Exterran Corporation (NYSE:EXTN) Q2 2019 Earnings Conference Call August 6, 2019 9:00 AM ET
Blake Hancock - Vice President of Investor Relations
Andrew Way - President and Chief Executive Officer
David Barta - Senior Vice President and Chief Financial Officer
Girish Saligram - Chief Operating Officer
Conference Call Participants
Kyle May - Capital One Securities
Greetings and welcome to the Exterran Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Blake Hancock. Thank you, Mr. Hancock. You may begin.
Good morning and welcome to Exterran Corporation's second quarter 2019 conference call. With me today are Exterran's President and Chief Executive Officer, Andrew Way; David Barta, Exterran's Chief Financial Officer; and Girish Saligram, Exterran's Chief Operating Officer.
During this conference call, we may make statements regarding future expectations about the Company's business, management's plans for future operations or similar matters. These statements are considered forward-looking statements within the meanings of the U.S. securities laws and speak only as of the date of this call.
The Company's actual results could differ materially due to several important factors, including the risk factors and other trends and uncertainties described in the Company's filings with the Securities and Exchange Commission. Management may refer to non-GAAP financial measures during this call.
In accordance with Regulation G, the Company provides a reconciliation of these measures in its earnings press release issued yesterday, and a presentation located in the Investor Relations portion of the company's website.
With that, I will now turn the call over to Andrew.
Thanks Blake, and good morning, everyone. Thanks for joining the call. To kick things off this morning, I would like to take you through some highlights on the quarter and the business, and then Girish will walk you through the operational and commercial details. Operationally, we executed well on our contract operations projects with one commencing start-up in the Middle East during the quarter, another facility recently started up the past few weeks in Latin America.
We also had an excellent quarter commercially in aftermarket services, which Girish will discuss later. Our total company revenue and adjusted EBITDA were the highest quarterly results we have delivered since the spin, driven by strong execution of our teams in all of our facilities. We continue to focus on the things that we can control, especially around working capital, commercial terms and cost management. Our focus on these metrics drove another very strong quarter of operating cash flow of $35 million.
For the first half of 2019, we recorded operating cash flow of $84 million. During the quarter, we also spent $14 million on share repurchases, retiring a little over 1 million shares. We have now returned around $19 million to shareholders in the form of the buyback this year. Product sales booking, however, remained slow during the quarter.
There were several projects that were pushed into July, which we've since booked. That said, our customers continue to remain cautious on capital spending resulted in timing challenges. Our conversations are revealing the complexities of their challenges as they have projects with strong business cases, but the focus on capital discipline is causing delays and decisions and creating pent-up demand in our opinion.
Ultimately, this will put a strain on the industry's supply chain as customers demand shorter cycle times, while lead times for key components will remain constant. We have strategically built up an inventory of some key components, which are assigned to a specific pipeline of projects.
We keep a watchful eye on inventory as we've driven working capital to industry-leading levels over the past three years. Right now, we are comfortable with our inventory investments and are confident it will convert into revenue, given the commitments and indications we have from our customers.
Our Water Treatment business continues to progress as our bid book continues to get stronger. Inquiries and diligent discussions are growing every day as both producers and water mid-streamers continue to look for solutions on the treatment side. Our focus and strategies paid off. We have another pilot under way with an international customer, and we're hopeful that it too will lead to an order in the coming quarters.
While adoption of new technologies within the energy space is more systematic process with the longest cycle, I'm very pleased about the opportunity set and macro landscape that lies ahead for the business. Internationally, both the ECO and product sales pipeline remained very strong. What is exciting is that we see customers that we've sold to in the past, looking to expand and add facilities, their return to the market is a promising development as we look toward international growth.
Even though we have confidence that our North America order book will improve in the second half of the year, we are being proactive in getting out in front of some industry challenges and have already started working on rightsizing the business. To that end, we did take a restructuring charge of $5.8 million during the quarter.
These actions should lead to SG&A levels moving to around $165 million per year run rate in the second half of 2019, which is down from 2018 levels of $178 million. I would like to point out that this level isn't too far from where we were at the trough. But over this period, we've continued to invest significantly across the organization in business controls, engineering, new product development and quality. We're continuing to drive greater efficiencies throughout our operational and corporate organizations.
Our decision to consolidate our Houston compression facilities last quarter is another example of our proactive nature to quickly adjust our business to improve cash flow and returns. At the end of the day, we're scrutinizing every product and service we have to drive acceptable returns and cash flow. Our strategy hasn't changed with the near-term headwinds the industry has been facing and the macro landscape longer term remains very supportive of our business.
With that, I'll now pass it over to Girish to go through operations and our markets.
