Exterran Partners, L.P. Management Discusses Q3 2012 Results - Earnings Call Transcript

Nov. 2.12 | About: Archrock Partners, (APLP)

Exterran Partners, L.P. (EXLP) Q3 2012 Earnings Call November 1, 2012 11:00 AM ET

Executives

D. Bradley Childers - Chief Executive Officer and President

William M. Austin - Chief Financial Officer and Executive Vice President

David Miller - Former Vice President

Analysts

Michael W. Urban - Deutsche Bank AG, Research Division

Joseph D. Gibney - Capital One Southcoast, Inc., Research Division

Tom W. Rhee - Wells Fargo Securities, LLC, Research Division

Operator

Good morning. Welcome to the Exterran Holdings Incorporated and Exterran Partners LP Third Quarter 2012 Earnings Conference Call. At this time, I'd like to inform you, this conference is being recorded. [Operator Instructions] Earlier today, both Exterran Holdings and Exterran Partners released their financial results for the third quarter ended September 30, 2012. If you have not received copies, you can find the information on the company's website at exterran.com.

During this call, the companies will discuss some non-GAAP measures in reviewing their performance such as EBITDA as adjusted, EBITDA as further adjusted, gross margin, gross margin as adjusted and distributable cash flow. You will find definitions and a reconciliation of these measures to GAAP measures in the summary pages of the earnings release and on the company's website at exterran.com.

During today's call, Exterran Holdings may be referred to as Exterran or EXH, and Exterran Partners as either Exterran Partners or EXLP. Because EXLP's financial results and position are consolidated into Exterran, the discussion of Exterran will include Exterran Partners unless otherwise noted.

I want to remind listeners that the news releases issued this morning by Exterran Holdings and Exterran Partners, the company's prepared remarks on this conference call and the related question-and-answer session include forward-looking statements. These forward-looking statements include projections and expectations of the company's performance and represent the company's current beliefs. Various factors could cause results to differ materially from those projected in the forward-looking statements.

Information concerning these risk factors, challenges and uncertainties that could cause actual results to differ materially from those in the forward-looking statements can be found in the company's press release, as well as in the Exterran Holdings' annual report on Form 10-K for the year ended December 31, 2011, Exterran Partners' annual report on Form 10-K for the year ended December 31, 2011, and those set forth from time to time in Exterran Holdings' and Exterran Partners' filings with the Securities and Exchange Commission, which are currently available on exterran.com.

Except as required by law, the companies expressly disclaim any intention or obligation to revise or update any forward-looking statements. Your host for this morning's call is Brad Childers, President and Chief Executive Officer of Exterran Holdings and Exterran Partners. I would now like to turn the call over to Brad. Mr. Childers, you may begin

