Q2 2023 CSI Compressco LP Earnings Call
Participants
John Earl Jackson; President, CEO & Director of CSI Compressco GP LLC; CSI Compressco LP
Jonathan W. Byers; CFO & Director of CSI Compressco GP LLC; CSI Compressco LP
Robert W. Price; COO & Director of CSI Compressco GP LLC; CSI Compressco LP
Brian V. DiRubbio
Brian Vincent DiRubbio; Former Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Jay Spencer; MD; Stifel Financial Corp.
Jeffrey Scott Grampp; Senior Research Analyst; Alliance Global Partners, Research Division
Selman Akyol; MD of Equity Research; Stifel, Nicolaus & Company, Incorporated, Research Division
Presentation
Operator
Good morning, and welcome to CSI Compressco LP's Second Quarter 2023 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 will now turn the conference over to Mr. Byers for opening remarks. Please go ahead.
Jonathan W. Byers
Thank you, Alan. Good morning, and thank you for joining CSI Compressco's Second Quarter 2023 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 analyses 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 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 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 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 information provided on this call speaks only to management's views as of today, August 7, and may no longer be accurate at the time of replay.
With that, I'll turn it over to John Jackson.
John Earl Jackson
Thanks, Jon. Good morning, everyone, and thank you for joining our call today. I want to start out today with some overall macro comments. We've mentioned some of these in the past, but I think they're worth repeating to reflect why we are so bullish about the future for CSI Compressco. First off, the market is tight, especially for horsepower over 600 horsepower.
Utilization remains high, looks to remain that way for the foreseeable future. Customers are committed capital out through 2024 and beyond to ensure the compression they need will be available. In addition, the compression industry has been and continues to be capital disciplined. Generally, the players are interested in reducing their leverage. This may be through EBITDA growth, absolute debt paydown or both. Also, there has not been a significant new entrant into the market deploying a significant amount of new capital in the compression space.
Also, the producers want to own less compression as a percentage of their overall compression needs. This is a result of many factors, including their own capital allocation decisions around returning cash to shareholders, under spending cash flow and finding qualified labor to maintain the equipment. Deliveries of new equipment are stretching out well beyond a year as engine deliveries continue to extend making it necessary for customers to plan further ahead.
The speculative new build that has occurred in prior cycles is not happening in this cycle as the compression companies are able to contract new build units before committing capital. Also, the terms of contracts have improved. This is reflected in the duration of contracts, inflation protection on those contracts and better underlying terms. This has greatly derisked the near-term redeployment risk for CSI Compressco and the compression industry as a whole.
The cost to build a new large horsepower unit is up 40% to 50% over the last 2 to 3 years. This has required continual adjustment to contract compression pricing for new build units as well as existing units to reflect market rates. All the changes that I've described argue for a prolonged upcycle for compression.
There's no excess new supply coming into the market. It is all contracted and generally for multiple years. The needs for compression continue to grow. The natural gas production and associated gas areas continue to increase. And with the pending construction of LNG facilities, potentially doubling the export capacity over the next few years, dry gas basins should also perform well over time. Overall, with this macro backdrop, we believe the future is bright for our company and industry.
Since the beginning of this improving cycle, CSI Compressco has had goals of growing EBITDA in a disciplined manner, improving our operational execution to be cost efficient, while reducing our net leverage significantly. Our approach to achieving these goals relative to discretionary cash flow has been to allocate our capital spending to be in line with our cash flow, thereby leaving gross debt materially flat.
We have begun to shift our spending trend relative to expected cash flows, down slightly over the second half of '23 and '24 as far as those relative cash flows at what we're going to do with it for some absolute modest debt paydown. On the fleet side of our capital, we've been building large horsepower units and making our existing fleet ready and available for broader applications where it makes financial sense.
Additionally, on the revenue portion of our business, we are continually repricing and terming out our fleet to reflect current market conditions as contracts conclude their primary term and are up for renewal. In addition, we have a lot of focus on improving our operational rigor on the cost as it relates to the contract compression business. On the AMS portion of the business, we have been pursuing high-return projects, focusing on projects where we have expertise, increasing the pricing for labor to reflect appropriate returns and improving attention on project management.
As we look at the results for the second quarter of 2023, we believe our financial results reflect the impact of these efforts. This quarter continues the multi-quarter trend of increasing contract services revenue, EBITDA growth and improving net leverage metrics. This quarter, our utilization was essentially flat as we sold our Egyptian operation during the quarter, which reduced our operating horsepower via the sale.
As we continue to reprice our fleet to market as contracts come off term, we look to optimize the renewal of fleets where possible to achieve the highest return. This may mean a slightly lower rate in a lower cost basin or higher rates in tight labor market areas. The idea is to end up with the best return for those assets. We pursue longer-term multiyear renewals on our large horsepower, but price our contracts to reflect the duration of a contract. This means that a key customer desires a shorter-term contract. We will work with the customer by offering the term, the customer desires, but charge a higher rate to reflect the option value the customer is requesting.
