Southcross Energy Partners' (SXE) CEO John Bonn on Q4 2015 Results - Earnings Call Transcript

| About: Southcross Energy (SXE)

Southcross Energy Partners LP (NYSE:SXE)

Q4 2015 Earnings Conference Call

April 22, 2016, 11:00 ET

Executives

David Lawrence - VP, Treasury & IR

John Bonn - President & CEO

Bret Allan - SVP & CFO

Analysts

Andrew Burd - JPMorgan

Neal Sengupta - TPG Capital

Operator

Welcome to the Southcross Energy Fourth Quarter and Year-End 2015 Conference Call. [Operator Instructions]. It is now my pleasure to introduce your host Mr. David Lawrence Vice President of Treasury and Investor Relations. Thank you, you may begin.

David Lawrence

Thank you, Operator and good morning everyone. We appreciate you joining us for the Southcross fourth quarter and full-year 2015 financial and operating results call. With me today is John Bonn, our President and Chief Executive Officer and Bret Allan, our Chief Financial Officer.

Before we begin, I would like to remind all participants that our comments today will include forward-looking statements. It should be noted that a variety of factors could cause the Partnership's actual results to differ materially from those anticipated results or expectations expressed in these forward-looking statements. For a complete discussion of these risks, we encourage you to read the partnership's earnings release and our documents on file with the SEC.

Today's call will also contain certain non-GAAP financial measures such as gross operating margin and adjusted EBITDA. You can refer to the 10-K that we issued last week for important disclosures and reconciliations regarding such measures and their definitions. The 10-K is available to view, print or download on the Investor Relations tab of our website at www.southcrossenergy.com. That section of our website also includes reconciliations to the non-GAAP measures that we will discuss on this call in connection with our 2016 guidance.

Now with those opening remarks, I would like to hand the call over to John Bonn, our President and Chief Executive Officer. John?

John Bonn

Thanks, David. Good morning, everyone and thank you for joining us. I recognize it has been a while since we last talked to you. We want to take this opportunity to provide an update on recent developments to Southcross, in addition to reviewing our fourth quarter results. Before we discuss the fourth quarter, I think it is important to address the successful emergence of Southcross Holdings from Chapter 11 bankruptcy. I'm very pleased to have the restructuring of Holdings behind us, so that we can focus our time and effort entirely on positioning Southcross to not only weather the current market environment but also for future growth.

I would like to remind investors that Holdings owns 100% of the general partner interest in Southcross, roughly 60% of the limited partner interests and also owns two important operating assets - the Lancaster gathering and treating system and the Robstown Fractionator. Both of these are fully integrated with the Southcross system and operations. While Southcross was not involved in the Holdings' restructuring, the successful completion has very clear benefits to all of this company's constituents. Among the most tangible benefits was the repayment of all past due inter-company receivables owed to Southcross by Holdings and a new $50 million equity commitment. Equally important is that Holdings is well capitalized and has sufficient liquidity to support future growth and development, thanks to the support of our lenders and private equity sponsors.

TIG Global Energy Partners and Tailwater Capital have invested a combined $170 million of new equity in the Holdings, including the $50 million equity commitment to the MLP. We believe the success and speed of the Holdings restructuring demonstrates the strong conviction of the Holdings lenders and our private equity sponsors in the future of Southcross. With that background, I will now provide a brief summary of our fourth quarter results with MLP. Against the backdrop of continued low commodity prices and reduced drilling activity, we had a successful quarter with both strong EBITDA and volume performance.

Our adjusted EBITDA was $24.9 million, an increase of 6%, compared to the third quarter. Our fourth quarter processed gas volumes of 437 million cubic feet per day were consistent with the third quarter and down only slightly from the start of 2015. We continue to believe in the competitive strength of our fully integrated system of assets, our strategic position in the core areas of Eagle Ford and our direct access to the premium Corpus Christi market. However, we also recognize the continued uncertainty around volumes for the remainder of 2016 and beyond in the current lower for longer commodity price environment.