D. Bradley Childers

Great. Thank you, and good morning, everyone. First, I'd like to begin by expressing our concern to everyone affected by the devastation caused by Hurricane Sandy. Our thoughts and prayers are with all of you. We wish you the best possible recovery for your families, your homes and your communities. With me today is Bill Austin, CFO of Exterran Holdings and David Miller, CFO of Exterran Partners. On today's call, I'll review our third quarter results to provide an update on our performance initiatives. Overall, we delivered another good quarter. Our focus on operational improvements had led to continued strengthening in our financial results. Let me highlight what we've accomplished. At Exterran Holdings, EBITDA as adjusted was $126 million in the third quarter, which is 28% better than the year-ago period and 25% higher than last quarter. Our third quarter EBITDA is our highest level of quarterly EBITDA in over 2 years. At Exterran Partners, distributable cash flow was $29.5 million in the third quarter, which is an increase of 15% over the year-ago period and 8% over the prior quarter. As in previous calls, I'm going to discuss our results in the context of 4 priorities for 2012. First, we continue to work on improving the profitability of our core businesses through better pricing and cost management. Our fabrication business, we achieved our highest level of gross margin dollars in 3 years. This improvement results from 3 factors: First, solid market demand for our compression, production and processing equipment; 2, reduced cost as a result of better performance in our fabrication facilities coupled with sourcing initiatives that reduced our material costs; and 3, improved pricing through centralization of pricing decisions. As a result for the quarter, we achieved a 14% gross margin, 5 percentage points higher than the 9% gross margin reported in the prior-year period. In our AMS business, another quarter of improved performance and attributable to continued solid demand for our products and services and improved pricing and cost discipline. I'm excited about the progress we've made in our aftermarket services business, which is on track to record our most profitable year in this business in over 5 years. In North America contract operations, margins declined as expected from the prior quarter level, which benefited from a tax adjustment and we were impacted by higher maintenance and cost expenses. But by and large, we maintained the margin improvement from the first quarter and we're continuing our cost reduction efforts to drive long-term and sustainable improvement to our operating costs in North America contract operations. Second, let me talk about our disciplined growth. In the third quarter, we grew our North America operating horsepower by 38,000, and start activity was at its highest level in over 4 years, the stopped activity declined from the first half of 2012. Behind this aggregate growth was the increase of about 51,000-horsepower in rich gas, liquids prone and shale plays. This more than offset the decline of -- the 31,000 more than offset the decline of about 14,000 in the conventional dry gas areas. Looking forward, we see attractive opportunities in the marketplace for operating horsepower growth, both near and long term. This positive market outlook supports our plan to continue to invest in new equipment in order to improve the competitiveness of our fleet, further standardize our equipment and improve our operating cost structure. Furthermore, our backlog for contract operations remain strong and as a result, I expect that we will increase North America working horsepower in the fourth quarter, and for the full year, which was one of our key goals for 2012. In addition to investing our fleets, we continue to make investments in parts of our fabrication business where we see good returns. The most significant is our previously announced production equipment fabrication facility in Ohio, which we expect to open in the first quarter of 2013. And we're also investing in expanding our capacity in our existing production equipment and processing and treating fabrication facilities to meet market demand. In our international contract operations business, third quarter revenues were somewhat lower than expected driven by slippage in project installations and delays in renewing a couple of our key contracts in Latin America. Our backlog of new business remains solid, however, and includes new projects starting in Latin America and Asia in the fourth quarter. Foreign and further unexpected delays continue to expect fourth quarter revenues in our international contract operations business increased sequentially and be above year-ago levels. Finally, our fabrication business backlog was over $1.2 billion, up 107% over the prior-year level as we continue to see strong demand for our products throughout the world. We expect this solid level of backlog will result in significant year-over-year revenue and gross margin growth in 2013. Third, with respect to the actions we've taken in managing our portfolio, we're now in execution mode. We remain committed to executing the sales of our contract operations in AMS business in Canada and our production equipment fabrication facility in the U.K. as we've discussed in previous earnings calls. Finally, we remain committed to reducing leverage at Exterran Holdings, which was one of our major goals as we enter 2012. Our covenant total leverage ratio has improved from 4.3x at year end 2011 to 3x as of September 30, 2012. I'm pleased we've performed better than our target for the year and that we've done this ahead of schedule. We will continue to actively manage our capital and reduce leverage at Exterran Holdings over the long run. In addition to the operational achievements, as previously announced, in August we completed the sale of our wholly-owned assets in Venezuela. Net proceeds from this sale were combined with the net proceeds from the March sale of our Venezuelan joint venture assets, total about $504 million. To date, we've received $174 million of the net proceeds from these sales and are due to receive the remaining $330 million in quarterly cash payments through the third quarter of 2016. These proceeds greatly enhance our financial flexibility now and in the future.

In summary, I continue to be excited about the positive developments at Exterran. We've made good progress in improving our performance in 2012. And with continuing initiatives focused on improving our costs, a solid backlog of business and some encouraging market trends, I'm optimistic about our opportunities to further improve our performance in 2013. I look forward to discussing our continuing progress with you next quarter. Now, I'd like to turn the call over to Bill for a review of our financial results at Exterran Holdings. Bill?

William M. Austin

Thanks, Brad, and good morning. Overall, Exterran Holdings had a much improved financial performance in the third quarter as we're starting to see a more significant impact from performance initiatives, including pricing, commenced earlier this year. As a reminder, due to the nature of our business, our results move around a bit from segment to segment and quarter to quarter. But importantly, I believe the progress we've made this year and our plans for future improvement should set us well as we exit this year and enter 2013.