We are also using the opportunity to improve unit density where possible by recontracting units closer to core asset installations. This is a long process with over 4,000 units in our fleet, but we've made a lot of progress over the last 2 years and continue looking for ways to improve our operational performance.
Our fleet utilization in the quarter at 87%, a slight contraction from last quarter, primarily reflecting the sale of our Egyptian operations and some units that are in transition between locations and customers.
CSI's are [stipulating] horsepower, which represents over 80% of our fleet has a utilization at the end of the second quarter of 93% and our large horsepower fleet that being defined as our horsepower over 1,000, is 95% utilized, up about 0.5% from Q1 of '23. We do not include horsepower that is contracted but not revenue generating as utilized in our calculation. We have additional horsepower contracted that is not yet deployed because of customer timing of make-ready work on the unit before being deployed.
Finally, as it relates to cost, we have seen the rate of inflation come down quite a bit from last year. We see this in all phases of a cost structure, that being primarily fluids parts and people. This is not to say we are not experiencing any inflation, but it has slowed to a more modest pace. As we look to the remainder of 2023, we reiterate our full year guidance for EBITDA of $125 million to $135 million and our year-end net leverage guidance of 5.2 to 4.8x.
We are currently inside both of those ranges on a 12-month -- trailing 12-month basis for EBITDA and a quarter-end net leverage. Overall, we remain bullish about the macro environment, the longevity of the cycle and how CSI is positioned to perform over the coming quarters. We continue to focus on returns and deleveraging versus absolute growth.
We will continue our focused approach to capital allocation by adapting the market and pursuing the best options for long-term value creation. We have made some significant progress on operational execution and have a lot of this area, we would be focused on in the coming months. We believe this cycle will continue longer and stronger as we believe in the long-term fundamentals of natural gas and especially our ability to perform at a high level as we go forward.
I'll now turn the call over to Jon Byers.
Jonathan W. Byers
Thank you, John. For the second quarter of 2023, CSI Compressco reported adjusted EBITDA of $32.5 million compared to $26.4 million in the second quarter of 2022, a 23% increase. Our contract services revenue grew 10% year-over-year from $64.3 million in the second quarter of 2022 to $70.5 million in the second quarter of 2023.
This was driven by continued improvement in utilization and pricing, particularly among our large horsepower equipment. Year-over-year, our utilization increased to 87% from 82.8% in the second quarter 2022. Our AMS revenue grew 31% year-over-year and was 22% higher than the prior quarter.
Moving on to profitability. Our contract services gross margins were 49%, up about 220 basis points over Q1 and our AMS business continues to perform well with gross margins of just over 20%, also up a little over 200 basis points from Q1. Distributable cash flow was $11.4 million compared to $8.4 million in the second quarter of 2022, and we'll pay our second quarter distribution of $0.01 on August 14, with a distribution coverage ratio of 8.1x.
Total liquidity, cash on hand plus outstanding ABL capacity was $44.8 million on June 30, 2023. And as of August 3, our total liquidity is $51.6 million which compares to $46.4 million at the end of 2022. Our capital spending guidance for 2023 remains $43 million to $48 million, and we anticipate exiting the year with a net leverage ratio of (inaudible). We're executing on our plan to reduce our overall leverage while growing the business, our net leverage continues to step down from our Q3 2021 peak of 6.8x down to 5.1x as of Q2 2023.
So we're already within our net leverage guidance range for year-end 2023. If you annualize Q2 2023 EBITDA, we now have a net leverage ratio of 4.9x. Most of our debt is fixed rate, and this has helped us in the rising interest rate environment, resulting in a minimal impact on our overall interest expense. As John said, in 2023, we plan to reduce our overall growth capital spend relative to prior years and to emphasize debt reduction, liquidity and generating free cash flow.
Our guidance for 2023 is unchanged. We'll now open the call to questions.
Question and Answer Session
Operator
(Operator Instructions)
Our first question comes from Jeff Grampp of Alliance.
Jeffrey Scott Grampp
So was curious the commentary on continuing to increase the amount of contracts that have indexed to inflation. Do you just have an estimate within kind of the longer-term contracts, however you want to define that, what percent are indexed to inflation?
John Earl Jackson
So I'd say, just in rough terms, if you look at our overall revenue of contract compression revenue, we probably have about 1/4 of it that's subject to CPI, but you've got to dissect that a little bit further in that you've got your smaller horsepower fleet is 1 year or less, a lot of times in your contract terms.
So you probably only have about 60%, give or take of your revenue stream at any point in time, 60% to 70% that has any term to it. And of that, probably 1/3 of that is 1 year or less. So we're probably about 50% of our overall multiyear revenue. And I'm just these are very round rough numbers, probably about half of our multiyear revenue is under CPI because we were only able to institute that in the third quarter, late third quarter, beginning of fourth quarter last year.
