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Edited Transcript of CCLP earnings conference call or presentation 27-Feb-19 3:30pm GMT

Q4 2018 CSI Compressco LP Earnings Call

OKLAHOMA CITY Mar 4, 2019 (Thomson StreetEvents) -- Edited Transcript of CSI Compressco LP earnings conference call or presentation Wednesday, February 27, 2019 at 3:30:00pm 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 W Barber

JP Morgan Chase & Co, Research Division - Analyst

* Praveen Narra

Raymond James & Associates, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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

I would now like to turn the conference over to Mr. Sergeant. 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, Danielle. Good morning, and thank you for joining CSI Compressco's Fourth 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 announcements that went out early this morning and as posted on our website, our Form 10-K is planned to be filed with the SEC on or before March 1, 2019.

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 once again pleased to report significant sequential improvement in revenue, adjusted EBITDA and distributable cash flow. We improved sequentially in every quarter this year, starting with the second quarter of 2018 coming out of the 2015 through 2017 downturn.

Our fourth quarter revenue was the highest in the history of the company since the acquisition of CSI in August of 2014. Throughout the year, we made progress growing all of our business lines, improved our balance sheet by eliminating maintenance covenants, deployed new large horsepower equipment at high returns, made strong additions to the management team on our reaping the operational and financial benefits from the fully integrated ERP system we deployed in 2017.

2018 has been a great success, and we are looking forward towards continuing to improve the business in 2019 as the compression market remains very strong across all of our business lines. We expect all of our business lines to improve year-over-year as we continue to focus on additional efficiency improvements with our field, fabrication, aftermarket network and back office functions to capture additional margin.

We have a strong demand for additional field compression while carrying a backlog for new equipment sales of $105 million and have a variable demand for our aftermarket services. As a result, we will continue to push price increase into the market to improve our cash flow and returns on capital.

While some of the industry struggle with Permian Basin takeaway constraints, we continue to see our business as part of the solution. Demand for our compression services to address the issues impacting the -- impacting demand for some wellsite service companies remain strong, and all of the additions to our fleet are backed by customer commitments.

Demand for new unit sales also continues to stay strong as can be seen by our backlog of $105 million at the end of 2018 and an additional $12 million of orders so far this year, all of which we expect to deliver in 2019.

Outside of the Permian, the rest of the North American compression market is also holding up strong. Today, we are in the position across all basins to direct capital to those customers and those projects, which offer the highest returns.

I'll now spend a few minutes on each of the individual lines of business and provide some perspective on how they are performing. Our compression services business segment continues to be robust and growing. We've increased revenues for 7 consecutive quarters and continue to project sequential improvements into 2019. These improvements are driven by the high horsepower units we are deploying to our existing customers and at rates above the current fleet. 2019 capital expenditures that we expect to fund from cash on hand or from cash flow from operations are expected to be between $60 million and $65 million, inclusive of $18 million to $20 million for maintenance capital expenditures. In addition, and as Elijio will elaborate, we have an agreement with our general partner that TETRA will buy and lease towards an additional $15 million of high-horsepower equipment that equates to approximately 20,700 horsepower. CSI will then have an option to buy this equipment from TETRA anytime over the next 5 years.

TETRA is supporting us in this manner, so we can continue to focus on generating free cash flow to reduce our leverage ratio, and so we do not have to issue equity at low unit prices. TETRA's commitment is very important to us as we fulfill our customers' demand. From the self funding we are doing, plus the support from TETRA, we expect to deploy approximately 99,000 of new horsepower into our fleet in 2019, all with customer commitments. This compares to the 92,000 horsepower we deployed in 2018, mainly in the Permian Basin, South Texas and SCOOP/STACK and almost exclusively high horsepower units focused on gathering system and centralized gas lift.

Since the end of the downturn in 2017, we have placed orders for approximately 196,000 additional horsepower to be added to our fleet, again, with approximately 99,000 scheduled to be delivered in 2019, inclusive of the TETRA commitment. The vast majority of additions are for -- or have been large government systems or centralized gas lift units, each over 1,000 horsepower, for which demand continues to be very robust. All of the orders we deployed have specific client commitments. We are focused on our customers with the strongest balance sheets in the shale basins with flexible gas production and on concentrations of equipment that give us the best returns.