Thanks, Andrew. I wanted to start today with our aftermarket service business, which has developed strong traction over the past couple of years, and the second quarter brought in some significant commercial wins. This segment is an important one for us as it provides us long-term stickiness with the customers we sell products to and also gives important insight into the operability of our plants, which then feeds back into improvements for both our ECO and product sales business. It is also a business with solid gross margins, low additional overhead and minimal working capital and CapEx requirements.
In North America, we continue to make good progress on both commissioning and initial part sales, which are a starting point for longer-term operations and maintenance opportunities. In 2019, our run rate of volume in the first half is set to double what we did in this region in 2018. We have talked about our focus on upgrades in the past in this segment and that are starting to bear fruit with the signing of a contract for over $10 million for a single project in the Middle East, Africa region. This specific contract is for refurbishment on an offshore production platform.
And with the FPSO market becoming stronger, we believe that we are well positioned to get one or two of these types of large and complex upgrade contracts every year. We also signed some key contracts in both our Asia Pacific and Latin America regions, ranging from overhaul services to long-term parts agreements and operations and maintenance services.
All of these wins are positioning us to grow this business over the long-term despite having some operations and maintenance contracts drop off due to plants being taken out of service. We are also focusing our efforts in AMS on the more profitable aspects of maintenance, operations and upgrade services and exiting lower margin services, such as routine maintenance and provision of craft labor.
The major impact of this is in Brazil, where we had a number of low-margin contracts and are shifting our focus. While we will continue to fulfill our obligations on existing agreements, we are no longer pursuing that type of site labor work and the impact of that is included in the restructuring charges we took in the quarter.
Moving on to our contract operations business, we had several small but meaningful wins during the quarter in Latin America and the Middle East that are allowing us to redeploy idle assets, improving the overall returns on our asset base. Our backlog remained fairly consistent during the quarter as a couple of additional renewals came through.
That said, we still expect another $300 million to $500 million in renewals over the next 12 months to 18 months. As we have said in prior calls, we still have over $2 billion of revenue opportunities in the pipeline over the next 24 months. In the U.S. given our customers focus on capital discipline. We are also seeing opportunities for us to leverage our contract operations model.
Following this topic of capital discipline, we are clearly seeing orders for our processing and treating facilities slow over the first half of 2019. What provides us optimism is the feedback loop our customers, suggesting there is plenty of demand looming for these facilities. This is reflected in our P&T bid book, which now sits over $700 million, up from $500 million at the end of the first quarter.
Overall, the demand for our services and equipment globally remains robust and while near-term order challenges are evident, we see plenty of opportunities to grow our business over the coming years. We talked last quarter about the consolidation of the two compression facilities in Houston.
This is on track, and we expect full consolidation to be completed by the end of the year. Compression demand has certainly slowed relative to last year, but we continue to see significant volume opportunities. However, as we have stated, we do not have plans to compete for low-margin commoditized compression units.
While the consolidation of our Houston facilities is a very significant strategic action, as Andrew mentioned, there are a number of other strategic cost actions we have taken. Firstly, we have put in place very rigorous controls on all discretionary spending. We have opening rhythms and metrics to monitor spending across multiple categories, including travel, contract label, telecom MRO, etc. This allows us to not only optimize spend, but also share best practices across the company.
Second, we have taken the difficult but necessary steps to optimize our SG&A levels through the reduction of over 5% of our global SG&A headcount. This has been done in a careful and thoughtful manner while ensuring that our core competencies remain intact as demand picks up.
Third, we are looking across our organization in restructuring and reorganizing to maximize span of control and minimize reporting layers. While it is always important to ensure functional expertise, we are finding ways to consolidate functions and reduced management layers.
This also enables better communication and faster decision-making. Finally, we are ensuring that we are empowering our teams in the regions with the capabilities to deliver to our customers. This includes putting more decision-making in the regions, while ensuring strong governance mechanisms and communication rhythms from our central teams. All of these efforts and more are well under way, and we are confident that our proactive approach will help us optimize our cost footprint for the future.
I will now pass it over to Dave to discuss our second quarter financial results.
Thanks, Girish. The second quarter reflects a very solid performance with adjusted EBITDA of $53 million on revenue of $391 million and was in line with our expectations. As Andrew mentioned, operating cash flow from continuing operations was $35 million. From a segment standpoint, contract operations posted revenue of $90 million, while gross margin was $59 million, resulting in a gross margin rate of 66%.
Revenue increased as we became fully operational on a project in the Middle East that we booked a little over two years ago. For AMS, revenue was $30 million and gross margin was $9 million. This resulted in a gross margin rate of 30%. The sequential revenue increase was a result of the second-quarter seasonal recovery and our commercial successes.
