CSI Compressco LP's (CCLP) CEO Tim Knox on Q2 2016 Results - Earnings Call Transcript

| About: CSI Compressco (CCLP)

CSI Compressco LP (NASDAQ:CCLP)

Q2 2016 Results Earnings Conference Call

August 05, 2016, 10:30 AM ET

Executives

Tim Knox - President and Director, CSI Compressco GP

Derek Coffie - CFO

Elijio Serrano - CFO, TETRA Technologies Incorporated

Analysts

Marshall Adkins - Raymond James

Andrew Burd - JPMorgan

Gabriel Moreen - Bank of America Merrill Lynch

Mike Gyure - Janney

Martin Malloy - Johnson Rice

Operator

Good day and welcome to the CSI Compressco LP Second Quarter 2016 Results Conference Call. The speakers for today's call are Tim Knox, President and Director of CSI Compressco GP; Derek Coffie, Chief Financial Officer of CSI Compressco; and Elijio Serrano, Chief Financial Officer of TETRA Technologies Incorporated who owns the general partner. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. Tim Knox. Please go ahead sir.

Tim Knox

Good morning and thank you for joining the CSI Compressco second quarter 2016 results conference call. I'd 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 analysis 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, adjusted EBITDA, free cash flow, distributable cash flow, distribution coverage ratio or other non-GAAP financial measures. Please refer to this morning’s press release or to our public website for reconciliations of non-GAAP financial measures to the nearest GAAP measure. 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 has posted on our website, our Form 10-Q is planned to be filed with the SEC on or before August 09, 2016.

Again, thank you for joining us. We do appreciate your interest in CSI Compressco. First I want to welcome to the setting and introduce to you Derek Coffie, Chief Financial Officer for CSI Compressco who joined us on June 20 as was previously communicated. Derek will initially focus on providing support through our operations team helped to complete the development and implementation of our new ERP system, and help to evolve our financial planning and analysis process.

Elijio Serrano, Chief Financial Officer for TETRA Technologies who remain engaged with us as CSI Compressco to provide support to Derek and myself. Elijio will take the lead on financial comments today and for the immediate future, he will continue to assist CCLP with the capital markets and the investment community.

Derek Coffie

Thank you Tim. I’m glad to be a part of the CCLP team and on this call with all of you today, and I've enjoyed a very busy first seven weeks of communication the business. I had a pleasure of meeting a few of those on the call while in New York in June, and look forward meeting more of you in-person in the future.

Tim Knox

Well, thanks Derek, and again, welcome to the team. Glad to have you here. I’ll start the discussion by sharing with you some of the results and key financial indicators that we use to measure our business. I’ll discuss the changes to our fleet and fleet utilization, equipment sales and backlog, the overall performance of the business, and our outlook as we continue in the challenging environment 2016. And then as mentioned, I’ll turn the call over to Elijio Serrano to cover more financial details.

Total revenue of $76.1 million for the second quarter of 2016 is a decline of $5.6 million or 7% from the $81.7 million of revenue reported in the first quarter of 2016, with $2 million of the decline attributable to reduced equipment sales, $4.5 million attributable to reduced compression services, and a $900,000 increase in our after-market services revenue. Adjusted EBITDA at $24.8 million is a 600,000 or 2.5% decrease from the $25.4 million in the prior quarter.

Second quarter distributable cash flow of $15.2 million is an increase of $1 million or 7% compared to the first quarter of 2016. Continuing the trend, since making dramatic cost-to-fleet growth through capital expenditure, we were positive on free cash flow with $18 million in the second quarter of 2016 before the quarterly distribution and $5 million of free cash flow after the quarterly distribution. Our focus on cost control and cash flow in the current downturn remains intact.

Cash utilized for capital expenditures in the first and second quarters of 2016 combined totaled just over $6 million. Headcount dropped by roughly 20 during the second quarter or 2.5% to 759 employees, with an approximate 20% reduction year-to-date.

Additional wage reductions and compensation related expenditure cuts have been enacted where appropriate. Second quarter SGA expenditures at $8.2 million are the lowest in the past eight quarters and a sequential step down the past two quarters. At 10.75% of second quarter revenue, this is lower than the prior two quarters in that regard as well.

Exiting the second quarter of 2016, our compression services fleet consisted of 1,130,674 horsepower, a reduction of 586 horsepower compared to prior quarter. Quarter end utilization was 76%, with 857,148 horsepower utilized, a 15,725 horsepower reduction in utilized horsepower.