We're focused on positioning Southcross for success during this period of market uncertainty and to take advantage of growth opportunities as they arise. As a result, we're aggressively evaluating our operating G&A expenses, as well as our capital budget. We believe that there are additional opportunities to reduce our expense structure and growth capital expenditures while maintaining our commitment to safety and reliability and also driving EBITDA growth and cash flow.

We're also vigorously pursuing new customers and expanding our relationship with existing customers through creative contract structures and we have already seen success with this effort. I am confident about the future of Southcross. And together with the rest of our leadership team, we're committed to taking the right steps to position the company to maintain profitable operation within the current environment and generate returns to our unit holders.

With that, I'll now turn the call over to Bret to discuss our fourth quarter results and outlook for 2016.

Bret Allan

Thanks John and good morning everyone. I'm going to start with a review of the fourth quarter and then provide some guidance on for 2016. As John noted, we delivered adjusted EBITDA of $24.9 million for the fourth quarter which was at the top end of our guidance range of $23 million to $25 million. A few drivers of these strong results are - increased Y-grade production due to higher recoveries at our processing facility, an increase in gas volumes associated with higher margin customers and higher margins for our Mississippi and Alabama system.

O&M expenses for the quarter were $21 million, about 10% higher than third quarter. This is driven by the timing of certain expenses - specifically, there was an annual true up associated with the T2 joint venture. In addition, we completed several preventative maintenance projects that been deferred from the first half of the year. Adjusting for these timing items, a normalized quarterly average O&M is about $18 million to $19 million which is in line with prior quarters. G&A expenses were $6.4 million, compared to $6.8 million in the third quarter. This 6% decrease reflects our continued efforts to lower our overhead cost structure.

In an ongoing effort to control costs, we will remain diligent in our management both G&A and O&M expenses in the coming months. At the end of December, our outstanding debt was $609 million, including about $182 million on our revolver. Our leverage ratio for the fourth quarter was approximately 6.3 times and was 5.75 times at the benefit of a $14.9 million equity cure which was funded on March 30. The equity cure included a cash contribution from Holding - $11.9 million and the remaining non-cash amount of $3 million is available under our credit agreement. The $11.9 million has contributed under the terms of the recent $50 million contribution agreement entered into withHolding. We expect to issue common units of Holdings shortly, as consideration for the cash contributions.

Looking ahead to the first quarter of 2016, we're expecting adjusted EBITDA to be between $20 million and $22 million. This decreasing EBITDA from fourth quarter 2015 is driven by decline in processed gas lines during the first quarter, partially offset by higher NGL prices and an associated increased in fractionation spreads. The most significant factor affecting volumes in the first quarter was an outage at the Holdings' own Lancaster gas treating facility that begin in mid-February. These Holding volumes ultimately flow to the Southcross processing facility, per our inter-company agreement. There was a fire at the Cowden State handling facility and while it did not directly affect the treating facility, it required the plant to be shut down until new Cowden State facilities were installed. In addition to these new handling facilities, Holdings elected to use this downtime to accelerate a variety of planned operational upgrades. As a result, operations at Lancaster did not restart until early April.

Volumes have begun to ramp back to pre-outage levels over the last few weeks and continue to be directed to Southcross for processing. Plant upgrades will provide increased reliability and help to enhance operational efficiency going forward. Other drivers of the volume declined during the first quarter included relatively modest production declines from a few producers, as well as the previously announced early contract termination by Sanchez. As a result, our volumes for the first quarter of 2016 are expected be down around 20% from our fourth quarter volume. While this decline is disappointing, I want to point out a few facts.

