CSI Compressco LP (NASDAQ:CCLP) Q3 2022 Results Conference Call November 3, 2022 10:30 AM ET
Company Participants
Jon Byers – Chief Financial Officer
John Jackson – Chief Executive Officer
Conference Call Participants
Brian DiRubbio – Baird
Selman Akyol – Stifel
Operator
Good morning, and welcome to the CSI Compressco LP’s Third Quarter 2022 Earnings Conference Call. The speakers for today’s call are John Jackson, Chief Executive Officer of CSI Compressco LP; and Jon Byers, Chief Financial Officer of CSI Compressco LP. Rob Price, Chief Operating Officer, is also in attendance. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Mr. Byers. Please go ahead.
Jon Byers
Thank you. Good morning, and thank you for joining CSI Compressco’s Third Quarter 2022 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’re 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, gross margins, adjusted EBITDA, free cash flow, distributable cash flow, distribution coverage ratio, leverage ratio, utilization or other non-GAAP
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Please refer to this morning’s press release or to our public website for reconciliations of non-GAAP financial measures to the nearest GAAP measures. 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 is posted on our website, our Form 10-Q will be filed later today. Please note that the information provided on this call speaks only to management’s views as of today, November 3, and may no longer be accurate at the time of replay.
With that, I will now turn it over to John Jackson.
John Jackson
Good morning, and thank you for joining our call today. We’re pleased to see this quarter’s financial results reflect — to begin to reflect some of the improvement that’s been occurring in compression space in the last few quarters. Our contract services and aftermarket service businesses all continued to show strong activity. The revenue positives up to this point have been largely offset by inflation and the effect of foreign currency amidst the strengthening dollar worldwide.
This quarter, we have seen the core business outpace the inflation costs for the first time in a few quarters. This is not to say we have recouped the entire effect of cost increases in this cycle, but we are making progress in pushing some of our activity improvement now through EBITDA. As it relates to our fleet or contract services business, utilization continued to improve quarter-over-quarter for the sixth straight quarter.
Price increases on the existing deployed fleet have begun to close the gap of the effects of inflation. This is translated into increasing fleet revenue quarter-over-quarter for 7 consecutive quarters. Our cost picture, however, remains challenging as people remain in short supply. Parts costs continue to rise and fluids costs such as lube oil remain at elevated levels even with the recent crude oil declines from their summer highs.
As a result, we expect cost pressures to continue into the fourth quarter in early ’23. We believe we can mitigate the effect of the cost increases through pricing and cost management efforts. In addition to the further price increases on our fleet, we have several idle units that are contracted for redeployment over the fourth quarter ’22 and into ’23. The aftermarket services and parts business or AMS business has performed well this year with increasing revenues and improving margins. We have a strong pipeline of AMS activity, both in current contracted work, outstanding bids and current customer requested proposals.
This pipeline provides us visibility through the first quarter 2023. And based on what we’ve seen this year, we would expect the activity levels in the AMS business to stay elevated through 2023. The primary constraint on growing the AMS business is finding incremental qualified people to execute quality work. Our overall industry is short of people, and this affects our contract services business as well as our AMS business.
Our incremental capital spending for the remainder of this year and the first half of 2023 will be spent deploying the idle fleet units, converting additional units from natural gas-driven engines to electric motor drive units and deploying new build units as they are completed. As we mentioned in our press release, if our customers do not return a significant amount of horsepower to us over the next couple of quarters, we will be nearing full utilization of the U.S. reciprocating fleet. We will continue to grow our large horsepower fleet in ’23 as we currently have some new build units on order that are contracted to deployment in the second half of 2023.
While electric motor drive units remain interesting to customers and we continue to see bidding opportunities, the pace of deployment remains a question mark as customers work through the dynamics of installing significant amounts of electric motor drive units. This includes acquiring long lead items, attempting to determine the overall capacity of the local grid that’s available with many different groups planning on accessing the current available excess capacity. And then ultimately determining the reliability of that electrical supply.
We plan to continue to be a provider of both natural gas engines and electric motor drive units as our customers evolve and their distribution of their compression across various basins. As we think about growth capital for 2023, we plan to provide specific guidance on our year-end call, and we expect it to be reduced from our 2022 levels of growth capital. While our customers have continued to express interest in additional large horsepower for the future, we are building modestly into 2023 as we’re positioning CSI Compressco to generate free cash flow and increase liquidity during the year.