Equipment in our largest horsepower segment 800 horsepower and above was 85% utilized at the end of the quarter with utilization of 71% in the 101 to 800 horsepower range, and 65% utilization of equipment to 100 horsepower and below.

We maintain our focus on maximizing the utilization of our existing compression services fleet with oil prices showing sustainability above the $14 level since mid-April. And natural gas prices now pushing above $2.50 since mid-June, we have seen increased interest from numerous customers for gas lift and vapor recovery applications and also some improvement in dry gas well head applications in our small and mid-horsepower segments.

Within price coming from many regions but primary the Permian, Delaware, Niobrara [indiscernible]. In addition, several of our larger customers have recently indicated the potential to increase their budgets going into 2017. We view this as a positive indicators for the second half of the year, and are encourage as we begin to plan for 2017.

Compression services revenue were $58 million for the quarter, a 7.5% decline from prior quarter, a result of horsepower utilization, the effected implementing price concessions that were granted in the prior quarter, as well as continuing pressure on compression services pricing.

The total capital expenditure forecast for 2016 remains at $20 million to 25 million as previously indicated. This consists of a $12 million forecast in maintenance capital, $6 million invested in our ERP project and up to $7 million invested in other growth opportunities.

Year-to-date maintenance capital expenditures through the end of the second quarter totaled $3.7 million and reaffirming our $12 million full year guidance we do anticipate increased activity in the second half of the year. Once fully implemented in 2017, we anticipate $4 million in annual savings from our ERP investment.

In the equipment sales business we recorded $8.7 million in revenue for the quarter of which approximately $0.5 million came from used equipment sales. The continued reduction in equipment sales have been expected in line with the ongoing decline in equipment sales bookings and backlog. Our new equipment sales backlog at June 30, 2016 was just over $25 million and approximate $1 million reduction from the prior quarter as we booked orders totaling roughly 7 million in the second quarter.

Before turning the call over to Elijio, I’d like to comment on our previously announced second quarter distribution of $0.3775 per common unit which was flat with our distribution from the prior two quarters. We continue to believe that this level of distribution combined with cost initiatives and other actions that we are taking is appropriate for the partnership at this time and is one of the several considerations in appropriate management of the balance sheet cash and debt.

Please note that this distribution comes with the coverage ratio of 1.19 times in the second quarter and as previously mentioned resulted in $5 million of free cash flow after the distribution.

With that I’ll turn call over to Elijio.

Elijio Serrano

Thank you, Tim. Tim mentioned earlier that the adjusted EBITDA for the second quarter was $24.8 million down $600,000 from the first quarter. Second quarter adjusted EBITDA was unfavorably impacted by $1.1 million as we increased our amounts for bad debt expense. When reporting adjusted EBITDA we do not normalize for bad debt expense. However this is a permissible add back when competing our leverage ratio and times interest earned ratio for bank compliance purposes.

In the press release, we had included a preliminary second quarter bank EBITDA of $26.8 million. If we complete the compliance certificate submitted to the bank this number will turn out to be $26.0 million up 469,000 improvements over the first quarter of this year which was $25.6 million. After two quarters EBITDA for the credit facility with all permissible add back is $51.6 million with the second quarter being better than first quarter.

On the balance sheet cash increase of $10 million at the end of March to $16.7 million at the end of June. Balance sheet debt was $569 million at the end of June compared $556 million at the end of March. Therefore our net debt improved by $4 million in the second quarter to $552million. Funded debt calculated for the compliance certificate was $590 million at the end of the second quarter. Our leverage ratio was 15.04 times against the covenant of 5.5 times. We previously announced an amendment to our credit facility covered by the leverage ratio at the end of June and September of this year has increased to 5.5 times and steps up to 5.75 times at the end of this year.

We have taken a series of steps that includes revenue initiatives, cost actions, our focus on working capital and significant reductions in capital expenditures that will allow us to remain in compliance with the covenants. An example of how aggressively we managed [indiscernible] days sales outstanding. Despite the financial challenges our customers are going through our organization is focused on timely invoicing and aggressively pursuing all outstanding receivable.

Days sales outstanding at the end of June was 47 days a two day improvement at the end of the quarter and we believe our 47 days compares incredibly well against the industry. Distributable cash flow in the second quarter was $15.2 million an increase of $1 million from the first quarter of this year. As a result of coverage ratio increased on 1.11 times at the end of March to 1.19 at the end of June.

