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Edited Transcript of CCLP earnings conference call or presentation 8-Aug-18 2:30pm GMT

Q2 2018 CSI Compressco LP Earnings Call

OKLAHOMA CITY Aug 23, 2018 (Thomson StreetEvents) -- Edited Transcript of CSI Compressco LP earnings conference call or presentation Wednesday, August 8, 2018 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Elijio V. Serrano

CSI Compressco LP - CFO of CSI Compressco GP Inc

* Owen A. Serjeant

CSI Compressco LP - President & Director of CSI Compressco GP Inc

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Conference Call Participants

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* Charles Willaim Barber

JP Morgan Chase & Co, Research Division - Analyst

* James Marshall Adkins

Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research

* Michael Christopher Gyure

Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs

* Selman Akyol

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good morning, and welcome to CSI Compressco LP's Second Quarter 2018 Earnings Conference Call. The speakers for today's call are Owen Serjeant, President; and Elijio Serrano, Chief Financial Officer. (Operator Instructions) Please note this event is being recorded.

I will now turn the conference over to Mr. Serjeant. Please go ahead.

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [2]

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Thank you, Michelle. Good morning, and thank you for joining CSI Compressco's Second Quarter 2018 Results Conference Call.

I would 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, backlog 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 early this morning and as posted on our website, our Form 10-Q is planned to be filed with the SEC on or before August 9, 2018.

I will start with an overview of our performance, then turn the call over to Elijio Serrano, our Chief Financial Officer, who will provide more details on our financial results and projections.

I'm pleased to report significant EBITDA improvements in Q2 over Q1. The CCLP team has undertaken a series of initiatives to get better prices for our equipment and services, deploy equipments previously idle and invest capital in high-return opportunities. We have continued to focus on improving efficiencies in our field operations, at our fabrication facility, at our aftermarket distribution centers and in the back office, all supported by our newly implemented ERP system.

This quarter reflected the impact on our financial results from those efforts and efficiency improvements. We believe that there are further benefits coming as we continue on these initiatives into the future.

The upturn of the compression market in North America continues to be strong. Our customers are demanding more compression equipment and services from CCLP, and we've been able to adjust and quickly respond to those demands.

Let me walk you through our 3 business segments: Compression Services, new units and aftermarket; and describe how they are performing and continuing to improve in these strong market conditions.

Firstly, our Compression Services business segment continues to be very robust. To address the increasingly growing demand from our customers for our Compression Services equipment, we decided to increase our 2018 projected total capital expenditures to be between $110 million and $120 million, inclusive of $18 million to $20 million for maintenance capital expenditures. This is an increase of $20 million from the guidance we provided earlier this year.

This year, via the strong capital expenditure, we anticipate that we'll be adding approximately 130,000 horsepower to our fleet. Of this, approximately 85% is over 1,000 horsepower. All orders are customer specific as we are not ordering nor building equipment on a speculative basis for our fleet.

We are being very disciplined in how we allocate that capital and are only targeting new investment opportunities, with ROIC of 20% or higher, focused on high horsepower equipment in geographic areas where we have existing strength and customers who continue to want to partner with CCLP as a supplier with flexibility and the experience to offer Compressor Systems solutions. This allows us to leverage our existing network and infrastructure and secure incremental margins better than what the fleet as a total are currently attaining.

Given our focus on returns on capital, we have identified the appropriate customers, regions and projects that will properly compensate us for the services and equipment we offer and meet our hurdle rates. We continue to work closely with these customers on the future -- their future compression systems requirements, providing solutions to a range of compressor applications and horsepower ranges.

We also continue to -- repricing with our Compression Services customers as contracts roll over or new contracts are put in place, especially for larger gas gathering system assets. These increases started to materially impact our results in the second quarter of 2018. We are pleased with the progress on price actions to reflect the increased demand for large horsepower equipment. We believe all new equipment we deploy today from our services fleet is at leading edge pricing with our customers and in the most active basins.

We expect the combination of improved pricing and lower cost to fabricate equipment, given our vertical integration, to continue to drive up our returns on capital.

Secondly, our new unit sales activity remains strong. In January, as earlier reported, we secured our largest new equipment order in the company's history, pushing our fabrication backlog for third-party sales to over $100 million. And even though we had strong shipments in Q2, our backlog at the end of the second quarter remained above $100 million, and we had another very strong booking quarter with incoming orders over $25 million in Q2. Additionally, since the end of Q2, we have already received an additional $18 million from a large midstream operator in the Permian Basin that is expected to ship in early 2019, pushing our backlog to around $120 million as of this date.