The new units we are deploying are priced higher than other selling units in our fleet, and the incremental margins we are achieving on those units are materially higher than our existing deployed units. As a result, the new units are generating returns on capital of approximately 20%. The incremental margins from recent fleet additions and contemplated new 2019 fleet additions are materially higher as we deploy those units into existing networks and where we already have clusters of equipment, allowing our mechanics and technicians to service those units without making incremental trips in new locations. Our deployment of new fleet horsepower is working, and we expect to continue to leverage our footprint to increase fleet size and improve margins.

Pricing cuts continue to increase through 2018 for our compression services business as contracts rolled over or new contracts were put in place. We expect to deploy the new equipment at pricing significantly above our legacy fleet and expect price increases in mid-single digits for equipment that is rolling over on year-to-year contracts. We have already had some of these discussions with our customers and identified several opportunities to increase pricing, especially for the higher horsepower equipments, which continues to be in high demand and which, in turn, provide us with opportunity to get leading-edge prices for fleet additions and contract rollovers.

Lead times for new units continues to be between 9 and 12 months. Our equipment sales activity, especially for new units, was extremely strong in the fourth quarter and was the highest since the August 2014 CSI acquisition, benefiting from extremely strong bookings at the beginning of 2018. We have record bookings in the second and third quarters of 2018 and more traditional booking levels in the fourth quarter of 2018. Fourth quarter bookings were $18 million for new equipment orders and are $12 million for January and February of 2019.

We ended the year with a healthy backlog of $105 million, all of which is expected to be delivered in 2019. We completed the 2018 with orders of almost $190 million, a record for us. Our 2019 delivery book is nearly filled due to lead time of key components. Our new equipment quotation pipeline is extremely robust, and we anticipate stronger incoming orders as the year progresses and customers continue with their investment plans. Most of these orders are scheduled to be delivered into the Permian Basin, Delaware Basins and South Texas to midstream operators that are investing to address takeaway constraints and to build reasonable gas processing facilities. As we mentioned in the past, when selling new equipments, we also potentially benefit in the future for selling parts and services through our aftermarket networks to support customers who purchase from us through the life of the equipment. Many customers choose us to help maintain their equipment after the initial sale. Our new equipment sales in 2018 were very strong, and we expect to increase that on a year-over-year basis, leading us to believe our aftermarket business is also getting stronger.

Given the record fourth quarter, new equipment sales are $53 million. We anticipate the first and second quarters of 2019 will return to normal levels of $30 million to $35 million before increasing in the second half of the year, reflecting timing of when the orders were received and timing on receiving the engines and compressors. With aftermarket services, we enjoyed another very good quarter, growing 10% sequentially to $21.9 million in revenue as customers accelerated projects into the fourth quarter.

We more than doubled our revenue since the fourth quarter of 2017. Our margins for the quarter also increased sequentially by 60 basis points. We expect this business to continue to stay strong in 2019 as the industry adds horsepower to the market and is in need of equipment overhauls of parts sales. And as previously mentioned, some of our customers accelerated their aftermarket spending in December, and therefore, we expect the first quarter to fall off a bit, all due to timing of major overhauls but then expect the remainder of the year to be stronger.

In summary, the compression industry is in great shape, and demand is strong. Our customers continue to have more demand for compression to deal with high volumes of associated gas from the shale play drilling programs, and our business is directly benefiting from this across all of our business lines.

Our utilization for 1,000 and higher horsepower equipment focused on gathering systems and centralized gas lift was 95% at year-end. We are essentially at full utilization for large horsepower equipment. We deployed an incremental 20,134 of active horsepower during the fourth quarter, increasing the amount of deployed horsepower to 983,848.

Overall utilization for the entire fleet is at 86.6%, up from 86.3% at the end of the third quarter and up from 83.2% at the end of fourth quarter 2017. The vast majority of the increase continues to be deployed in the areas with the most activity and demand, including the Permian, Eagle Ford, SCOOP/STACK areas in Oklahoma and in South Texas where approximately 70% of our operating horsepower is deployed.

With that, I'll turn it over to Elijio to provide some financial details on the quarter, then we'll open us 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. Fourth quarter revenue increased sequentially by 20%, primarily due to the continued strong activity from aftermarket services and a record high in new unit sales. Compared to a year ago, revenue is up 66%, with equipment sales improving 194% to $55.6 million.

Aftermarket services revenue increased 102% from last year to $21.9 million. And Compression Service revenue increased 14% to $60.6 million. All 3 of our business lines increased sequentially as well. Our new unit sales activity, which complements our compression services business, had an extremely strong quarter as we delivered the highest sales quarter since the acquisition of CSI in 2014.