In summary, we continue to see a strong demand environment for our products and services heading into the fourth quarter of ’22 and the beginning of ’23. Inflation continues to be the major unknown variable. We will remain flexible as we navigate the rapidly changing environment and position ourselves for success. So as we conclude this year, we’re excited about the future. The natural gas space continues to be critical for reliable energy supply to power not only in the U.S. but much of the world. We are excited to be a part of that effort and look forward to an exciting 2023.
I’ll now turn the call over to Jon Byers.
Jon Byers
Thank you, John. For the third quarter of 2022, CSI Compressco reported utilization increase from 78.9% in Q3 of 2021 to 85.1%. Our reported revenue increased $94.9 million compared to $77.7 million in the third quarter 2021. Our contract services revenue was up to $67.5 million from $59.4 million in the third quarter of 2021, a 14% increase. Year-on-year, our AMS revenue was up 66% to $23.2 million compared to $14 million in the third quarter of 2021.
Third quarter adjusted EBITDA was $29.8 million compared to $25.7 million in the third quarter of 2021, a 16% increase. Distributable cash flow was $13.1 million compared to $10.6 million in the third quarter of 2021. We’ll pay our third quarter distribution of $0.01 on November 14, with a distribution coverage ratio of 9.3x.
Moving on to the balance sheet. Our total liquidity, cash on hand plus outstanding ABL capacity was $51.3 million on September 30, 2022. As of November 1, our total liquidity was $42.7 million, which compares to $32.7 million at year-end. Our net leverage ratio in the third quarter of 2022 is 5.7x, down from our peak of 6.8x in Q3 of 2021. We continue to expect a downward trend in our net leverage ratio through the rest of ’22. On October 17, we extended our Spartan ABL from a maturity of January of ’24 to October of ’25, leaving CSI with no significant credit maturities until 2025.
Our capital spending guidance for ’22 remains $55 million to $65 million. As John said, this is mainly driven by high-return projects, including reconfiguring large horsepower units to meet customer demand; electrification of older, large and medium horsepower units and some large horsepower new builds.
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…our plan to reduce our overall leverage while growing the business. Our net leverage ratio stepped down from 6.8x a year ago to about 6.3x at year-end 2021. And now we sit at 5.7x. If you annualize our third quarter ’22 EBITDA, we have a net leverage ratio of 5.2x. Most of our debt is fixed rate. This has helped us in a rising interest rate environment, resulting in a minimal impact on our overall interest expense.
Our focus in ’22 has been reducing leverage while balancing liquidity and growth. Looking forward to ’23, as John mentioned, we plan to reduce overall growth capital spend relative to this year and emphasize debt reduction and liquidity. Longer term, we remain focused on simplifying our capital and organizational structure and positioning CSI to thrive in all phases of the energy cycle.
We’ll now open the call to questions.
Question-and-Answer Session
Operator
[Operator Instructions] And our first question will come from Brian DiRubbio with Baird.
Brian DiRubbio
So first question for me. As I look at the results, it was nice to see that you’re able to deploy more horsepower without any degradation in the margins given those extra costs. Just — can you just help us better understand what the current pricing environment is and how that’s helped you to offset that?
John Jackson
Sure. I think we’ve seen — over the last year, we’ve seen a continually increasing cost environment, inflation being transitory, not transitory, all these different thoughts from our customer base. So the ability to drive price increases second half of last year was there but at a minor level, let’s say, 3% to 5%, perhaps. And then you really moved into Q1, Q2 this year, you saw everything take off with the Russian invading Ukraine, parts and supply is getting very tight, parts going up 25%, crude oil going from $80 to $120. Everything really took off on us in latter Q1 and into Q2, and that was an immediate cost hit. And that’s really been able to — that’s allowed us to really push price increases to our customer because we absorbed the cost increases in the front half of the year.
So our price increases that we’re getting now really trying to recoup that cost increase are in the double digits, generally. Every customer is different. Some are more towards the market now as they were just recently put out. Some have been on for 2- or 3-year terms, and they’re coming off at much lower rates. So the overall effect is that the price increases we’re getting now are reflecting the cost environment from the first half of the year.
Obviously, prices continue to go up. Parts continue to rise. Like I said in my comments, lube oil, which we use a significant amount of lube oil on our units, running them each month. If you were to go back a year ago, lube oil on average was running in the third quarter, let’s say, $7.50 a gallon, and it’s running — going in the fourth quarter, it’s running between $11.50 and $12.50. And so when you use a whole lot of lube oil every month, that’s costing us $1 million a month in additional lube oil cost from a year ago.