First, volumes on our Lancaster system returning to fourth quarter averages. Additionally, we're benefiting from increased volumes through several customers on our system who recently completed some ducts. Finally, our fixed NVPs provide margin protection from lower volumes. However, we recognize that, consistent with the broader market, 2016 volumes overall will be down from 2015. Our current anticipated incurred growth capital spend for full year 2016 is in the range of $20 million to $30 million. This lower number is the result of our ongoing effort to scrub our capital spending, based on our current needs.

We're laser focused on using free cash flow from the business to pay down debt and reduce our financial leverage. We continue to evaluate opportunities to lower our cost structure and focus our growth capital expenditures on near term growth initiatives and activities needed to ensure the safe and reliable operation of our business. We do expect to utilize some portion of our remaining $38 million of committed equity cure to remain in compliance with our credit agreement leverage covenant, as it steps up to five times by year-end. However, the dollar amount of the potential equity cure, will depend on a wide range of factors including, 2016 volumes and the actual amount of growth CapEx incurred.

As John mentioned, the completion of the Holdings restructuring gives Southcross significant liquidity, including cash on hand and availability under our revolving credit facility. Further, we expect that the business will continue to generate free cash flow that we can use to reduce our debt.

With that, I'll turn the call back over to John for a few closing remarks before we open up the line for questions.

John Bonn

Thanks, Bret and thank all of you for joining us this morning. We're committed to taking the right steps to ensure the future success of Southcross. While we recognize that the last few months have been very difficult for our unit holders, we believe that the steps we have taken were prudent and necessary to weather the current commodity price uncertainty, to provide a path forward for sustaining growth at Southcross and to generate future returns for our unit holders. Now we'll open up the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Andrew Burd from JPMorgan. Please go ahead.

Andrew Burd

First one is with the first quarter now complete about a month afterwards is there anything you can share about the need for the equity tiers in the first quarter maybe the quantum of what that would be?

Bret Allan

I think right now we're expecting to have very minimal need for equity tiers in the first quarter. We have the benefit of the prior equity tiers that we've done to-date so I think it will be pretty modest.

Andrew Burd

Okay and then have you contacted by any chance your bank group to extend the higher covenant waiver because I believe your leverage covenant comes in through the end of the year to five times if I'm not mistaken

Bret Allan

It does, it does step down to five times by the fourth quarter of 2016 we have not had discussions with the bank group at this point around making any modifications to that, we really been focused on getting holdings through the restructuring and we feel very good about the success we had accomplishing that.

Andrew Burd

And then last one on the capital structure I believe the holdings has the right to buy in the partnership once the certain threshold of ownership has been met. I think it was 80% correct me if I'm wrong, does that only apply to common units outstanding or does that apply to LP units outstanding in other words incorporate subordinated and preferreds as well.

Bret Allan

Essentially they have to own 80% of each class of the units in order to call in the remainder.

Andrew Burd

And then on the operation side any insight into how many rigs are currently operating on your acreage and any insight into stock inventories?

John Bonn

The rig counts are down obviously I think there's only about 42 rigs in all of Eagle Ford right now and we’ve just seen a continued drop in our areas as you can expect. The primary of web [indiscernible] continue to be the most active along with La Salle but the activity is definitely down. We haven't really gotten the 2016 plans yet from our customers, they are wrapping those up. A lot of them will be having earnings call here in the next couple of weeks as well and they are finalizing the plans but what we're hearing is that they are probably -- their budgets for the year are 40% to 50% of what they were last year.

Andrew Burd

That's very helpful thank you and obviously everyone has limited insight there so appreciate the color. In terms of the expenses in the fourth quarter I think last call you indicated that they are seasonally lower and backing out the one-time items, it still seems it was roughly flat sequentially, is there anything to that or is the kind of 18 million number that was quoted a good run rate going forward on the OpEx side?

Bret Allan

I think Andy as I pointed out in my prepared remarks thinking $18 million - $19 million OpEx range is a good run rate and that's what we're continuing to try to achieve throughout the year obviously there are a number of seasonal impacts but we have continued to work diligently to manage the cost to that level and I think we have a path to get there for 2016.