Compression services gross margins was 43.6% in the fourth quarter, which includes the impact of $2.1 million of nonincome tax contingencies. Excluding this item, Compression Service gross margins would have been 47.1%, an -- a decrease of 10 basis points from the quarter due to slightly higher labor and inventory-related costs. However, we continue to see the benefit from better pricing and other efficiencies as contracts roll over, as additional large horsepower units are deployed at higher rates and from the benefits of our ERP system, which improves operational efficiencies.

As Owen mentioned, we continue to deploy new equipment with returns on capital of approximately 20% driven by the higher pricing on the new equipment and by deploying new units to existing clusters with our strongest customers.

Aftermarket Service revenue was $21.9 million with gross margins of 19.2%. We continue to see strong demand and growth in this area as documented by our 10% sequential revenue growth and improved margins. We saw a big push of some of our customers to complete projects in the fourth quarter as well as buy additional spare parts to exhaust their 2018 budgets. As a result of this year-end push, we believe the first quarter will be a bit softer but don't see the demand stopping as the year progresses.

Equipment sales of $55.6 million were with gross margins of 9.4%, which is 100 basis points improvement over the third quarter margins. This reflects the delivery of equipment from the backlog that we started building in the third quarter of 2017. We continue to look for further efficiencies in our equipment sales business to improve margins in the future and expect that future margins will be above 10% going forward. The 2018 margin reflects orders that were placed in 2017 and early 2018, which were at lower prices before demand fully picked up. And as mentioned in our press release this morning and as Owen mentioned earlier, we don't expect fourth quarter 2019 to be at the fourth quarter levels but rather to be more in line with our results from the middle quarters of 2018 for equipment sales.

Our backlog at the end of '18 stood at $105 million after receiving $18 million of orders in the fourth quarter. Since year-end, we have received an additional $12 million of new orders that we expect to deliver all the current backlog in 2019. Orders placed after the first quarter of 2019 will most likely be delivered in 2020 due to the lead times of the key components for our equipment. In the fourth quarter, we recorded a $2.4 million noncash benefit to adjust the carrying value of our Series A convertible preferred units. We also recorded a $2.1 million nonincome tax contingency in our field compression segment.

Adjusted EBITDA in the fourth quarter was $30.2 million, a $3.6 million improvement from the third quarter. Our coverage ratio was 28x, up from 1.07x in the third quarter due to the stronger earnings and the distribution reduction we announced on December 20.

It is interesting to note that our current ratio would have been 1.5x if we had left a distribution at $0.1875 per unit. This give you a sense -- this gives you a sense as to how strong the quarter was.

As a reminder, on December 20, we announced plans to reduce the quarterly common unit distribution from the fourth quarter from $0.1875 per unit or $0.75 per unit per year that was previously in place to $0.01 per unit per quarter or $0.04 per unit per year. Our intention is to review this reduction in the -- of the distribution in the second half of 2019 and determine the best use of cash after redeeming the $30 million of Series A preferred units that are currently outstanding, so that we can determine the deployment of cash from operations that will create the most value to our unitholders.

This year, we intend to use savings from the reduced distribution to cash redeem the remaining Series A preferred units in order to avoid issuing common units that might further dilute our existing unitholders.

With respect to the balance sheet, our goal, as communicated on May 31 at the Investor Conference that we held, continues to be to improve EBITDA leverage ratio from the current levels to 4.5x or better. And we believe we are making progress with that goal without issue in diluted equity.

Our press release provided guidance for 2019, which is consistent with the guidance we provided on December 20. We continue to see a strong market across all our business lines and have seen little impact from the drop in oil prices in the fourth quarter or the Permian takeaway constraints. We believe year-over-year, all of our business lines will improve and increase over 2018 despite the slower start in the first quarter from equipment sales and aftermarket services.

The key points of our guidance are the following: we expect 2019 adjusted EBITDA to be between $125 million and $140 million, up from $99 million last year. This represents a year-over-year growth of between 26% and 41%. We continue to see the cumulative impact of price increases as contracts roll over, stronger market demanding more horsepower, new investments coming online delivering 20% type returns, plus a continuous strength of the aftermarket services at strong backlog we are entering 2019 with. We expect 2019 revenue to be between $490 million and $520 million, an increase of approximately $50 million to $80 million from 2018. As already mentioned, our top line growth year-over-year is to come from each of our respected business lines.

