Southcross Energy Partners' (SXE) CEO John Bonn on Q2 2016 Results - Earnings Call Transcript

| About: Southcross Energy (SXE)

Southcross Energy Partners (NYSE:SXE)

Q2 2016 Earnings Conference Call

August 5, 2016 11:00 ET

Executives

David Lawrence - Vice President, Treasury and Investor Relations

John Bonn - President and Chief Executive Officer

Bret Allan - Chief Financial Officer

Analysts

Andrew Burd - JPMorgan

Ryan Levine - Citigroup

Bill Harman - Harman Investment Properties

Will Hardee - RBC Capital Markets

Ajay Lele - Invesco

Operator

Good morning and welcome to Southcross Energy Partners Second Quarter 2016 Financial and Operating Results Call. As a reminder, today’s call is being recorded and your participation implies consent to such recording. [Operator Instructions] With that, I will turn the call over to 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 second quarter 2016 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 adjusted EBITDA. You can refer to the earnings release that we issued this morning for important disclosures and reconciliations regarding such measures and their definitions. You can also obtain a copy of our earnings release in the Investor Relations tab of our website at www.southcrossenergy.com.

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. As I am sure that you know, in spite of some recent positive trends, midstream competition in the Eagle Ford remains high and the timing of the eventual recovery and upstream activity in the region is still a bit uncertain.

Our focus at Southcross is on lowering our costs, reducing our debt, enhancing our operational performance, evaluating new strategic opportunities and expanding our customer relationships. We will be implementing numerous opportunities to reduce both OpEx and G&A over the course of the next several quarters. And our improved June 30 balance sheet, with significant debt reduction, highlights our progress towards improving our liquidity.

In addition, at our plant locations, we have identified ways to lower our energy consumption and continue to explore other avenues for operational efficiency. While there is still uncertainty with regard to the timing and pace of the recovery in drilling activity within the Eagle Ford region, we have been encouraged to see rig activity increasing recently with 12 rigs added across the Eagle Ford since the low point earlier this summer. Additionally, the inventory of drilled and uncompleted wells in the Eagle Ford remains high, with recent estimates of close to 900 DUCs. We also continue to see producers increasing the rate of return estimates for Eagle Ford wells with lower third-party expenses enhancements to well efficiencies. Consistent with our discussions with producers, we are optimistic about the longer term potential for the Eagle Ford and believe that we are very well positioned to capitalize on the eventual volumetric recovery.

Additionally, our Mississippi and Alabama pipeline systems continue to perform well with throughput of about 147 million cubic feet a day on the systems in the second quarter in line with last quarter. These assets remain a very stable and growing contributor to our results and we are continuing to evaluate new opportunities in the Mississippi and Alabama markets. We believe that the actions we have taken today and our ongoing focus on improving our operational efficiency rationalizing our assets and reducing our costs will help us to align with the current market environment.

With that, I will now turn the call over to Bret to discuss our second quarter results.

Bret Allan

Thanks, John and good morning, everyone. We delivered adjusted EBITDA of $15.6 million for the second quarter, down from $20.7 million in the prior quarter. Pro forma for anticipated year end minimum volume commitment true-up payments from our producers, our EBITDA for Q2 was approximately $16.4 million. The primary drivers of the decline were a 7% drop in processed gas volumes along with higher expenses. The volume decline was driven by basically the same factors I described in our last call.

As a reminder, these included a Gulf Coast producer that chose to bypass processing proportion of its lower Btu gas, a customer that elected to move its production to its own plant capacity and a midstream competitor with an Mbtu through the end of 2015 that elected to redirect their gas through their own processing facility. Southcross experienced only a partial quarter impact in these three unique situations in the first quarter. Separately, we saw a decline in volumes at Conroe processing facility due to a producer with operating issues caused by field level flooding and experienced modest production declines from Eagle Ford producer in line with regional trends. The impact of these declines was partially offset by the late April restart that of the Lancaster gas treating facility owned by Southcross Holdings. As a reminder, the Lancaster facility delivers gas to the MLP for transportation, processing and fractionation. This facility continues to perform well and the volumes have remained at pre-outage levels.

