning of this year despite the very challenging market conditions.

And this is after we paid $4.8 million of legal and advisory fees to compete the debt swap in June of this year, which is a reduction of total debt, which resulted in a reduction of total debt of $9 million and push $250 million of maturities into 2025 and 2026. Brady mentioned that we sold our Midland fabrication facility and related real estate and that we have targeted the sale of $13 million of compressor assets in the second half of this year.

We are improving our fleet, selling older, idle smaller units to generate cash to either retire debt, investing in the technology that Roy mentioned, that we believe will generate higher operating margins or investing in our larger compressor units. We are focused on high-grading the fleet and continue to move towards the higher horsepower units.

Our objective is to generate $15 million to $25 million of free cash flow by early in the third quarter of 2021. To partially pay down the maturing $81 million of unsecured notes and to refinance the remaining amount.

We see limited growth going forward going towards growth capital in the next 12 months as we focus on debt reduction. Growth capital expenditure opportunities are targeted to be funded by the sale of smaller units.

For the full year 2020, we expect growth capital expenditures of between $6 million and $7 million. We expect maintenance capital expenditures of between $20 million and $21 million.

We're able to reduce capital expenditures by almost 25% in the third quarter from the third quarter of last year reflecting a slowdown in activity level. We continue to invest in technology to drive greater margins and enhanced returns.

This year, we expect to spend between $5 million and $6 million, primarily on the Helix system as mentioned earlier. Other than the $81 million of unsecured notes that are due August 2022, the $555 million of first and second lien bonds are not due until 2025 and 2026.

Our net leverage ratio at the end of September was 5.4x. This compares to over 7x during the prior downtrend.

And as I've mentioned before, we don't have any maintenance covenants that we need to comply with. And also, as mentioned earlier, we don't have any amounts drawn on a revolver.

We generated $14 million of free cash flow this quarter as we sold our Midland fabrication facility and other smaller underutilized assets which generated approximately $21 million of cash. For the total year, we anticipate generating a total of $30 million of cash from sale of smaller and underutilized assets and from the sale of our fabrication facility in real estate.

September year-to-date we generated $13.7 million of cash from operating activities. Free cash flow for September year-to-date was $24.7 million.

Distributable cash flow was $10.5 million in the third quarter, which increased by 25% as we benefited from the sale of used units. Through September, distributable cash flow was $27 million.

On an annualized basis, distributable cash flow would be $36.5 million, or $0.77 per common unit. This compares to our unit prices, close of business on Friday of $0.8s.

This is not a bad cash yield. Overall, we had a good quarter, completed the sale of smaller, underutilized assets and exited the fabrication business and monetize those assets, generate liquidity to improve our balance sheet.

We continue to invest in technology to reduce headcount and maintain good margins despite price pressures that we are seeing across the industry. And if natural gas prices go higher due to a drop off in shale gas production, CSI Compressco was positioned to deploy our big unit toward centralized gas lift applications in our smaller units to enhance production from the smaller wells.

We are pleased with how we are managing through this downturn as we reposition our fleet, deploy technology and concentrate our opportunities with a larger; low capitalized customers that we will develop in the coming market. With that Nick, let's open it up to see if there are any questions out there.

Good morning. A few questions for you.

Maybe starting with Helix, sound interesting but I always believe in sort of seeing is believing. What exactly are you offering?

Is it an up charge service? Or is it just better maintenance through the preventative maintenance that will allow your customers just to operate, up and running more consistently?

That's a good question and clarification. So Helix is a telemetry solution that we have on our concession packages.

And it consists of an IoT gateway that collects data from multiple points on the actual package. And as an example, a 3516 unit would have 76 different data points that it gathers.

That information is then streamed through to our front end application; we will make that available to our analysts who are looking continuously at the performance of the package. Working with predictive maintenance solutions enhanced by machine learning to predict failure prior to catastrophic failure or shut down.

And it's also providing a dashboard of metrics, compression, performance, metrics, and information to our customers, and to our all of our management team. And so it's providing a lot of visibility.

It's something that we've outfitted and we will update our entire fleet of compressors with, as well as offer it as a software as a service through our aftermarket service and [Tech Difficulty] compression.

Brian, I'll add that having predictive maintenance will make us more cost effective rather than have scheduled maintenance. And also allow us to be more proactive in any downtime with our equipment.

And as Roy mentioned, as we preview this with some of our customers, the feedback has been very, very strong and positive.

Got it. So this is more of as I think about this going forward, this is more about the savings that you'll see rather than a revenue opportunity in summary, is that correct?

Yes, the only thing I would add to that, Brian, we will definitely realize some savings from a maintenance perspective. But I mean customer selection of compression, one of the -- top reasons why they pick compression companies is based on the reliability on the runtime of your compressors because it's directly related to their daily production.

So we would expect market share gains and premium pricing where we have our Helix deployed.

Understood, got it. And then maybe switching gears, Elijio, as we think about sort of CapEx spending, I know you've got -- you said it's $20 million to $21 million for maintenance, if you think about growth CapEx spending, and I'm looking at these unsecured debt mature for another call it 20-months.

How are you sort of the balancing current property purchasing some of those unsecured in the open market versus investing in the company in growth projects?

So, Brian, we've got very little growth capital right now ahead of us. Anything that comes up is going to be unique to a specific customer.

And it's going to be targeted toward our top two to three super majors in our well capitalized because we might not have that equipment in the fleet. But at this point, the amounts are minimal given that we do have some idle equipment available.

We've see that we've been generating cash flow from month-to-month, quarter-to-quarter earnings. You've seen that we're generating cash, also from monetizing some of the smaller, older underutilized assets.

We believe that we can accumulate anywhere between $15 million and $25 million of cash between now and August of next year in less than the next 12 months. We'll use that to prepay or retire some of the $81 million.

And we fully expect to find a market to refinance the other $60 million or so.

Got it and that refinance, you're going to aim for late next year, I'm assuming?

Yes, our intention is not to let it go current and to refinance it before we have this call improvement.

Okay, that makes sense. Just final question for me, outside of which what you've already discussed about in terms of asset sales, is there anything else that we should be thinking about as potential sources of cash over the next 12-months?

Now, we'll just do aggressive, good old fashioned cost management to drive earnings and have current period cash earnings covering interest expense to cover any maintenance capital; we will continue to prune the fleet, look at anything that we don't believe will get us a decent return, and we'll look to sell those into the market. We think that the combination of those two will put us in a good position to generate cash and refinance the $81 million.

Got and actually, I like to get one more free; just any thoughts on the pricing environment or your competitors acting rationally? Just love your final thoughts on that.

Yes, Brian, since we have Roy here who's closer to the day-to-day with our operations; I'll let him respond.

Sure. Brian, so we do continue to see some pressure on pricing, highly dependent on the market, the region and the customers.

And at this point in time, we're seeing the majority of our competitors out there, show some restraint with respect to pricing. Although some of the smaller players do continue to seem to be lowering their expectations, when it comes to pricing.

And, Brian, I'll add, in the last downturn that lasted a little over three years, the cumulative price discounts were in the high single digits, which mirrors what we're seeing today. And also remember that the swap out cost on the big unit is incredibly expensive.

And the industry has been disciplined and everybody has pretty much stayed on their own swiveling and swapping out one service provider for the other for a price discount and paying a significant swap out cost; doesn't make it economical for the customers. And that's what we think has led to a level of pricing discipline that is not seen in some of the other markets in the energy sector.

Thank you, Nick. We appreciate everyone's interest in CSI Compressco and thank you for taking the time to join us this morning.

This concludes our call.