Second, we continue to work on improving our net leverage ratio with the goal of taking it from our current levels to 4.5x or better, which is consistent with the message that we delivered last year. We are making progress toward that goal as earnings improve. Based on the 2019 adjusted EBITDA guidance, our net leverage ratio will be in the 4.5x range at the high end of the adjusted EBITDA range to 5x at the low end of the adjusted EBITDA range, a material improvement from our current levels, reflecting a strong rebound in earnings that we are seeing. Improving our leverage metric is one of the key priorities.

Third, we made a decision in December to reduce our quarterly common units distribution with the intention of using the retained cash to cash redeem the remaining Series A preferred units in order to avoid further dilution from our existing unitholders. We intend to revisit the common unit distribution after the Series A units are fully cash redeemed in the second half of the year.

Four, we expect 2019 capital expenditures to be between $60 million and $65 million, inclusive of $18 million to $20 million of maintenance capital expenditures. Our total capital expenditures are estimated to be $42 million to $45 million that we expect to self fund with cash on hand or cash flow from operations.

Owen mentioned earlier that we anticipate delivering approximately 99,000 horsepower in 2019. Please note that in the fourth quarter of last year, we received and paid for approximately $23 million for engines and compressors that were being constructed at the end of 2018 and counted as CapEx in 2018. These units will be completed and delivered early this year. We do not intend to issue equity nor incur additional debt to fund our growth capital opportunities. And as previously mentioned, TETRA Technologies as our general partner has agreed to purchase $15 million or 20,700 horsepower of compression equipment that will be deployed to our fleet to meet our customer demands. This 20,700 horsepower will be leased from TETRA, with CSI Compressco having the right to buy the equipment anytime over the next 5 years at CSI Compressco's discretion. Between TETRA's commitment to support us and our own capital growth plans, we believe we will satisfy all of our customer demands and at the same time, grow within our cash flows.

We will continue to be very focused on returns and improving margins as we grow and will maintain a very capital-disciplined approach to how we grow the business in 2019 and beyond. We will be prudent in answering our customers' demand and focus only on those growth opportunities, which provide the highest pricing and returns.

With that, Danielle, we'll open the call for 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 Praveen Narra of Raymond James.

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Praveen Narra, Raymond James & Associates, Inc., Research Division - Analyst [2]

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I guess, when we think about the large horsepower side of things, obviously, you guys talked about getting pricing and that legacy contracts rolling on to better pricing and better margins. So how do we think about the cadence of contract rollovers for the [130]-strong legacy contracts as we go through in 2019, what percentage?

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

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Praveen, it's Owen here. So if you look through -- a lot of the contracts, like on a year basis from a pricing review standpoint, so we look at a lot of those contracts through the second half of this year are going to go back through a pricing review process. Now bear in mind, that's going from the low of the market, so that's sort of the back end of '16 and into '17. 2018 was a lot of recovery in terms of going through that first pricing review with customers. And we've talked before on the larger horsepower units that we were in the sort of mid- to high teens on rollover contracts. I wouldn't expect to be that high going into 2019, and we indicated in this -- in the narrative where we feel it will be. But we do have a lot of contracts, again, that will be going through reviews in the second part of the year on a rollover basis. The new equipment, again, that's 92,000 horsepower last year, 99,000 this year, so a bit of a rollover of 5,000 horsepower goes into the first quarter 2020. But again, they all have higher prices than what the existing legacy fleets. Now the brand-new units, emission standards configured at this stage for gas lift operations, so you can generate a higher price of that equipment.

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Praveen Narra, Raymond James & Associates, Inc., Research Division - Analyst [4]

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Right. Okay. If we can move to the equipment sales side, obviously, you guys still have a pretty significant backlog. How should we think about margins for that going forward? Or can we still see margins improve from here? Or how do we think about it?

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

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Yes. We've posted a number there in the narrative there of about 10%, which is higher than what we see in our 2018 and 2017 before. And a lot will depend on the general activity, but we do see quite a robust pipeline of opportunities. So the market indicates that there's a great deal of activity out there. And what we'll be doing, we'll be pushing that pricing level because of the constraints in the industry. We're using the same cost suppliers for new units for the most part as we do for fleet, and that's why we recognize how we price our equipment. So again, we'll continue to be aggressive there, and we still have a healthy backlog. And we've got line of sight on some good opportunities in Q1. I've got -- I can't control timing. I mean, there's still a bit of volatility there on the units side, but I think that's just going to be short term as people turn the corner into 2019 and resolve their own project timing issues. Well, again, a lot of opportunity out there that should be -- we should realize some increased price on there. And again, on the cost side, we continue to drive efficiencies in the operation where we can.