Now I'll provide a summary of the results for Exterran Holdings. As Brad said, we generated EBITDA as adjusted of $126.4 million for the third quarter as compared to $101.5 million in the second quarter of 2012. During the third quarter, we received our second installment of $4.8 million from the sale of our joint venture assets in Venezuela. I'll remind you the cash payments from this sale of our Venezuelan assets are not included in that calculation of EBITDA that I referred to before. Before I discuss the segment results and give guidance for the fourth quarter, I think it is worth noting that we recorded positive albeit modest earnings per share from continuing operations excluding charges of $0.02 per share in the third quarter. This is our first such positive performance in 3 years.

Now turning to our segment results. The North American contract operations revenue came in at $152 million in the third quarter, somewhat above our guidance range, driven by growth in our working horsepower. Gross margin was 50% in the third quarter as compared to 53% in the second quarter and 51% in the first quarter. Profitability in our third quarter was slightly negatively impacted by a relatively high maintenance expense in coal activity. North American operating horsepower increased by 38,000 during the third quarter as growth in the liquids rich and shale plays offset declines in the conventional dry gas area. Looking ahead at the fourth quarter, we expect slightly increased North American contract operations revenues in that $152 million to $153 million range helped by the deployment of our new build horsepower as we modernize our fleet and we expect modestly higher margins in the fourth quarter. Maintenance capital decreased to $23 million in North America during the third quarter as compared to $24 million in the second quarter of 2012. Maintenance capital spending in the fourth quarter is expected to be flat to slightly lower from those third quarter levels.

Now moving on to international contract operations. Our revenue was -- came in at $111 million for the third quarter. This is somewhat below our guidance and is somewhat below the second quarter revenue of $113 million due to some delays in the timing of certain project installations and some renewals of contracts. Our third quarter results included a full quarter contribution from a large compression project in the Middle East, which started operations in that second quarter. Importantly, our current backlog for international contract operations were -- is in excess of $50 million of annualized revenue and includes new business in Mexico, Brazil, Colombia and Indonesia. Looking at the fourth quarter, we expect international contract operation revenues in the $116 million to $118 million range and margin percentage to be similar to the third quarter levels. It will benefit from the full quarter contribution of that project in Mexico that we've referred to and the recent startup of our project in Colombia. We do remain optimistic about growth opportunities in our international contract operations business and we do expect increased operating horsepower at the end of 2012 as compared to the year-end 2011.

Now moving on, our fabrication operations, again as Brad said, had a solid performance in the third quarter, not only meeting our target for improved profitability but beating that handling. Fabrication revenue was $361 million somewhat above our guidance range and up from the $268 million in the second quarter. Gross margins came in at around 14% against somewhat higher than our guidance and up from 10% in the second quarter. Third quarter results included the benefit from higher margins realized in a couple of projects in our Eastern Hemisphere. But basically, our profitability benefited from healthy backlog levels and improved pricing embedded in our -- in that backlog. Our fabrication backlog was $1.24 billion at the end of the third quarter, again an increase of 177% over prior-year levels. Strong demand in that liquids rich and shale plays in North America continued to be the primary driver for our increased fabrication backlog. I'll break down the fabrication revenue a little bit more. It was comprised of about 36% compression, 55% production and processing and 9% Belleli Energy. It was roughly 3 quarters in North America and 1 quarter from international. Further, as we look at bookings for the third quarter, they were roughly equally mixed between North America and international markets. And then the backlog is roughly 2/3 North America and 1/3 international.