The demand for new equipment sales is strong and rising, and we expect that trend to continue for some time as companies build out infrastructure and takeaway capacity in key basins.

The industry is short on large horsepower equipment, as it continues to build out pipeline and processing capacity in constrained areas in North America, more specifically in the Permian Basin. With the recent margin expansion and additional third-party orders, we expect the new unit segment to be a much improved EBITDA contributor to the overall company on a go-forward basis.

Thirdly, our Aftermarket Services have continued to grow in recent quarters, with another strong top line delivered in Q2. Our customers are catching up on previously deferred maintenance, are ordering more spare parts, completing more overhauls and engaging in reapplication engineering and site technical support. The long lead times on new equipment is pushing many customers to bring back to service older equipment that requires our services to catch up maintenance, recondition equipment, etc.

While margins in this business can sometimes fluctuate due to the mix of parts and services, we expect this business to continue to grow in the second half and deliver substantial returns. Importantly, this business does not need any capital to grow. The aftermarket business is correlated to the equipment sales business as discussed previously. Our customers who purchase new equipment from us often return over time to purchase aftermarket parts and services and that should -- trend should continue as we sell more equipment.

The gas compression industry is going strong, with each quarter seemingly stronger than the prior one. The U.S. rig counts are stabilized above 1,000 rigs settling roughly between 1,030 and 1,040 in the last 10 weeks. Our customers now have more demand for compression to deal with higher volumes of associated gas from the shale play drilling programs, which bodes well for our business. Over 800 rigs are designated as oil rigs, with 70% of these in regions where we have the majority of our deployed equipment and where the majority of our new fleet additions are headed.

Our quarter-over-quarter utilization for 1,000 higher horsepower equipment focused on gathering systems is now at 94.1%, a significant uptick from 92.9% at the end of the last quarter. We deployed an incremental 18,505 of active horsepower during the quarter, increasing the amount of deployed horsepower to 932,467. Overall utilization for the entire fleet is at 85%, up from 84.2% at the end of Q1 and up from 78.9% at the end of second quarter 2017.

The vast majority of the increase and the areas with the most activity and demand include the Permian and Eagle Ford Basins as well as SCOOP/STACK areas in Oklahoma, where around 70% of our operating horsepower is deployed. Today, we are [out of] capacity of all our large equipment, but are building more equipment funded from the recent bond offering and existing cash flow and expect all of these investments to meet our previously mentioned return hurdle rates.

In the second quarter, in addition to the bond offering we had reported at the last earnings call, we also finalized a $50 million asset-based agreement mainly to fund working capital needs and outstanding letters of credit. The overall new debt structure provides us greater liquidity and flexibility to respond to the increased customer demands. Today, our new debt structure is without maintenance covenants, which is a major plus for our business.

With that, I'll turn it over to Elijio to provide some financial details on the quarter. Then we'll open up for questions.

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [3]

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Thank you, Owen. Second quarter revenue increased sequentially by 17%, primarily due to better pricing, continued stronger activity from Aftermarket Services and new unit sales.

Compared to a year ago, revenue is up 33%, with equipment sales improving 94% to $28.1 million. Aftermarket Services increased 43% from last year to $15.1 million, and Compression Services revenue increased 13% to $56.7 million.

Revenue for all 3 business lines increased sequentially also.

Compression Services margins in the second quarter were 46.2%, an increase over the first quarter of this year by 460 basis points due to better pricing, the lack of weather events that impacted us in the first quarter and continued improvements in our efficiencies. We exited the quarter with Compression Services margins of 47.5%, reflecting the benefit of cumulative price increases and efficiency initiatives that Owen mentioned earlier.

Aftermarket Services revenue was $15.1 million, with gross margins up 14.9%. We continue to see strong demand and growth in this area as customers continue to catch up on previously deferred maintenance, to deploy idle equipment and rebuild their inventory stock in anticipation of continued higher activity levels. The sequential margin -- the sequential drop in margins came from a mix of parts and services, which can vary due to the call-out nature of some of the work.