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [6]

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And Praveen, let me add also, I think, 2 important points and remind our investor community of our fabrication business. So we do fabrication in the same location that we also build for our own fleet. And the other thing, as we receive orders, we get deposits and progressive payments such that we're working capital positive through the entire cycle. So this is more than a 10% margin that we're recognizing from equipment sales. It's also a business that is cash flow positive throughout the cycle and actually creates positive working capital for us in the process.

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Praveen Narra, Raymond James & Associates, Inc., Research Division - Analyst [7]

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Right, right. If we can move on -- if I can -- and I just want to ask one more question, just on the TETRA leaseback agreement. I guess, can we talk about -- sorry, can we talk about how that profitability split works between the 2 companies? Is it a 50-50 share? And then, can we also kind of touch on what the capacity to do more of these deals are?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [8]

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So a couple of responses. We'll evaluate this as opportunities come up. We mentioned that we want CSI Compressco to be self-funded. We don't want CSI Compressco to issue equity. We don't want to incur additional debts. So we'll carefully evaluate any other opportunities that they have and see whether we self fund with better profits or whether TETRA continues to support in the current capacity that we've mentioned we're doing right now. The second item is that TETRA is investing the capital. TETRA is taking the risk on the equipment. So they're going to make the majority of the returns. But CSI Compressco will make a margin on this equipment as they put it in service to customers.

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Operator [9]

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The next question comes from Jeremy Tonet of JPMorgan.

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Charles W Barber, JP Morgan Chase & Co, Research Division - Analyst [10]

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It's actually Charlie on. On 2019 guidance, you gave us a little color, and apologies if missed it. But can you talk about the gross margin expectations for compression services, how that is relative to '18, and what might cause that to maybe move a bit high or low versus expectations?

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Elijio V. Serrano, CSI Compressco LP - CFO of CSI Compressco GP Inc [11]

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A couple of items, Charlie. The first is that we've mentioned that all the new equipment being deployed is going at much higher pricing, and we're also deploying that equipment in 2 existing clusters of equipment, so that the fall-through or the incremental margins are significantly better than the existing margins. So we expect that it will average up all the margins. Then Owen mentioned also that we continue to focus on operational efficiencies, use our ERP system to schedule and preplan a lot of the maintenance. So we expect our gross margins on the compression services to increase year-over-year. We also talked earlier about fabrication that we expected to increase to the 10% and slightly above range. And we also expect the aftermarket services to continue to operate in the 20%-plus-type range.

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Charles W Barber, JP Morgan Chase & Co, Research Division - Analyst [12]

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Great. And then on your distribution. So later this year, you'll reevaluate the distribution policy. Can you talk a little bit more about that? Maybe how that might work? Do you anticipate kind of reversing the step-down gradually? Or do you think that maybe you might implement maybe a bit more cushion, a higher coverage to give yourself more room there?

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

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So very good question, Charlie. If you look at the information that we've put out in our guidance and take the midpoint of our EBITDA, which is about $123 million, interest expense is -- cash interest expense is about $48 million, maintenance capital is $18 million to $20 million, and cash taxes are $3 million to $5 million. That gives you $60 million that we have a decision is to have -- do we utilize that $60 million? This year, we've made the commitment that, that $60 million, $30 million of it will go to redeem the Series A for the balance of this year. And we've also mentioned that we're going to self fund our growth capital. So the other $30 million is spoken for growth capital. Now we're talking about how do we take that same $60 million and take advantage of that cash being generated from the business in 2020 and whether we increase the distribution and reinstate it into what level, whether we do a new unit or we purchase units on the open market, whether we reduce debt and buy debt on the open market or whether we continue to invest in growth capital at 20% opportunities. That is the review that we're going to go through, discuss with our board and lay out a strategy at the upcoming earnings call that we'll have after Q1. So we'll make those decisions as we see the year progress. But we're in a position to where we think that we've got a business generating a solid $60 million-type free cash flow that we can determine how to best create shareholder value.

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Operator [14]

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(Operator Instructions) This concludes our question-and-answer session. I would like -- I would now like to turn the conference back over to management for closing remarks.

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Owen A. Serjeant, CSI Compressco LP - President & Director of CSI Compressco GP Inc [15]

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