And finally, we continue to make progress in working towards the implementation of our new ERP systems for CSI Compressco that will give us better tools to manage the business, allow for automated capture of data with the mechanics and technicians in the field while working on our equipment. It will also provide numerous flow of data from the coating pumps all the way to the collection of our invoices.

This system will go in live in the first quarter of next year and allows the opportunity to reduce our operating expenses by more than $4 million a year. We are taking the opportunity in this weak environment and investing technology that will have a quick pay back and allow us to leverage a system when the market returns and we have horse power without having to add administrative and back-office resources. Our commitment towards investing during this down cycle demonstrates the confidence we have of achieving cost reductions and preparing for the upturn in the market.

And with that I’ll turn it back to Tim.

Tim Knox

Thank you, Elijio. And at this time, we would like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Marshall Adkins of Raymond James. Please go ahead.

Marshall Adkins

Good morning, guys. It sounds like your custom conversations are fairly positive and interest levels picking up. I'm assuming it's fair to say at least from a revenue or activity standpoint, Q2 was the bottom is that fair?

Tim Knox

I think we can get it more accurate right in future quarters. But you can certainly see a slowdown in the decline in the fleet and then you add other things that have happened and currently happening in a lot of positive indicators to draw a line and say that Q2 is the bottom when Q3 hasn’t happened yet so a bit risky. But we're optimistic it’d be better if thinking our world is holding. It’s was nice to see it there. But there are lots of positive things and lots of things pointing us towards some comfort and confidence. But we’ll talk in three months.

Marshall Adkins

Right. So let’s just say things are flattish from here, it also sounds like that there’s still potential for more margin deterioration or am I hearing that wrong whether you said pricing pressure still robust but you’ve also brought down cost. So how should we think about margins going forward, if indeed we're in a flat environment?

Tim Knox

So there is pricing pressure, and perhaps the pricing pressure is moving from the producer to more a competitive environment as we and those of the industry desiring the utilization up that also adds to the pricing pressure. But I mentioned that the second quarter reduction in fleet revenues there’s a lot of that that occurred because of concessions offered in the first quarter. So I think that we're passed that that largest slog, if you will.

But it's a competitive environment, it's a place where we're at in the mid-70swith utilization and of course our higher small horsepower category, our larger horsepower are bigger component of small horsepower impacts our utilization compared to a couple of guys. But the market has some capacity that the compression services market does. So that’s going to keep pricing competitive for a while.

Elijio Serrano

And Marshall this is Elijio. I would couple of data points. If you look at the gross margin on our compression fleet, second quarter a year ago was 48.5% gross margin. The first quarter of this year was 49% and we just reported the quarter with 48.5% gross margin.

And I think that speaks to the words that Brad Benge our Head of Operations, is doing within the organization of aligning cost putting pressure back on our suppliers, properly managing the fleet and the technicians and mechanics to hold margins within 50 basis point of the prior quarter and consistent with a year ago despite the pricing pressure I think it reflects how aggressive Tim and his organization have been managing the cost structure.

Marshall Adkins

Well, that was really my question is when we net out the price pressure with the stuff you’ve done to counteract at it, it sounds like we need to be thinking about margins kind of flattish from here, is that fair?

Elijio Serrano

Yes. I believe so, yes.

Tim Knox

And then Marshall I’ll also add that when we get our system in we've identified synergies that Brad running operations can further implement and counter some of that when we implement our system over next year.

Marshall Adkins

Last one just following up on the cost side from me. SG&A fell dramatically, how sticky is that going to be on the way back up and we’re obviously forecasting a pretty robust recovery. Assuming that plays out over the next year or two how sticker are those SG&A and other costs that you’ve been able to pull down.

Elijio Serrano

One of the reasons that we’ve been aggressively working on getting the system implemented and that’s where we’re investing quite a bit of money and developing and implementing the ERP system is to try to gain synergies by using technology. We’re in the processing of collapsing back - a lot of those back office functions into Houston and leverage TETRA’s back office infrastructure.

We believe that when our system goes in we’ll be able to get not only cost and headcount synergies at the field level, we expect to get a significant amount of same synergies in the G&A function.

So I would say that the SG&A will only increase relative to say ops commissions as an example or any cash incentive bonuses that are tied to an improved financial performance of the company.