Equipment sales were $28.1 million, with gross margins of 14.1%. This reflects the delivery of equipment from the backlog that we started building in the third quarter of last year. Our margins in this line can vary based on the type of equipment we're delivering. We have made great strides to improve our manufacturing efficiencies and cost, and the benefits have been materializing over the last couple of quarters. We expect to see continued increases in equipment sales in the second half of 2018 as a result of the $102 million backlog.

In the second quarter, we recorded a $600,000 noncash gain to adjust the carrying value of the Series A units. Adjusted EBITDA in the second quarter was $23.3 million, a $4.1 million improvement from the first quarter.

The press release that we issued this morning updated guidance in 3 key areas. First, we increased the projected total year adjusted EBITDA to be between $97 million and $102 million. To achieve the midpoint of $99.5 million of the guidance, we will have to deliver adjusted EBITDA of $57 million in the second half of this year, up 34% over what we achieved in the first half of this year of $42.5 million. The cumulative impact of price increases, full impact of the second half of the year of idle equipment deployed in the first half of the year, new investments coming online delivering 20% type returns on capital plus the continued strength of the Aftermarket Services [in] the delivery equipment will allow us to achieve this guidance.

At the Investor Day we hosted in New York City earlier this year, we mentioned that we expect our net leverage ratio to improve materially as the year progresses. We expect to deliver stronger earnings in the second half of the year, as I just went through that, with each quarter getting sequentially better. We reconfirm our earlier commentary that based on the fourth quarter annualized adjusted EBITDA, our year-end leverage ratio will be in the 5.2 to 5.4x range, a material improvement from our current levels, reflecting the strong rebound in adjusted EBITDA that we are seeing.

Second, we mentioned in our press release that our distribution coverage ratio is expected to materially improve in the second half of the year versus the first half of this year. We provided a range of 1.2 to 1.5x for distribution coverage ratio in the second half -- in the press release.

I encourage you to read the press release Schedule D that outlines our assumptions on this guidance. This will be driven by the stronger adjusted EBITDA and lower maintenance capital.

And third, we raised our total year capital guidance by $20 million as we secured customer commitments to deploy an additional $20 million of capital from the bond offering. All in this -- all in all, the stronger income statement is driving an improvement in the balance sheet. Owen mentioned several times that we are very carefully investing the proceeds from the bond offering and are focusing our investments on higher-return opportunities where we have the concentration of assets that give us better incremental margins.

Despite the stronger activity levels, we continue to work on streamlining our operations. With the ERP system that we deployed in August a year ago, we continue to see opportunities to streamline and reduce costs, both at the field level and at the back office. Included in our second half guidance is a benefit of lower cost and efficiencies as a result of the ERP system. We are on track to deliver the $4 million in system savings that we committed to deliver when we went live with this system a year ago, August 1.

With that, we'll open it up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Marshall Adkins of Raymond James.

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James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research [2]

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On your equipment utilization, you've got to 94%, which is an exceptionally high number for the large horsepower. Are we effectively maxed out there?

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [3]

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Marshall, it's Owen. On all intents and purposes, yes, we are. The level of returns coming back from that size horsepower is very limited, it's highly utilized in the field. And so that's why on growth capital, 85% of our investments is focused on that size of horsepower and is ready to be deployed as soon as we're ready to ship it.

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James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research [4]

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Okay. So that means that to get to average horsepower utilization of 85%, obviously, the lower horsepower is still fairly low. Give us an update on how those utilization trends are in the lower horsepower and pricing trends as well. And is there a chance you get more of that back to work?

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [5]

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Sure. On the -- what I'll describe on the midrange, the 1,000 -- 100 to 1,000, that's still quite high. On the reciprocating units, again, slightly different application, different basins, but nonetheless in the high 80s range. The smaller horsepower below 100, the [gas shaft lift], we started to see improvements on that. It's up sequentially over the back end of the year and we filed an application for that in conventional wells moving away from some of the unconventional wells where they're more subject to sort of gas prices as opposed to oil prices and oil production. So each part of the fleet has moved up, but certainly, at the -- below 100, there's more opportunity for -- finding more opportunities in the field the 100 to 1,000 is getting up into the high 80s range.

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James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research [6]

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Okay. Last one for me. I know you guys have been getting phenomenal returns on the new horsepower you're adding. But you still have, at least now, very high debt levels. At what point in time do you scale back the new builds and start to pay down debt, Elijio?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [7]

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No, you're right on the first point, Marshall. The equipment that we're deploying is into existing customers with an existing infrastructure and footprint, incremental margins are very attractive. I think that we will continue to exploit those opportunities in the process. If we see demand in those areas drop off and we don't achieve our hurdle rate, we retain the cash and use that to delever as part of the process. I also mentioned that based on the Q4 annualized run rate EBITDA, our leverage ratio is going to be down in the 5.2 to 5.4 range, material improvement from where we are right now.