Now for the fourth quarter, we expect fabrication revenues in that $350 million to $370 million range with margins slightly lower than our second quarter in the 12% to 13% range. Moving on to our aftermarket services business in the third quarter, revenue came in at $96 million and gross margins again above 20%. It actually came in at 21%, both in line with expectations. Looking at the fourth quarter, we expect our aftermarket services revenues to be in the $85 million to $90 million range and margins again above 20%. Although AMS revenues are expected to be down somewhat sequentially as we expect a little seasonality in North America activity, our AMS business continues to perform well with good margins. Moving on, our SG&A expenses came in at $86 million in the third quarter, down from $94 million in the second quarter, which in that second quarter included a charge of some $7.6 million related to sales tax audits associated with prior years. In the fourth quarter, we expect SG&A expenses to move slightly higher in that high $80 million range. Net capital expenditures came in at $99 million for the third quarter. Growth capital within that was about $56 million, including some $34 million in North America, primarily from our previously announced fleet build program. Maintenance capital spending for the quarter was $30 million. Again, we continue to see good opportunities to deploy growth capital in the United States and in the international markets. In 2012, we now expect our net capital expenditures after sale proceeds of some $375 million to $400 million and that's up from our previous guidance of $350 million to $375 million. This is driven by attractive investment opportunities primarily in the United States. On the balance sheet, total consolidated debt increased by $98 million in the quarter and came from $1.8 billion at June 30, to $1.71 billion at September 30. Debt declined some $119 million at the parent level and increased by $21 million at the partnership level, and this was to help fund organic growth opportunities in the MLP, and David will talk a little bit more about that in his section. Our working capital levels are still a bit higher than we would like and I think you will see and we expect to see some near-term improvement this quarter in that area. Available but undrawn debt capacity at September 30, it was approximately $705 million, including some $236 million at the MLP. As of September 30, Exterran Holdings had a total leverage ratio that's up from a covenant debt total debt to adjusted EBITDA of some 3.0 as compared to 3.7 at June 30, 2012. Just as a reminder, our leverage ratio was 4.3 at the end of 2011. As Brad said, one of our key goals entering this year was to reduce our leverage ratio at the Exterran Holdings levels. Initially we said we'd bring it down to 4.0 by the end of 2012. The second quarter, we raised our target to 3.0 and clearly, we've met that goal. We will show continued improvement in the fourth quarter to further reduce our leverage.

As Brad discussed earlier, we completed the sale of our Venezuelan wholly-owned assets in August 2012 and received $127 million in net cash proceeds at closing. In addition, in the third quarter we also received the second quarterly payment from the sale of our Venezuelan assets, which was completed earlier this year. We've not recognized the remaining amounts payable to us as a receivable and therefore, we intend to recognize payments in the period such payments are received. These 2 transactions have significantly increased our financial flexibility and are expected to generate cash payments to us for approximately $20 million per quarter into 2016. Income from discontinued operations for the third quarter included the benefit from the sale of this wholly-owned assets in Venezuela, but it also included an impairment of long-lived assets and inventory that total some $28 million related to our plan to sell our contract operations and aftermarket services business in Canada. This charge is in addition to the one we took in the prior quarter we made to this planned sale.

Now we will move on to Exterran Partners. Earlier today, Exterran Partners issued a separate earnings release. And continuing the practice to initiate last quarter, we plan to have a separate discussion of partnership financial performance. So I'll now turn the call over to David for a review of the financial results of Exterran Partners. David?

David Miller

Thanks, Bill. Exterran Partners had another good quarter of performance with significant year-over-year growth in EBITDA and distributable cash flow, driven primarily by our drop-down strategy. In the third quarter, Exterran Partners' operating horsepower increased by 33,000 to approximately 1.94 million operating horsepower, driven by organic growth in liquids-rich plays. Revenue grew to $99.3 million in the third quarter as compared to $97.2 million in the second quarter, largely due to our growth in operating horsepower. Exterran Partners generated EBITDA as further adjusted of $46.2 million in the third quarter as compared to $45 million in the second quarter. Distributable cash flow was $29.5 million in the third quarter, up from $27.3 million in the second quarter. Distributable cash flow coverage in the third quarter was 1.3x. Cost of sales per average operating horsepower was $25.29 in the third quarter, up 7% from the second quarter of 2012, due to the higher maintenance in call-out activity in North America contract operations referenced by Bill earlier, and slightly lower benefits from ad valorem taxes in the third quarter. Q3 2012 cost per horsepower were down modestly from Q3 2011 levels. Over the longer term, Exterran Partners expects to benefit from the cost reduction initiatives in Exterran's North American operations as mentioned earlier by Brad. Last week, Exterran Partners announced a quarterly distribution increase for the third quarter 2012 and its distribution is now $2.03 on an annualized basis. This distribution is $.0.5 higher than the second quarter 2012 distribution and $0.02 higher than the third quarter 2011 distribution. On the balance sheet, total debt increased by $21 million during the quarter, from $644 million at June 30, $665 million at September 30, as capital was deployed to fund internal growth opportunities. Available but undrawn debt capacity at September 30, was approximately $235 million. We believe that our debt capacity provides us with the financial flexibility to finance the organic growth of Exterran Partners compression services business and positions the partnership for future acquisitions. As of September 30, 2012, Exterran Partners had a total leverage ratio, covenant debt to adjusted EBITDA of 3.7x, up slightly from 3.6x at the end of the second quarter. Gross capital expenditures for the third quarter 2012 were $40.2 million, consisting of $29.9 million for fleet growth capital and $10.3 million for compression maintenance activities. We continue to have attractive organic growth opportunities primarily in liquids rich and shale plays, including projects coming online in the fourth quarter of 2012. We expect total fleet growth capital expenditures to be in the $100 million range for the full year 2012 and maintenance capital expenditures are expected to be in the $40 million range for 2012.