Marshall Adkins

Perfect, thanks guys.

Operator

Our next question will come from Andrew Burd of JPMorgan. Please go ahead.

Andrew Burd

Hi, good morning. Tim you were talking about price concessions. Would say that CCLP is gaining market share or defending market share and are there particular regions where you are being particularly aggressive?

Tim Knox

Price concessions have occurred everywhere so I would not attribute it to any one specific region over another and from a market share standpoint I think that we are, we picked up a few places, we’ve lost a few places. I would say that we’re holding our own through this cycle.

Andrew Burd

Great, and then I think Tim you had also mentioned that we could see some higher budget allocations for compression next year by some producers. I guess, two folds on that, the first is timing. When do you think at CCLP that you would find out about that higher activity. Would that be a decision that they make in ’16 or is that more of a ’17 type of event that we’d find out about that.

Tim Knox

So we’ve recently - we’ve already had those discussions and of course we’re hearing at the field and the office levels so we need to see that come out their press releases and conference calls to get the confirmation there but it is encouraging to hear one of our major customers talk about increasing actually south Texas, in the Eagle Ford which has been a bit more hard hit for us maybe in some of the areas.

So we’ve heard the conversation over the past month or so. Now oil coming back from 50 to 40 maybe that slows it down. But to answer your question with any more certainty we got to take what oil price we’re at. But it seems that as 2016 is winding down and as we’re making the 2017 plans we hope in the coming three months we get some clarity.

Andrew Burd

Great. And then the second follow-up to that was in terms of as your customers emerge from this down cycle do you see their compression needs changing at all, if they are going to be – are they going to in house more of or are they going to outsource more of it, it doesn’t matter because you guys participate in both but I don’t know if you’ve seen any indications of that so far.

Tim Knox

We haven’t but I am going to speculate that so much work on balance sheet is going on I am going to speculate that we’re not going to see people who traditionally have outsourced I don’t think we’re going to see them suddenly want to own. I would assume that they are going to want to keep their capital focused on expiration and development and getting the uncompleted wells completed. So I certainly my speculation is that we will see a good market for the compression services.

Andrew Burd

Okay, great. And then last is balance sheet question. Elijio first I might have missed, what was the bank covenant debt to EBITDA for the quarter.

Elijio Serrano

26.0 and just to clarify in the press release we included a preliminary number of 26.8, the final number will be 26.0 for bank purposes.

Andrew Burd

Okay. Sorry, the debt to EBITDA just the ratio.

Elijio Serrano

I am sorry, the debt is 5.04.

Andrew Burd

Okay great. And then looking at the second half of this year I mean clearly you guys are doing great, you are free cash flow positive after distribution so there is really not a cash flow issue but as we lap the much higher EBITDA that was generated in the second half of last year even if we kind of stay flat from the first half run rate it seems like we’re at least converging towards covenant.

So do you see that there is enough wiggle room and flexibility that as you lap that higher EBITDA last year that you’ll be okay or have you started to pursue possible equity infusions to the business or something to bring the numerator of that equation down a little bit.

Elijio Serrano

Good question. So I mentioned earlier that bank EBITDA was $26 million in the second quarter and this is the quarter after the price of oil dropped all the way before $27 in February. Through the first two months of this we’re at 51.6 and you can either extrapolate or if you extrapolate you can come in and adjust whatever you feel the second half is going to be.

We believe that a bank group that we’ve got a really tight relationship with. A company that’s generating in our opinion solid EBITDA in this market will allow us to work with them should we need with them again on covenant. And we think that between the earnings that we have, the cost actions in a very supported back group that we shouldn’t have any issues in the future.

Andrew Burd

Okay, great. So it’s more – it’s highly unlikely there will be kind of a forced infusion of equity because the bank group is appreciative of your core cash flows and the strength of your business and isn’t going to punish you at the cyclical trough basically is what you kind of what you are saying.

Elijio Serrano

I would say that we’ve got a really solid relationship with our bank group.

Andrew Burd

Okay, great. Thanks very much for taking my questions.

Operator

Our next question will come from Gabe Moreen of Bank of America Merrill Lynch. Please go ahead.

Gabriel Moreen

Hi, good morning guys. Just speaking of the infusion of equity. Is looking at some of the alternatives that some other MLPs have talked to like the preferred market or private equity. Is that something you’ve considered or would be a consideration?