Our NGL production for the quarter of about 36,000 barrels per day, down from 40,000 barrels per day in prior quarter, was consistent with our decline in processed gas volumes. O&M was $19.6 million for the quarter, about 17% above the first quarter. However, this is the result of the deferral of certain maintenance expenses from the first quarter, as I mentioned on our last call. Our O&M expenses year-to-date are in fact below our 2015 quarterly average. We also expect to benefit from current facility upgrades and enhancements that has the potential to meaningfully lower future operating expenses. G&A was $8.2 million compared to $7.9 million in the first quarter. Adjusting for non-recurring and non-cash add back, G&A for Q2 was $6.6 million, which is similar to first quarter. We expect adjusted G&A in the second half to be around $6 million per quarter, reflecting the benefit of current cost cutting initiatives.

Turning to the balance sheet, we are extremely pleased to report a substantial reduction in our outstanding debt since last quarter. Specifically at the end of June, our outstanding debt was $570 million, which includes about $131 million on our revolver. This represents a $69 million reduction in debt form the first quarter. We ended the quarter with $5 million in cash and $53 million in availability on our revolver. The increased liquidity and debt reduction is the combined result of the repayments of all past due inter-company balances from Holdings to the MLP following the Holdings restructuring, the sale of certain non-core assets and the first quarter equity cure from Holdings. The asset sales included approximately 20 miles of non-strategic pipeline along the Gulf Coast and a surplus gas turbine. There is no earnings impact associated with these sales. As a result for our efforts to lower our debt balances, our leverage ratio improved to approximately 5.4x, which is below the credit facility covenant of 5.5x. This means that no equity cure contribution will be required for the quarter. As a reminder, the financial leverage covenants stepped down to 5.25x next quarter and 5.0x at the end of the year.

With that, I will turn the call back over to John for a few closing remarks before we open up the lines for your questions.

John Bonn

Thanks Brett. Thanks again for joining us this morning. We appreciate your continued interest and you should know that the Southcross team remains focused on taking the right steps to position the company for future success. Now, we will open up the call for your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting question-and-answer session. [Operator Instructions] Our first question comes from Andrew Burd with JPMorgan. Please proceed with your question.

Andrew Burd

Hi, good morning. First question, have you seen any movement on ethane recoveries and have you quantified the upside potential in the past?

John Bonn

This is John. Right now, frac spreads on ethane are just slightly negative. And based on our contracts, we are actually rejecting some ethane and recovering some as well. It’s based on our sales agreements. We as most of folks are I think in South Texas are bullish on ethane in the longer term, but we have seen a near-term drop in proxy.

Andrew Burd

Okay, great. And then I think you made some comments about your attempt to gain market share in the future, especially over the next few years, can you kind of specify what particular competitive advantage Southcross can provide that maybe some of the larger integrating companies may have trouble doing?

John Bonn

Yes. We have talked about the some and when I say market, I think it’s not just – it’s across the board. We have had some very good success recently on exploiting our connectivity in the Corpus Christi channel ship channel area on securing multiple new markets with significantly higher pricing on the dry gas sales side. So, that’s the gas that we would sell that comes out of tailgate of our processing plants. And we are seeing the advantages of that. The higher we can sell the gas on the end of our system allows us to be more competitive on the supply side and past those that pricing advantage back on the gas supply standpoint as well. We are constantly working on the supply side. I think our size is actually an advantage. Generally, producers see us as more a responsive than flexible and nimble to meeting their needs than our larger competitors. So, I think there is a niche for us, where our size is an advantage as well.

Andrew Burd

Okay, great. That’s great color. Next question is on the balance sheet, probably for Bret, how long does the leverage calculation credit your equity cares, is that four quarters or is it longer?

Bret Allan

Yes, each time we do an equity care. We get that benefit for the next four quarters.

Andrew Burd

Okay. And I think the first cure that you announced was this call last year that was attributable to the second quarter. So, is that a second – had we lapsed that now with the second quarter, because it was kind of payable on the third quarter, I guess, it’s more of a third quarter?

Bret Allan

That’s correct. In the second quarter of 2015, we announced approximately $4.7 million cure. You recall we didn’t use the virtual basket for that. There was no cash, but we did get the cure credit for the covenant. That share has now rolled off and is not part of the Q2 ‘16 calculation. But as I mentioned, even with that rolling off, we were still able to come within the 5.5x covenant given the debt reduction that we have been able to do.