The margin rate was driven by the mix of the business. Revenue in the product segment was $271 million, the highest since the spin, and gross margin was $31 million, resulting in a gross margin rate of 11%.
Bookings for the quarter were $79 million. An increase in revenue for product sales sequentially was due to the strong throughput we achieved at all of our facilities, while margin rate declined slightly due to product mix.
Our product sales backlog was $362 million at the end of the second quarter, compared to $635 million at the end of the second quarter of 2018. SG&A expenses were $46 million, while up slightly, SG&A as a percent of revenue was 11.7%, which was down from the 12.4% in the first quarter. We also recorded an impairment charge of $5.9 million. This resulted from securing the agreement to sell certain idle assets. The sale should be completed in the third quarter and is expected to bring in around $5 million of cash.
Moving to the balance sheet. Total debt at the end of the second quarter was $459 million with available credit of $529 million. Our leverage ratio is in great shape at 2x and compares to 1.9x at the end of the first quarter.
Now turning to the outlook for the third quarter. Contract operations revenue should be up sequentially in the mid-$90 million range, with gross margin in the low to mid-60% range. For AMS, revenue should be similar to the second quarter, and margins for the segment should be in a more normal mid-20% range.
In our Product Sales segment, revenue should be between $175 million and $180 million. And this is only converting revenue from backlog and not assuming any sales of spec equipment for the quarter. Gross margin in the segment should be relatively flat sequentially.
SG&A should be between $40 million and $42 million, and we would expect this run rate to hold at these levels going forward. Adjusted EBITDA for the third quarter should be around $50 million as product revenue declines are offset by some of the cost actions we have taken and the improvements in ECO.
The guidance excludes further restructuring and impairment charges, which could result from additional cost reduction actions or further sales of idle assets. Revised CapEx for 2019 is expected to be around $200 million, which is down from prior guidance. Advanced payment should be roughly $110 million for the year, putting our net CapEx at around $90 million.
And with that, I'll turn the call back over to Andrew for his closing remarks.
Thanks, Dave. The first half of the year was a strong execution period for us as we generated record product revenue in each quarter. The challenges being customers converting proposals to awards. Despite this, our strong ECO and AMS backlog gives us a level of support many companies in our space don't have.
We are focused on what we can control around costs and capital allocation, new product development and customer relationships. For the full-year 2019, even though the market is softer now than we had anticipated, adjusted EBITDA for the year should be no worse than last year's results.
The exact outcome will be dependent on the order profile for the second half of the year. While there is a lot of focus on our product order number, the key differentiator for our business are the ECO and AMS segments, which provide strong stability for us despite what our product order book does quarter-to-quarter.
The two ECO projects that recently came online this year here, along with our growing AMS business will further support both of these over the long-term. This will also help alleviate some of the cyclicality created from our product segment.
We have strong expertise and experience in the products and services we provide and believe that our strategy of growing ECO, AMS and water, while focusing on driving improved margins in our products segment align well with our desire to be a leading midstream solutions provider. We are determined to drive shareholder value and are continuing to evaluate our portfolio to fully maximize our cash flow generation and return profile.
As I told you last quarter, the new era of oil and gas investment is here. We're seeing changes in our customers' behaviors as they look to minimize CapEx to improve their cash flows and returns. I believe the industry is beginning to better understand this new normal, and while it's still maybe a couple of quarters before due course of business resumes. It does feel like our customers are beginning to look beyond the coming quarters at their longer-term needs.
As I wrap up this call, I want to thank all of our employees for their hard work on delivering the second quarter success around record products revenue, strong AMS commercial wins and the commencement of one large ECO project during the quarter second – and the second commencing here early in the third quarter. You all have responded to everything that we've asked of you to enable the continued success of Exterran.
And with that, I'll now turn the call back to the operator. Thank you.
Thank you. [Operator instructions] Our first question comes from the line of Kyle May of Capital One Securities. Please proceed with your question.
Good morning. I was wondering if we could start with an update on the water business. I know you touched on it in your prepared remarks. But can you give us a little bit more detail on what you're seeing with the ECO contract that's in place, the pilots and any potential growth in the back half of the year?
Yes. Kyle, good morning. First, I'd like to say that the operations that we have operating in the U.S. right now for that – for the major E&P that we talked about is going very well. And we're using this as a reference for others.
We've been producing the spec water for this customer now for some time and hope we have some opportunities not only to expand the scope with this customer in the coming quarters, but also, by using this as a reference, we're able to bring other customers on site and see the technology in play.
Also an observation since probably the back end of last year but more so in the first quarter, as we've been seeing this momentum, our bid pipeline continues to grow and is above where we were in the second quarter. We're also seeing a number of projects that were in the final stages of signing.