So these are the kind of cost pressures that hit us earlier this year. They are now, I’d say, flatter. They’re not down. They’re still rising, but not rising at the rate we saw in the first half of the year. It’s a very long-winded answer, but the point is we’re 6 months on a lag to catch up with the significant cost increases we saw, and we’re just starting to see that now. We have more price increases to go because all of our fleet isn’t there yet. But generally, double-digit price increases at the moment.
Brian DiRubbio
Got it. And maybe — and that’s very helpful. How — I’m not sure if you want to answer this, but how much of your current horsepower in service do you think is sort of within a reasonable range of current market prices versus those that still have to reset?
John Jackson
I’d say in the last 6 months to let’s — I would say, I’m already thinking about Q3 — I mean Q4 and Q1 are kind of what we’re already working on those price increases. I would say we still have maybe 40%, 50% of our fleet is kind of there at maybe what you might consider market today. We have a lot of it is still under term. It has to come off. And you’ve got to look at our fleet in layers too. You look at the large horsepower. The large horsepower got tight first. And so we were able to raise prices earlier on the large, let’s say, the 1,500 horsepower and up or 1,200 horsepower and up back in Q1.
The smaller end of the fleet had a lot of excess capacity. That excess capacity has gone everywhere just about now from the 100 horsepower and 150 horsepower and up. And so we’re able to raise price on the smaller horsepower now. So I’d say — from a dollar magnitude, we’re probably 50% of the way there. From a fleet magnitude, we probably have a lot more units to touch on pricing just because the smaller end of the fleet has gotten tighter in the last 4 to 5 months. So there’s a lot of work still to do next year.
And really, it’s really managing the environment we’re in. I think the thing that you’ve seen, I think, on commentary on other people’s calls, and we didn’t really talk about it on our commentary, but in addition to just flat out price increase, we’re trying to push term, we want to have visibility. And with that term, we’re trying to price protect with price inflators, annual price inflators that are tied in. And I think we tried to do it last year and got a lot of pushback.
But as we moved into this year, it’s mandatory for us to do it on our sales force. So I think anything at 1,000 horsepower and up because those are getting multiyear deals, that they have price inflators on them so that we don’t have to go back and necessarily renegotiate every single unit, every single time even it’s on term. So we’re trying to do it in a multitude of ways. Price inflators, term, rate and then layer by layer to the fleet. So I’m not answering your question specifically because I don’t have that, but I’d say it’s around 50%.
Brian DiRubbio
Got it. But that extra color is extremely useful. Just help us understand the — what’s the market look like in terms of the ability to get new compression? I know that was an issue a couple of quarters ago that the lead times are really long. Has that changed at all? Is new compression still 12 to 18 months out?
John Jackson
Yes. The engines that you would order from Caterpillar today, if you — you might have a distributor that has a few engines around. But if you’re going to go out and get it in the back of the line today and say, I want to build 50 3608s or 3606s or whatever the case may be and the large, you’re going to be 52 to 58 weeks. That’s today. And depending on the size of the order, it’s going to move it out further. So that’s to get the engine.
So I was recently at a fabricator a couple of months ago. And there’s a lot of units completed. They come out of fabrication, don’t have an engine yet. I mean, they’re waiting on the engine because the timing of the delivery of the engine, while they give you a slot, say, “We think in 50 weeks, you’ll have it.” It may be 55 or 58 when it gets done because you go back to Caterpillar and they say, “I’ve got some engines done, but I’m missing 2 or 3 components still to get the engine completed to ship it to you.” So it’s just like a car manufacturer that’s sitting here today saying, I’ve got cars done on a lot except 4 or 3 things. So it’s all the way back up.
And so there’s not real clear delivery schedule within maybe 8 to 10 weeks or so, but that’s not really what your producer wants. Producers now are jumping out into ’24, and they’re trying to get bids for ’24 deliveries because know the variability in delivery is quite wide.
Brian DiRubbio
Great. That’s really helpful of you, guys. And as a final question for me. Jon Byers, as we think about 2023 and your focus on repaying debt. Are you going to attack the ABLs? Or just given where some of the second liens are trading in the open market today, is it sort of more attractive to pick off those opportunistically? Just love to get the thought process around that.
Jon Byers
Yes. I would say from a — just from a pure finance standpoint, it’d be great to be able to attack the first and second liens. There are some limitations we have in our bond indentures that may prevent us from doing that. So we’re working through some of that right now.