In summary, Exterran Partners had a solid third quarter, highlighted by intrinsic growth of 33,000 operating horsepower and 8% sequential growth in quarterly distributable cash flow.

D. Bradley Childers

Thanks, David. Kristine, at this point, we'd like to turn the call open for Q&A.[Operator Instructions] The first question comes from Mike Urban from Deutsche Bank

Question-and-Answer Session

Michael W. Urban - Deutsche Bank AG, Research Division

Starting out in North America and the U.S., in other parts of the industry, we've seen a slowdown of operators producing some spending. I mean, I guess, I would expect your business to move with a bit of a lag just given the nature of more production-oriented business. Is there, one, I guess, enough pent-up demand work to do to catch up from an infrastructure standpoint, from a production standpoint and also again the dry gas plays kind of bottoming out to continue to drive growth in your North American business. It sounds like you've got some near-term visibility there, just trying to think a little bit beyond that given the slowdown that we've seen elsewhere in the industry.

D. Bradley Childers

Sure. Mike, you really kind of got the, I think, the main part of the store already, which is we do participate as a later participant in this cycle. So how do the cycles move, we find the impact on our business to come somewhat later. And to be honest, that's also somewhat flatter as our business is much more driven by growth in production than it is by upstream drilling activity. So we expect the current downturn right now to both be not as impactful to our business. And if it is impactful, it will hit us a little bit later as later production growth may slow due to the activity levels at the current time. The other part is, with a slight movement, modest improvement in gas pricing, we're seeing less stopped activity, not so much growth but just less stopped activity in some of the dry and conventional gas plays. So the combination of those 2 things, 1, catching up with some of the production capacity expansion that's already taking place as we're now setting equipment to help with that production, as well as the impact in the conventional areas of slight improvement in the gas prices is really making it for a better current performance feeding us in the market right now.

Michael W. Urban - Deutsche Bank AG, Research Division

That makes sense. And sticking with North America, I believe you have, at this point, rolled out the new service delivery model in North America. I was wondering if you could spend a little bit of time talking about how you expect that to help you to timeframe during, which we should expect to see improvement there and if you can, what the expectations there, what the order of magnitude might be in terms of what you're expecting from a profitability standpoint.

D. Bradley Childers

Well, talking about the efforts first and the timeframe a little bit. What we're doing in the North America business is a long-term change, structural change, as to how we run the business. We are looking at simplifying and standardizing the platform that we use to operate that business and this is not a short-term, quick-hit, quick-fix effort. What we've done is to look at the fundamentals of the business, how we manage our labor, how we manage our equipment, how the back office organizes and dispatches the labor and supports it through parts sourcing. It's really a kind of a top to bottom review of how we operate. As we pull those apart, we're putting in place separate initiatives staged over at the right -- over a good period of time to be effective in how we drive this so that these are permanent, sustainable levels of cost improvement and management in the system. And while we started that effort in 2012, we expect to be working or all year long through 2013 as well to drive improvement in our cost structure, which will impact our margin positively over the course of the next really 5 and 6 quarters. And that's what I think I would look for is that level of sustained improvement in our cost structure and gross margin. And I'll also point out that not every quarter is necessarily going to show that same impact. Our business has some seasonality to it and some activity levels can come and hit us in a disproportionate way quarter-over-quarter, so I'm more interested in the impact and we're driving toward an impact on a year-over-year basis, but you should see continuous improvement in those gross margins over the next 5 and 6 quarters is the way I would -- the way I'd look at it.