Andrew Burd

Okay. And have you thought about or have you reached out to your bank group for a covenant waiver or extension of covenant waivers, especially as you potentially lap higher EBITDA in the second half of this year and as the cure benefit rolls off and as the current covenants step down through year end?

Bret Allan

We are in constant dialogue with the admin agent for the revolver and can’t really comment on the specifics there, but absolutely, that’s something that we are looking at.

Andrew Burd

Okay. And I mean is that – given where the equity prices potential for dilutive impact on the common equity, is that becoming immediate priority that we may see progress on by the next conference call or is that maybe a longer term initiative when it’s actually maybe needed?

Bret Allan

I can’t really commit specifically on the timing, but yes, I think given the step downs that are coming up later in the year, I think the benefit to trying to negotiate the covenant relief would be more beneficial here in the next two quarters.

Andrew Burd

Great. Thanks very much for taking my questions.

Bret Allan

Thank you.

Operator

Our next question comes from Ryan Levine with Citigroup. Please proceed with your question.

Ryan Levine

Good morning. Just to clarify around your cost reduction initiative, would you be able to provide any color around how material you expect that to be and what you are budgeting for?

John Bonn

This is John and I will kick this off and then we have spent considerable amount of time and have developed a very comprehensive plan that we will be presenting to the board. And so I would rather been here for the first time instead of share that with you, but it’s something that we plan to kick off here very quickly and carry through the next several quarters, but it’s an extensive plan.

Ryan Levine

Okay. And then on previous calls, you highlighted your MVCs would expire late this year and then several of that expires over the future years, can you provide color around or can you quantify how much cash flow is expected to roll off tied to expiring MVCs for next year and any update around those conversations with customers?

John Bonn

Yes. As we have talked before, as mentioned we have very few of our contracts that are coming due in the next few quarters that we have been in dialogue with the producers and actually, have a lot of success with negotiating with them. The pricing shorter term in general, we are seeing shorter term and lower fees as compared to the current arrangements but just given the competitive nature but we are able to invest higher. We have been able to retain the volumes.

Bret Allan

Yes. We just signed up renewed significant contract initially.

Ryan Levine

Is there any way of quantifying the potential cash flow impact for next year with the contracts that are rolling off?

John Bonn

No, I don’t think we are able to break that out in that kind of detail.

Ryan Levine

Okay. I think that’s all for me. Thanks.

John Bonn

Thanks Ryan.

Operator

Our next question comes from Bill Harman with Harman Investment Properties. Please proceed with your question.

Bill Harman

The question has been answered. Thank you very much.

Operator

Our next version comes from Will Hardee with RBC Capital Markets. Please proceed with your question.

Will Hardee

Yes. My first question was answered, which is on the debt covenants. Maybe John, you could address as you talked about in the prior quarters, you are doing some other kind of – there is a lot of drilling going on around Corpus Christi area and some volumes are dropping fairly dramatically in the Eagle Ford, your game plan was to try to secure those new contracts as well on the front end as well as going to the back end user, which just sounds like you are having some success rate, can you elaborate more on how you are trying to offset the decline in other areas?

John Bonn

Yes. We are aggressively pursuing three things within reach of our system, as you mentioned. And we have had some success as you just identified in the traditional Gulf Coast area, the economics there with gas prices jumping up closer to $3 and well costs down. You are seeing some more of the traditional vertical wells being drilled and we have had some success tying those in as well. And we have had some smaller packages we have tied in even behind the Holdings Lancaster system, which you know filters into us on the downstream side of treating plants and some smaller packages up and down our rich gas system as well. We just – we did had a major contract that was due to expire at the end of this year that we just closed on that yesterday, an extension of that agreement. And I think that it shows the – it was very tough competition, I missed that. And – but we were able to retain. And I think that it’s a great demonstration of our approach on the gas supply side and commercial side is we are very relationship oriented approach in the end. I think that relationship will play the key factor and as we begin to keep those supplies on the system. That being said, we also are working with multiple producers and had conversations about contracts that they have that are expiring or rolling off and then these may be smaller packages of gas slipping down our system. And again, I think that it is one of the advantages of us being a smaller prayer is that we could be more aggressive on the pursuit of those, because the smaller packages don’t move the needle on a major competitor system. The other thing what we are doing is, we are actively pursuing interruptible volumes from producers and we are having success with that as well, as they had excess gas beyond their portfolio of MVCs, they have – we are being aggressive and pulling those supplies into our system as well.