Elijio Serrano

I wouldn’t speculate in terms of any balance sheet actions that we want to take but I would say that the management team has been proactive and we’re not uncomfortable looking at all options and if we believe we need to pull triggers we would do that. At the same time our second quarter numbers are quite solid at $26 million from a bank perspective.

Gabriel Moreen

Understood. Thanks Elijio and just a quick question sort of maintenance CapEx and the cadence of spend there, is there something about I guess timing wise would you expect to spend a bit more in the back half of the year on maintenance or is there a change, can you kind of - CapEx bogie for the year.

Tim Knox

You know Gabe, obvious the run rate has it beating it. I am not going to pull the number down. If we are going to be optimistic into the last half of the year there is the possibility that we’re going to have run some things quickly through some shops some overalls to make sure we can respond to absolutely every opportunity that we have. So I am going to hold the guidance at $12 million but yes, obviously we’re below that run rate.

Gabriel Moreen

Thanks Tim.

Elijio Serrano

Gabe keep in mind that we’ve got quite a bit of idle horsepower so we can manage our fleet given that we’ve got excess equipment available.

Gabriel Moreen

Got it. And then just, I don’t recall I think in previous calls and using a slide on bad debt, you just talk about this obviously it’s a rough environment out there for some producers, was this just sort of a one off in a particular region with a particular customer or it something that maybe is more of an ongoing concern?

Elijio Serrano

We’ve got an internal policy that once a receivable ages beyond six months or if a receivable ages beyond a year we set up an allowance for bad debt. In the second quarter I would say that the vast majority of our reserve was generic in nature based on overall aging of the receivables. And so we’ve seen one of our account go into a Chapter 11. Once they went Chapter 11 we received already a couple of post Chapter 11 and this is probably more being conservative and consistently applying our allowance for bad debt policy.

Gabriel Moreen

Got it, thanks Elijio that helps.

Operator

Our next question will come from [Elliot Bond] [ph] of Royal Bank of Canada. Please go ahead.

Unidentified Analyst

Good morning. What kind of pricing would you think you would need to see the low horsepower start to move up on a percentage basis?

Tim Knox

I don’t think I am going to advertise what our specific current rate is for any particular product especially when have a such a significant effort in that class. I will say that have worked diligently to find the market rate for the gas jack and for small equipment and we feel that we’ve found it, we’ve hit it in a variety of regions and we are continuing through that. Now if the question is more about the pricing per million Btu then the rate for small equipment.

Customers even a year ago we were hearing numbers like $2.30 and $2.50 as the point in which they feel they can go out and operate just on in any well at the profit they need. So the current gas prices are very encouraging. The first drawdown on storage, the first summer draw down and what was a three years to five years that’s pretty encouraging too.

Now on the other hand there is an enormous amount of gas in the storage and obviously an enormous amount of deliverability of natural gas. So I think we’re there from that standpoint. I think this number up above 250 is a good comfort level for many, many producers.

Unidentified Analyst

And just a second one on a general on the market, a lot of people are pointing to the hot summer and potentially [indiscernible] cold winter, what’s your thought on pricing of gas going forward on a general basis?

Tim Knox

You know, there are several people on the call probably yourself included that are more qualified prognosticators of the commodity prices. Again the number is above 250. There was lot of fun in 2008 when the price was $8 but also began to negatively impact our business. So a number 250 to 350 probably does pretty well for us.

Unidentified Analyst

Thank you.

Operator

[Operator Instructions] Our next question will come from Mike Gyure of Janney. Please go ahead.

Mike Gyure

Yes, can you just talk about inventory levels at the end of the second quarter and then I guess where you see that trending for the rest of the year potentially I guess as a use resource of working capital?

Tim Knox

I am going clarify, inventory levels you said?

Mike Gyure

Yes.

Elijio Serrano

And Mike you are talking about industry inventory levels from a gas perspective is that correct, gas and oil.

Mike Gyure

No, I am sorry, you guys balance sheet inventory levels.

Elijio Serrano

Our balance sheet. So the majority of our – our balance sheet is split between two area, one of them is parts and components that we carry to support the field organization are 1.1 horsepower and then the other part of the inventory that we carry is to build any equipment that is being sold or parts that we carry for after markets services.

Clearly as the inventory for equipment sales has been declining as we buy compressors and engine only to support incoming orders so we don’t speculate, we’re not sitting on Caterpillar engines or Areal compressors and as we believe there is a firm order for that.