Operator

Your next question comes from Joe Gibney from Capital One.

Joseph D. Gibney - Capital One Southcoast, Inc., Research Division

A question related to this modest base in CapEx oriented around the U.S. side. I think, Bill, you referenced slightly higher than where we were before. Is most of that simply directed in plussing up the contract for you a little bit? I think there were some reference to increasing capacity a little bit on the TNT side. I'm just curious if you could provide a little color there?

William M. Austin

Joe, most of what we are seeing in that plus up is coming in North America in the fleet and it's in the compression fleets. So we've seen that increase demand and as we try to indicate to the fourth quarter, you're going to see some slightly higher revenues and better performance and a lot of that is deploying a new build, more modern fleet. So we see that demand coming in strong for next year so we really have to take a look at a what that's going to mean for next year as well. But in the planning process, we're not there, but we're seeing good demand in the North America and we see good demand in international as well

Joseph D. Gibney - Capital One Southcoast, Inc., Research Division

Okay. And just a couple of questions around fabrication, just curious about sort of the nature of some of the bids now within North America. Is it becoming a little more dominated by kind of smaller project processing plant demand, you're still seeing a fair amount of indicators for larger plants? And it looks like you obviously have a little bit more balanced inbound mix between them and international. This quarter, just kind of curious at the different kinds of outlook on the international side, the quarter-over-quarter getting a little bit better, just curious of what's happening there.

D. Bradley Childers

Joe, you're right, actually. We have seen a growing trend on the cost side towards some smaller plants, but the demand remains pretty good across the board. I think that there has been a little bit of a not a slowdown, but I think things have tempered a little bit from the high levels of activity we saw in prior quarters as some of the NGL pricing and bottlenecking NGLs had impacted some of the thinking and spending on the producer side. But we have seen a move in our opportunity portfolio to include more on the smaller side on the coal business. So yes, that is the trend that we've seen. As far as the mix and outlook in international, we have seen an improvement of both the opportunity set and quality of opportunity set in international, if that market is recovering and we're seeing the opportunity to capture more in future quarters and we think we're still on the front end of that recovery in our business for international bookings. So we are seeing a growing trend there that's going to help the backlog mix.

Operator

[Operator Instructions] The next question comes from Tom Curran from Wells Fargo.

Tom W. Rhee - Wells Fargo Securities, LLC, Research Division

This is Tom Rhee filling in for Tom Curran. When do you think you might be ready to consider meaningful acquisitions where you would focus in business wise and/or geographically? And also, have you guys participated in the auction of Thomas Russell in which Honeywell ultimately emerged as the victorious bidder?

William M. Austin

Tom, just a request, #1, we're not going to comment on sort of acquisition and divestiture activity. So I appreciate the question, but it's not one we're going to comment on. But I would ask if you could give us the front part of that question again just to make sure we got it.

Tom W. Rhee - Wells Fargo Securities, LLC, Research Division

Sure. When do you think you might be ready to consider meaningful acquisitions where you would focus businesswise and/or geographically? Any insight from that?

D. Bradley Childers

Sure. We are in the market and we'll consider acquisitions that fit with us strategically and what we're trying to accomplish in our business today. So it's not that we are adverse to it. However, I will tell you right now, we are much more focused on what we can do to focus on our current operations, improve the profitability of our existing businesses. That is the focus of our time and attention right now. So it's going to have to be a very strategic and well-priced transaction for us to want to contemplate a step up. It's not that we aren't going to look and it's not that we won't take advantage of good opportunities that present themselves, but right now, we're very focused on the self-help and turning this operation around with the operations that we have in driving profitability into the current portfolio.

William M. Austin

And if I could top that off, I would also say, we do have the financial flexibility now to look at this, just to add to Brad's comments.

Operator

At this time, there are no additional questions. I'll now turn the call back to Mr. Childers for final remarks.

D. Bradley Childers

Okay. Great. Thanks, everyone. We appreciate your time and attention this morning and we look forward to talking to you again next quarter. Thanks very much.

Operator

Thank you for participating in the Exterran Holdings Incorporated and Exterran Partners LP Third Quarter 2012 Earnings Conference Call. This concludes the conference for today. You may all disconnect at this time.

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