Andrew Burd

And then last question for me is on the -- I believe in he holdings reorg process there were some longer term guidance provided in terms of EBITDA that you intent or could achieve, any insight into some of the numbers or assumptions behind that is it mostly a volume assumptions or is that a commodity price increase assumption or anything would be great on that. Thank you.

Bret Allan

Sure, on those projections that we put out as part of that 8-K it does assume a modest commodity price rebound really in the very late we '16 into 2017 and corresponding drilling activity coming back into the Eagle Ford but it's a fairly modest increase in line with the curves that are out, the forward curves I think the biggest difference that I highlighted on the comments was around the capital we have particularly our projected capital needs based on the current needs of the business.

John Bonn

I would like to follow up on your question about activity if you don't mind. This is John again. The obvious question is how we are going to respond to that and as you know that we spent after the merger with TexStar in '14 we spent considerable amount of capital and effort integrating our assets connecting our processing plants to each other and the frac reconnects the frac facilities and frac facilities directly connected to each other etcetera, as we see volumes in activity decline those efforts are going to allow us to evaluate our system and take advantage of that interconnectability to leverage volumes where we need to see and create operating efficiencies and loads facilities in the most efficient manner and is a direct driver for some lower operating costs as we go forward. So I just want to point out that those are the things that we're working on as we react to the slowdown on the drilling activity.

Operator

Our next question comes from the line of Neal Sengupta from TPG Capital. Please go ahead.

Neal Sengupta

I was wondering if you could quantify -- you mentioned that your EBITDA [ph] guidance is 21 million context for 1Q '16, and you see that trending back to 4Q '15 levels for 2Q '16 and part of the volume decline is associated with an outage and some of it is associated with actual declines of your customers. I was wondering if you can breakdown what percentage of decline was due to outage versus the customers. Just trying to get a sense for the trends that you see in volumes they are being processed?

Bret Allan

For the outage that occurred holdings own Lancaster facility, about a six week outage to rebuilt those condensate facilities and due to the other operational upgrades that we had scheduled really for staggered throughout 2016. We took advantage of the outage to accelerate those upgrades and significantly improve the operating reliability of the system, however that outage does have an impact to MLP, I would estimate that the margin impact for that outage that occurred in the quarter was probably on the order of $1.5 million and we will see a little bit of that bleed into the second quarter as well since the plant was down at the very early part of April but we think based on the volumes that we're seeing coming back up we think the back half of the second quarter and then going forward will be more in normalized run rate.

So I think you could add back from our guidance of the first quarter about that 1.5 million on a run rate basis. Just to point out, I know we get questions about it. We do have business interruptions insurance and we will be filing a claim for that however there is a 30 day period on that so we expect the claim will be a fairly small for the MLP.

Neal Sengupta

And I guess one additional follow-up kind of associated with, you mentioned your capital budget, can you break down what you're ongoing maintenance budget is based on the volumes you saw in 4Q '15 versus your growth? I know you mentioned in the call I just wanted to make sure I got that right.

Bret Allan

Right. Maintenance capital budget in 2015 we incurred between $11 million and $12 million of maintenance capital, we do expect to achieve lower levels in 2016 probably closer to $9 million to $10 million of total maintenance capital for the year.

Neal Sengupta

And the remaining 15 and 20 or is it 25 to 30 or so with the growth?

Bret Allan

The number that I quoted for the growth capital--

Neal Sengupta

Of 20 - 30.

Bret Allan

Yes, that’s excluding the maintenance capital.