I expect that as the business rebounds and we start getting a backlog we’ll start placing orders with Caterpillar and Areal to build equipment for that. But right now I’ll say that we’re running only the minimum amount of inventory for the field organization or to support our aftermarket service opportunities.

Mike Gyure

Great. Thanks.

Operator

Our next question will come from Selman Akyol of Stifel. Please go ahead.

Unidentified Analyst

Hi, this is Tim on for Selman, thank you for taking our question. Back to the margin and concession comments you’ve made, how does Compressco eventually recoup those recessions, does it just take a higher commodity price? Thank you.

Tim Knox

Tim as when the prior cycles have all demonstrated utilization in the industry, the available supply and demand out of compression services is a big factor in that which of course that’s often led by the commodity prices be it the oil or the dry gas prices. We will - we recoup those prices as the market allows and we’ll work hard to be competitive in the environment that we’re in but so I think it’s directly attributable to utilization of compression services and how much underutilized fleet is out there in the industry which of course is driven by commodity prices.

Unidentified Analyst

Okay, got. And then so just as we kind muddle along the bottom here those concessions are still being provided so the environment is just super competitive, is that the correct understanding.

Tim Knox

It’s a pretty competitive environment. There is a lot focus of courser at our customer’s offices making certain that they getting the best prices for the best service they can and again we will do our part to support in that, continue working our cost keep our equipment utilized.

Unidentified Analyst

Okay, thanks. And then the credit facility agreement was the interest rate increase at all with the amendment?

Elijio Serrano

Something like 0.5 or so and it’s got several levels depending on the leverage ratio and some of those bands were left unchanged and I think the peak change and the highest leverage ratio bands was up like 0.5 a turn.

Unidentified Analyst

Great thanks. That's all I have.

Operator

Our next question will come from Martin Malloy of Johnson Rice. Please go ahead.

Martin Malloy

Good morning. I just had a question on the Delaware Basin, I guess in particular and maybe if you could talk about the build out of infrastructure there and how CSI is positioned.

Tim Knox

Well obviously the compressor systems part of the business is a Midland based company and it has been there since 1971. So we have a strong operations group to support anything in the greater Permian Basin with lot of idle equipment stored in that area so it’s easy to deploy. We have utilized man camps and temporary housing to keep our people close to our customers out in the very remote portion where otherwise it would be a couple of hour drive.

So as we see the active operators continue to focus some of the drilling out in that area, we’re going to make sure we’re staffed for it and have the right equipment in there. Our fleet, a lot of our fleet was originally designed for some of that production. So we’re in good shape with the right equipment, right people, the right location.

Martin Malloy

Okay, great. And then just one follow-up question. International demand maybe you could talk a little bit about that.

Tim Knox

International is a fairly small part of our total revenue. International equipment sales have been down just like domestic. We don’t want to get into all of the exact details of orders received but the 8 or so million picked up in the second quarter was an international project.

From a compression services standpoint, we know we operate in Mexico and Canada and Argentina and a few other areas but again it make less than 10% of our revenue typically.

So we'll stay focused on it. We’re teaming up with TETRA who owns our general partner on ways to capitalize on the TETRA’s footprint. It's a little bit more expanded that the CCLP but again things are competitive around the globe at this point.

Martin Malloy

Thank you.

Operator

Our next question will come from [George Hego] [ph] of [indiscernible]. Please go ahead.

Unidentified Analyst

I’ve seen some gas production forecast over the next several years indicating that almost all of the growth of natural gas production will be in the Marcellus and Utica area. Could you speak a little bit about your current market share in those formations compared to other parts of the country or any trend in that regard or any forward looking projections? Thanks.

Tim Knox

Yes, we’ve - maybe I’ve touched that enough in the past couple of quarters we talked about. The old compressor systems business which was acquired by Compressco right at two years ago, two years ago today actually, did not operate in the Marcellus and Utica, we’re a private company in Midland Texas and we just didn’t make it that far.

But that represents about 20% of the gas production. We have in very rough terms we have about a 9% or 10% market share in total compression services in the U.S. but darn near 0% in the Marcellus and Utica. So from our standpoint, it’s an enormous growth opportunity for us. There are some good, solid competitors in that area. So I’m sure they will defend their dominance.

But we do look at Marcellus Utica as an opportunity for growth. As things pick up, we’ve got a lot of idle fleet and it’s rational to think that we are looking in that direction.