So hopefully, a multiple of what we booked in the first quarter, and we're continuing to see great momentum as we go into the second half. I'd say outside of the U.S. is where we're probably seeing the most traction. And that's in the Middle East, where we're building strategic relationships right now with a couple of folks and one particular large producer that's standardizing their technology around our solution.
And we've been piloting some larger technology that we've called the CFU. It's a product that can handle between 50 and 150,000 barrels. And we'll be running this pilot for the balance of the year, and we're now introducing this technology into the U.S. as we've started to see water volumes continue to grow and really get centered around the larger processing sites.
So as I said in my prepared remarks, Kyle, the newer technology for this space usually takes a little bit more on a longer-term in nature for adoption, but the traction is gaining and is clearly showing that our strategy is paying off.
And so we have some great hopes for the second half and into next year with both the adoption of the smaller technology for the lesser barrels produced and also the larger-scale technology that we've been running in the Middle East, so very pleased with the progress so far.
Okay, got it. That's very helpful. And maybe next, can you give us a little bit of an update on the order rate? I realize there's some cyclicality in the business?
Yes. And clearly, as we've said in the prepared remarks, it's one of the areas that's been somewhat the most frustrating that we felt all year because the bid pipeline in certain products have been growing.
Girish mentioned that there are still opportunities for lower margin sort of spec compression that quite honestly, we've stayed away from and purposely, because our focus has been more around the integrated plants and more around processing in some of the niche markets that we've seen in compression.
But as I said in my prepared remarks, that we're encouraged by a couple of things. One, the conversation and dialogue just seems to be a lot more healthier and people are committing more conversations to timing of orders as opposed to if projects will happen or not.
We've also, in the first part of this quarter, already booked more than half the orders that we received in the second quarter and so our run rate for July was pretty strong. The P&T opportunity set itself has risen up to over $700 million of gas processing facilities. That's all in the U.S., which is a fairly robust, but timing, as I said earlier, has been a little tough.
Also, I think in relation to that because there's probably a second part of this question, Kyle, and that is the quick – how quickly you convert that if those orders come through. We have taken a strategic view on some key components.
And you've probably seen in our Q that we've built around $70 million of inventory since the sort of fourth quarter last year that we've allocated to a number of customers that we have identified for projects. So that if those orders come through, then not only can we see faster cycle times, but also certainly will help revenue recognition and cash recognition, working capital will be a lead.
And so we're seeing right now, lead times for processing and treating still around 40 to 50 weeks. So by having this inventory, we're going to be able to help in a number of areas where there's pent-up demand because there are a lot of activities. And if you just track the amount of projects that's in the pipeline that's public. And a lot of these projects have been committed to end users.
It's a question of how do you get these facilities to a place where we can bring them online faster than the typical lead times. So we feel very strong that that's an area that certainly showing more light than it has in the past.
And then, as Dave said, in relation to sort of the order commitment and revenue, we've taken the backlog that we have today and provided that as product guidance for the quarter. So it's really only executing what we have in backlog today.
And obviously, if we see some of those spec plants get converted in the quarter. That's clearly upside to what we've just communicated today. And so that's a little bit of what we see. And then internationally, we're continuing to see strength in all the markets.
In Latin America, we're very pleased with the progress of some projects, but also the Middle East. And as I said in my prepared remarks that we're very pleased that a lot of projects that we've delivered in the past for customers, they are coming back to us for train two or train three or a repeat of that project.
And so we're very hopeful that in the second half and early part of next year, those projects will come to fruition. And this is just what I would call a stall in sort of the cyclicality of what we're seeing on the product side, but very comfortable with the long-term strategy and feel very comfortable overall in terms of what we do.
Okay. That's very, very helpful. And maybe one thing, just if you could clarify, I know in the press release, you had mentioned July orders were kind of improving from what you'd seen or I guess the early part of 3Q. Can you give us any more contexts on that?
Yes. I can – we put that out there because it's important to give you a sense of how we're feeling both from a bid activity and a conversion. So we've converted in July and to-date, more than 50% of what we've seen in Q2.
And if you look at our Q2 order numbers, and if you look at our Q1 order number, our run rate for Q3 is already more than half of what we booked for the entire quarter. So it's a significant indication that the commercial activity is certainly feeling as though it's converting from bid activity to realization of orders.
Okay, got it. That's helpful. Well, that's all for me this morning. I appreciate the additional color.
Great. Thanks, Kyle.
[Operator Instructions] There are no further questions over the audio portion of the conference. I would like to turn the conference back over to management for closing remarks.
Great. Well, thank you, everyone, for dialing in and showing your interest in Exterran today and look forward to updating you at the end of Q3. Thank you.
This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.