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Operator [8]

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The next question comes from Mike Gyure of Janney.

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Michael Christopher Gyure, Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs [9]

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Can you talk a little bit about, I guess, capacity related to the backlog? I think the backlog you mentioned is about $102 million and potentially trending higher. Can you talk about, I guess, the ability and how large you could actually take that backlog as far as your infrastructure and the availability of product, engines, that sort of stuff?

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [10]

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It's Owen here. I'm going to talk about the capacity because that's -- that equipment is being built in our Midland facility. We've scheduled a workout, so we're very comfortable with the load levels against what the customer requirements are. And within that facility, we support both the backlog of new units and also what we require for the fleet. We also have a really good partnership with a local company to help us with some extra load that we may have. But generally speaking, the schedule that we have, the commitments we've made both to customers externally for third-party equipment as well as fleet side of our business are being held and being met by the Midland facility.

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Michael Christopher Gyure, Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs [11]

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And then maybe if you could talk about -- a little bit about the timing of the rolling off of the backlog into next year. Do you expect most of that to be delivered kind of mid to late next year? Or do you see that at the end of 2020?

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [12]

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At the moment, the new orders we're getting, now that we're describing Q2 and what we see the pickup in Q3, they'll generally be shipping in the first half of next year. So orders from now are going to be sort of building our backlog for the second half of the year. So we're anticipating a similar year in terms of shipments on the new unit side next year because of the activity. We're sitting on a lot of quotations, both budgetary and firm, and customers we are working with, as they start to look at building out infrastructure and takeaway capacity. That's where we're well positioned because that horsepower will go into pipelines, it will go into processing plants, and that's where we've been picking up these -- the influx of orders through 2018.

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [13]

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I would add, Michael, that any of the incremental orders that we received from here forward are unlikely to be delivered this year because of the lead time for the compression -- for the compressors and the engines, most likely delivered Q1, Q2 and beyond. So we pretty much have Q3 and Q4 shipments laid out for the rest of the year.

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Operator [14]

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The next question comes from Jeremy Tonet of JPMorgan.

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Charles Willaim Barber, JP Morgan Chase & Co, Research Division - Analyst [15]

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This is Charlie on for Jeremy. First one on the wellhead compression side. Just curious if you could touch on the opportunity set in the Permian, got a lot of takeaway constraints there. So curious on your latest discussions and kind of what you're hearing.

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [16]

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Yes. So on that particular topic, we spent time. So some of our key customers -- the top 10 of our customers out there, if you like. And they seem to be well positioned in terms of takeaway capacity. They tend to be larger operators that have existing capacity or committed to new capacity. And we're talking to them about the compression needs going into 2019 now, which again is into larger gas gathering/gas lift applications where the compressor on the pads might serve dual functionality. And then you get into sort of midstream companies, who have a tendency to buy the equipment because of longevity of a processor plant project and investing in new horsepower, as I just described, for the new processing plants that are stripping out LNG from the natural gas that's required as part of the process and takeaway capacity. So generally speaking, from our standpoint, it's positive. We're not seeing any pullback from the customers we deal with. In the inverse, they're starting to plot ahead and plan for their 2019 requirements.

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Charles Willaim Barber, JP Morgan Chase & Co, Research Division - Analyst [17]

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Okay, great. And then secondly, I think you discussed for the rollover contracts getting kind of 15% plus higher kind of pricing. What's the duration on that? When is that expected to kick in, by year-end? Or is this kind of...

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [18]

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It's an ongoing basis. We didn't sort of mention a percent in this particular call because we've pushed a lot on pricing as we've gone through the course of this year. We go into sort of a round 2, if you like, towards the back end of this year and into next. But certainly, new horsepower that's being deployed is at equivalent price to what it was, sort of predownturn. So that new horsepower is up at those levels, and we continue to take advantage of that sort of shortage in demand, especially on the higher horsepower ones.