Unidentified Analyst

Thank you.

Operator

And our next question will come from [Elliot Miller] [ph], a Private Investor. Please go ahead.

Unidentified Analyst

Thank you. I was pleased to see that the gross margins were up 1 percentage point from 48% to 49%. Is it fair to say that operating margins were up correlatively?

Elijio Serrano

Operating margins, Elliot - let me get it here for you.

Tim Knox

Well, as Elijio is looking that up, Elliot, this is Tim Knox. Remember there SGA also, we are working diligently to pull that down at the bottom line, now that plays into it. We had some good projects in our equipment sales.

If you go, run through all of different margins, the equipment sales margin in the second quarter on some specialty type work or higher than it might normally be which help pull that up as well.

Elijio Serrano

Elliot, let me give you a couple of good data point. So gross margins in total, the combination of compression equipment and after market, increased from 40.8% in the first quarter to 42.6% in the second quarter despite a $5 million revenue decline.

And I’ll talk a little bit about the flexibility of our cost structure. When equipment sales drops off $2 million, when compression services drops off almost a little over $4 million. And then Tim mentioned also that SG&A improved from 13.4% of revenue in the first quarter to 10.8% in the second quarter.

Depreciation is modestly flat right at the $18 million to $19 million range. So you’ll see us be able to maneuver the fuel cost of the SG&A as things get difficult in this market, and those are the controllable that we can get our hands around.

Unidentified Analyst

Okay. You mentioned, Elijio in response to a question that you have this very good relationship with the banks. They are very supportive. Your leverage ratio now is 5.04 times, your covenant is 5.5 times through September and then till 2017, it’s 5.75 times Do you actually think you need to go back to them?

Elijio Serrano

Well, if anybody were to offer me more cushion on the leverage ratio, I’d never say no.

Unidentified Analyst

I understand that. My point is based on where you are now, based on the recent increase, and based on the fact that as I understand what you said of the 5 million in free cash flow after distributions, you used 4 million to reduce your indebtedness. Why would you even need to go back to them?

Elijio Serrano

Well, we’ll monitor activity and if we continue to look at our forecast, if we think that there’s any exposure, we will have discussions with bank. If we believe that it’ going to be consistent or flat, we will leave it okay.

It’s a very fluid market. If you’ve seen price of oil in from 26 to 27 bucks up to $51, it collapse all the way down to $39. We are in a period of incredible volatility. This requires just constant weekly, monthly, quarterly monitoring, and have - with our lenders. And we will take appropriate actions if we think we need to. But at this point, $26 million for bank purposes in the second quarter, it’s not a bad number for us.

Unidentified Analyst

No, it’s very good. My assumption is that if things continue as they are, you won’t have to go back to them. Was I correct by the way, Elijio, that of the 5 million in excess free cash flow after distribution, you were able to use 4 million to reduce indebtedness?

Elijio Serrano

Yes. If you look at our net debt, which is balance sheet debt minus cash on hand, we improved that almost $5 million from Q2 versus Q1.

Unidentified Analyst

Good. And what is your topics for the year in terms of debt reduction?

Elijio Serrano

As much as we can.

Unidentified Analyst

Okay. You don't have a number?

Elijio Serrano

No. We don’t want to guide toward free cash flow type target.

Unidentified Analyst

Okay. Thanks very much.

Operator

And ladies and gentlemen, this will conclude our question-and-answer session. I’d like to turn the conference back over to Mr. Tim Knox for any closing remarks.

Tim Knox

Thank you. The $50 oil in the first half of June was welcome sign. Of course, we’ve all experienced. We’ve talked about it here, the pull back in the past six week in the lower 40s. But we do see optimism and positive signs from our customers at this level.

I’ve mentioned before we’re also encouraged by our customer’s ability to operate more profitably with natural gas off of those sub-$2 prices seen in the first quarter. And we are optimistic that commodity price improvements, modest recount increase combined with continued improvement in drilling and production efficiencies will increase demand for services and products that we provide in the future.

We will continue to diligently manage our business, our cost structure, and asset base in order to address the continued challenges faced in the current market. We will remained focused on generating positive free cash flow, minimizing cash outlays, protecting our balance sheet and investing all in opportunities that present a higher rate of return.

Thank you for your interest in CSI Compressco and thank you for taking the time to join us this morning. This will conclude our call.

Operator

Ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!