Paying down our ABL is very easy. Generally, we’ve been here over the last 18 months. Historically, we’ve drawn on our CSI ABL to make our semiannual interest payments and then pay that down over the following months. I expect that will — we will be hopefully drawing on that less as we build liquidity. And then the Spartan ABL, which is
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we’ve got a ballpark of $52 million drawn on that now. Our goal is to continue to pay that down as well. And really, from an interest rate standpoint now that the underlying indices vis-à-vis has increased. There’s really not a significant interest rate differentiation between buying in first and second lien versus ABL other than the fact that the first and second lien are trading in the mid-80s.
Operator
[Operator Instructions] Our next question will come from Selman Akyol with Stifel.
Selman Akyol
So taking a look at your CapEx and your ’23 commentary around it, you intend for it to be lower. Have you guys completed your capital expenditures related to technology? Or should we — another way of just asking is, is there going to be some of that next year?
Jon Byers
It’s going to be fairly minimal. It’s going to be fairly minimal. We’ve pretty much finished our ERP implementation. We have — I think we have about $1 million to $1.5 million left to actually pay, although some of that are incurred. So I would say we are winding down the technology
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Selman Akyol
Got it. And then it seems like — just listening, most of your torque in terms of repricing may be coming from those units that are out there on sort of 2- to 3-year contracts. And so I’m just curious as how much of your fleet is on sort of with 2 to 3 years left. And then am I thinking about that correctly that those are the ones with the greatest price increases.
Jon Byers
All right. sorry, are you — I guess, are you asking about contracts coming up on term? Are you asking — I mean basically you’re saying of the units that we have that are 2 or 3 years, are they candidates for price increases? Yes, go ahead.
Selman Akyol
Yes. So of the units that you have, right, some of them are coming up and they’re coming off 2- or 3-year contracts. Those are going to reprice, and I presume they’re going to reprice significantly higher. So I’m just trying to understand how much your fleet might be subject or exposed to that?
John Jackson
Well, I’d say right now, we have about 60% of our fleet has some term remaining on it, okay? So we’ve got about 40% of our fleet that’s on month-to-month. And when you look at the smaller end of the fleet, let’s call it the smaller end, 800 horsepower and down, just to keep it simple. Those are generally going to be 1 year deals or less. And they’re always going to be able to be repriced within a fairly short duration. So the larger end of the fleet, we have currently about 15% of our fleet has more than 1 year left on its term as of today.
So those units that do come off that have — that are coming off, yes, we are getting significant price increases. And I’ll just — just to give you an example of — I’ll take you to the cost side and not on the revenue side because that’s different for each producer. But an 1,875 horsepower unit 2 years ago, when we walked in the door, we’re being deployed here, those cost maybe $1.8 million — excuse me, $1.4 million to build them. I was thinking about a larger one, $1.4 million more to build them, and today, they’re $2.1 million. So they were up 50%. So when you just think about the cost of building a new one today and what that’s pricing at to get, let’s just call it the same economics, you’re going to have to move your price a lot on the existing fleet to get it into market or you have the ability to move that in the market, and it’s — they’re in very high demand.
So that will give you a sense of some of these units can move quite a bit. So you might move it. So just simply, you might have a unit that was running at 30,000, maybe you can get 40,000, 42,000, 43,000 for it now as an example of something that might move that’s been out for a couple of years.
But you’ve got to go back 1 year ago and think about what was being deployed 1 year ago. We weren’t getting necessarily 2- and 3-year terms for some of these units, we were getting on the midsize units 1,000, 1,500 — you’re getting 1 year terms a year ago, maybe 15 months ago. So those are going to come off term too, and the markets moved quite a bit on those also.
So I think the 1,000 horsepower and up, you still have a lot of torque across that entire fleet spectrum that’s going to come up to reprice again this year because last year, we weren’t able to get inflators on the fleet contractually. And this year, we’re also able to take let’s say 1,000 to 1,500 horsepower last year, we were getting 1 year terms. We’re getting 2- to 3-year terms now. And we’re able to get inflators in those. So I think we’ll see that continue to move in 2023 up.
Selman Akyol
Got it. And then last one for me. But in your comments, you referenced trying to simplify your structure as being one of your goals on a go-forward basis. And I’m curious as to what you’re exactly referring to? Is that the capital structure of the company?
Jon Byers
It’s definitely the capital structure of the company. We’ve been talking about that since Spartan acquired CSI in
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Organizationally, we’re also considering does it make sense to convert from the MLP structure.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to John Jackson for any closing remarks.
John Jackson
I appreciate everyone joining this quarter. We look forward to talking to you on our year-end call and how we finished the year and how ’23 is opening up, but we’re excited about the future, and thanks for joining us.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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