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [19]

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And Charlie, I'll add that as contracts roll over, they get renewed on an annual basis. And throughout 2017, as those contracts matured, they were renewed on a 1-year basis. So now they're rolling over again in 2018, starting January and, obviously, going through the year each month. And as each of those contracts roll over, we push the new prices into account, and that's why you're seeing a buildup of revenue and margin, as each month you get the cumulative impact of more contracts being -- are renewed at higher rates.

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Charles Willaim Barber, JP Morgan Chase & Co, Research Division - Analyst [20]

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Sure. Okay. Yes, it makes sense. Just another one on your growth CapEx outlook for 2019. Just curious if you could discuss that, how comfortable you are with your liquidity position heading into next fiscal year?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [21]

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Yes. So we haven't laid out any CapEx investment guidance for 2019. We want to continue with our very disciplined capital allocation approach that we have within the organization. If we believe that the margins are going to be there at a hurdle rate, we'll begin sourcing capital. But we're not going to precommit to anything until we know those returns, we have customer commitments, and then we'll cross that bridge in the future. But at this point, we're not yet committing to anything for '19.

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Charles Willaim Barber, JP Morgan Chase & Co, Research Division - Analyst [22]

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Okay. And then last one for me. During your Analyst Day, you mentioned the international business in Latin America and Canada. Just wondering if you could give more color there kind of opportunity set that exists there.

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [23]

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For international, as you know, we've had a presence in Latin America, with a good activity level in Mexico and Argentina, primarily in the smaller horsepower market, but we have seen larger horsepower opportunities come up. Now I'll keep going back to our capital disciplined approach. We benchmark those opportunities against what we have available in the United States with an existing customer, with an existing network, and we move capital to where the return is going to be the largest for our shareholders. And that's the approach we'll continue to take. So we flesh out opportunities, we run them through our modeling, we put them up against other opportunities in United States and that's how we allocate capital. Nonetheless, opportunities keep coming up in the 2 markets that we're focused on for Latin America.

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [24]

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Yes, I agree with that. I've just recently made a couple of trips down to Latin America. You've got the Neuquén Basin in Argentina where you now have as well as indigenous operators, international operators taking up assets down there. So despite some of the economic woes in Argentina, there is growing opportunity we see. And similarly in Mexico, although new government coming in might change some of the forward projections, but nonetheless, both countries, Mexico and Argentina, where we have a good footprint and can leverage off the TETRA infrastructure in those countries, does present opportunity for us going forward.

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Operator [25]

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The next question comes from Selman Akyol of Stifel.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Equity Research [26]

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Couple of quick ones. First of all, I appreciate your comments about leverage coming down in the back half of the year, but I guess, as you look out over the next cycle, what do you think the appropriate leverage ratio is?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [27]

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Selman, good question. When we had our analyst meeting in New York, we laid out an objective that over the long term, we want to be in the 4.5 range. And we're working toward the right balance between improved earnings with the right investments and then look at market -- capital market opportunities to get there. So that is our long-term objective, get us down in the 4.5x range.

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Selman Akyol, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Equity Research [28]

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Appreciate that. And then also, can you just talk a little bit about SG&A expenses in the quarter that came in higher than we were looking for?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [29]

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Yes. We had a few one-off items that impacted our quarter on the SG&A side. We expect that SG&A on a go-forward basis will be slightly under $10 million per quarter.

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Operator [30]

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The next question comes from [David Rothschild], private investor.

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Unidentified Participant, [31]

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I guess, as a private investor, I'm always concerned about security of your distribution to your investors. Are you comfortable going forward with the distribution where it's at?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [32]

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Good question. I appreciate you participating on the call. So when we had our investor meeting in New York earlier this year, we laid out that we had an opportunity to invest in this market. And as long as the returns were there, we're going to: number one, focus any market opportunity to invest in growth capital with high returns; number two, pay down debt; and number three, look at the distribution. Now with respect to protecting the distribution as it exists, we laid out in our press release this morning that our coverage ratio in the second half of the year, we expect it to be between $1.2 million and $1.5 million. I would say that, that is a very comfortable coverage ratio that we don't believe that the distribution is at risk at all.

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Operator [33]

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This concludes our question-and-answer session. I would like to turn the conference back over to Owen Serjeant for any closing remarks.

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [34]

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Thank you, Michelle. We appreciate everybody's interest in CSI Compressco, and thank you for taking the time for joining this morning on the call. This concludes our call.

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Operator [35]

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We appreciate your interest in CSI Compressco, and thank you for taking the time to join us this morning. This concludes our call.