Will Hardee

Can you say that perhaps this is the trough in the decline in volumes or is that too aggressive to state?

John Bonn

Well, it’s hard to say. May, June was the low point. It looks like on the drilling rigs and we are up about 12 since then. I think we are around 47 across the region now versus 35. I think the big thing that potential that’s out there is the DUCs. When prices start creeping backup, I think you will see some of those DUCs come on, where producers have already basically drilled the wells and having completed and they will be able to bring volumes on fairly quickly. The drilling costs now are around $4 million a well versus $7 million from several years ago. And then the wells are producing, I guess their efficiencies probably doubled over the past couple of years. So, the economics are certainly improving at the wellhead and that’s where it really matters. We just can’t control those commodity prices, but I think as we do seeing improvement, I think we are in good position to attracting the volume.

Will Hardee

And finally, are there any other asset sales, I know you had a line that you sold recently that wasn’t in use, is there anything else that might be in your bag of tricks?

John Bonn

No, not at this time. We – those were just kind of some strategic opportunities there that were really assets that didn’t fit our current needs and we are not looking at any wholesale sales of assets.

Will Hardee

Okay, thank you.

John Bonn

Yes, sir.

Operator

Our next question comes from Ajay Lele with Invesco. Please proceed with your question.

Ajay Lele

Hi, thanks very much for taking my question. Could you – I have just had two questions. One was around understanding the rigs and the best way to try to model those, like I saw that Cabot Oil isn’t drilling any wells this quarter, in second quarter, but has plans for later in the year. And AIG has increased its target number of wells to, I think it’s 190 from 160, which looked encouraging. Is there anyway I would like drilling from their activity into yours? And then the second question I had was just around debt reduction, if you could just help me out on how – you mentioned that you have got your planning to try to reduce debt, but if I look to your growth capital and if I look to your run-rate distributable cash flow, it doesn’t really generate that much free cash flow this year. So, I am just trying to understand your statement around debt reduction, because it doesn’t feel like there is lot of free cash flow in the system right now?

John Bonn

Paul, I will try and address the first question and I will let Bret jump in there on the second. We have seen – the activity right now seems – the majority of the activity, are in kind of the sweet spots, the currency [ph] in the Wood area, in the Webb, Dumont [ph] areas where you are seeing probably between the two about half of the rigs in – active rigs right now in the Eagle Ford. And you did mention Cabot, yesterday, you indicated they are going to drill some wells in the third quarter and EOG has been active. I think what we are planning is that they are just really focused on their sweeter spots and taking advantage of the improved economics, while the service costs are below. And to your question, are we going to be able to bring additional volumes from that additional activity, that increase in activity that we are seeing, we certainly hope so. I mean, we are talking to them constantly, but we have to be mindful of the fact that main producers have MVCs in place. And so for them to switch providers, they need to be able to exceed their current minimum volume commitments. And there is very little acreage out there that is currently undedicated. But what we are also seeing is and I think you will pickup if you will and the activity of acreage being acquired and traded, we can anticipate there will be some consolidation of that in this market and hopefully that will aggregate some volumes and bring more supplies to our system.

Bret Allan

And Ajay, this is Bret, on your second question around debt reduction, I think the key lever that we are going to be looking to pull for further debt reduction is that, that CapEx lying down. As you noted, we are using a part of our free cash flow currently for the growth CapEx, but the majority of the remaining 2016 growth CapEx spend is to finish projects that are already underway to support customer volumes. And as those projects wrap up, that’s going to allow more free cash flow for debt reduction. I would also add that any future equity cures that we have would also bring in cash from Holdings to that we could deploy to our debt reduction. Does that answer your question? We might have lost, Ajay.

Operator

Okay. Ladies and gentlemen, you have reached the end of our question-and-answer session. At this time, I would like to turn the call back to John Bonn for closing comments.

John Bonn

Again, thank you for your questions and your continued interest in Southcross. We look forward to speaking to you again soon on our third quarter call and hope all of you have a safe day.

Operator

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

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