Neal Sengupta

Got it, 30 to 40, context, so significant ramp down from last year. You’re more focused on near term projects more immediately realizable and can you talk about I know that you probably are not [indiscernible] some of the conversations that are going, some of your stress customers but [indiscernible] to you briefly mentioned their capital spending budgets in terms of production at Eagle Ford, what's their focus is on in terms of when you are looking at the forward curve for natural gas and they are putting in their own hedges to kind of start generating cash flows from the wells they have already drilled but haven't completed -- do you’ve a sense for what the breakeven for the Eagle Ford region is now versus six months ago with some of the elements of the cost structure is coming down. I know it's a high-level question, I know it's different every single county but you guys are in the biggest county in terms of natural gas production, so want a sense for what you thought the bellwether level was in terms of being production cuts or production increases.

John Bonn

Well I think you kind of answered your own question sorry, but you’re exactly right it varies from county to county and IP rates are a big impact obviously and you also noted that the counties I mentioned earlier were still a higher levels of activity and [indiscernible] and web, we obviously are in those counties and pull supplies out of those areas and gather volumes and have customers in those areas. You know I don't know that we have anything any new information anyone else doesn’t have, you're probably in that $50 seems to be a magic number but in certain areas $40 seems to be sufficient for them to earn returns. It just kind of varies on county by county and certain spots within those counties so it's really kind of hard to give you any real general guidance there for that.

Operator

Our next question comes from the line of Theodor Eike [ph], a Private Investor. Please go ahead.

Unidentified Analyst

I had a question about, you may already have answered this it was related to the news release on the fatalities at the plant a few weeks ago. And I wondered if there was any residual impact on that in terms of litigation or anything that could impact your PR stance in terms of customer accounts.

John Bonn

First of all it was a very tragic event and we're extraordinarily saddened by the incident and the loss of life. While there is an investigation going on, independent investigation we're doing our own internal investigation, the facts that we know are that we had a third-party contractor performing some work that is routine in our industry at one of our pipelines at the tailgate of the Woodsboro processing plant. Early indications are that the piece of equipment utilized by this third-party contractor had a failure and that's what caused the incident. Three workers were injured, two were fatalities one for us and one for a third-party contractor. I just think it's too early to comment directly to your question as the investigations are on-going. I can't say that we’re reviewing our entire safety practices across the company, as is the third-party contractor and we're reviewing our policies for this type of activity, it was a [indiscernible] which is again very common in our industry and I think we just need to let the look investigations play out and give our employees and our company some time to heal.

Operator

[Operator Instructions]. Our next question comes from the line of [indiscernible] from Wells Fargo Advisor. Please go ahead.

Unidentified Analyst

I know its way premature to ask this question but customers kind of are wondering is there a clear path to a resumption of even a small dividend in the future do you think?

Bret Allan

As you know the Board makes the determination on the reinstatement of distribution and I think the Board would be looking at a variety of factors obviously market conditions, the financial leverage on the MLP, our future capital requirements as well as our forecasted free cash flow. We believe that the prudent thing to do in the near term is the use that free cash flow to reduce our debt and drive our leverage numbers down closer to the covenant levels but ultimately that will be a decision for the Board as to whether we reinstate a portion of the former distribution payments.

Unidentified Analyst

And is there a leverage factor there, does it have to be under five times or under four times or is it just more or less at the discretion of the Board?

John Bonn

Precisely looking at the variety of factors that I just outlined. There is no set target that we're trying to achieve.

Unidentified Analyst

And some of the contracts that you had towards the end of last year that I guess caused you to have to pay these guys immediately instead of the normal 60 day layover, have those been reworked?

John Bonn

Are you referring to some of the holdings contracts associated with the restructuring?

Unidentified Analyst

Yes

John Bonn

Yes, I think with the successful conclusion of the restructuring we're back in normal payment terms for really all of our customers.

Operator

Ladies and gentlemen we have no further questions in queue at this time. I would like to turn the floor back over to management for closing remarks

John Bonn

Well thank you all of you for your questions and your continued interest in Southcross. Again we will speak to you in few weeks when we discuss our first quarter 2016 results and hope all of you have a safe day. Thank you very much.

Operator

Thank you. Ladies and gentlemen, this does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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