So we still have contracts rolling off that as they roll off, we term them up and we term them up. If we term them up both the year, we term them up with CPI. I don't know of any case since we've started instituting CPI, where we have not been able to achieve a CPI inflator -- that's a lot of -- whether you asked for, but there you go.
Jeffrey Scott Grampp
No, I appreciate the details. And is there a reason why you guys would not want any new contract to have to be indexed to inflation. Is there a business case to be made that you'd want something that's maybe a bit more fixed or maybe there's a predetermined escalator in there? Or is it your opinion that to the extent that customers are willing to acquiesce to that request that every kind of new contract as you guys are going to be pushing for that.
John Earl Jackson
Well, we're going to be pushing for it. And you got to recognize all Ts and Cs are all terms and conditions are all subject to a variety of gives and takes, and that could be either standby rates and whether the contract holds, that are putting it on standby and all kinds of other things where it is. So I guess there could be a case where someone says, I want to cap of some sort that we don't like or some other modified CPI that doesn't really -- that exposes us in a way.
Our real goal is to reduce or eliminate the exposure to inflation on a multiyear contract. And we can get that in a multitude of ways, but the primary and the easiest way in our mind is to get a CPI that generally reflects our cost structure changes, too. But there could be a case, I guess, but not generally that we're working on or aware of.
Jeffrey Scott Grampp
Yes. Understood. Okay. That makes a lot of sense. And last 1 for me, just on the capital allocation side, you guys hit a couple of times in the prepared remarks about kind of shifting the focus towards absolute debt paydown rather than kind of accelerating on the EBITDA front.
How much of that would you attribute to these debt maturities coming up and wanting to maybe tackle those? And reduce the overall debt levels? Or would you say that maybe it's a more kind of structural change in yourself and the industry's view of allocating capital?
John Earl Jackson
I wouldn't say it's a structural change in allocation of capital other than one, we do have some debt maturities coming up, so that's something to take a look at. But we also have to look at where everything trades and what the best return is.
And at the moment, just based on rising interest rate environment that we've been in, our bonds trade off relative to where they were trading a year ago. And so we committed all of our capital a year ago into this year primarily. We have a little bit of free cash flow left this year. And then we go into next year, we've under committed a little bit of our capital for next year, but mostly committed. So now as we think about that delta wedge of what's left to commit right now, it's a much more attractive return to either build liquidity, but more importantly, buy bonds off the market if available, at a 15% to 25% to 35% rig return.
So looking at -- if you can get a 25% or 35% rate of return, I think we're going to take a hard look at that relative to building a new unit. So it's really capital efficiency.
Operator
Our next question comes from Selman Akyol from Stifel.
Selman Akyol
So look -- just wanted to step back for a moment and going back to sort of the index to inflation. And I heard you say 50% of your multiyear fleet is under CPI. I guess how much of your fleet is then 1 year or less should we be thinking about?
John Earl Jackson
How much of our fleet is -- has term of 1 year less?
Selman Akyol
Correct.
John Earl Jackson
Right now, we have about -- it's about probably 60%-40%, 60% -- we have probably 40% -- a little over 40% of our fleet has over 1 year left on its term on a revenue basis, revenue dollar basis.
But if you look at that in the context of -- on a spot basis, how much has turned left, over 70% of our fleet revenue-wise is under term but only 40% of it's over 1 year. So we've got a lot to tackle over the course of the coming 12 months is what I'm getting to.
Selman Akyol
Got it. Got it. And then just to be clear when you talk about your fleet, are you talking about it in terms of horsepower or units?
John Earl Jackson
I'm talking about this in the terms of horsepower. Units would be wildly different because we have so many gas jacks that are small.
Selman Akyol
Got it. So nice improvement on the gross margin. And I'm wondering, is there much more to go there?
John Earl Jackson
Well, we think we'll continue to see repricing of our fleet to market. So there's a little bit variable yet. And as I kind of alluded to in the comments, that the operational execution is really where we've been spending time over the last -- not that we haven't been focused on that, but it's been a very, very busy 1.5 years, putting a lot of equipment out, building a lot of new equipment, electrifying units, just turnover high levels of terminal coming out of COVID, retraining new people.
So all that is all very interesting, but we've now been able to over the last 4 or 5 months really focus in on planning and executing our day-to-day work. And that has begun to reap some dividends, but I don't think we're there yet as far as what I'd say is smooth, monthly execution all the way across the board. We've got all kinds of metrics we track internally, whether it's doing our PMs on time or what kind of operational upsets we have or what's going on, and we're seeing a lot of improvement over the last few months, but we're not at nirvana yet.
We're not at the promised land. So I say all that to say there's more to come. But if I was to step on my operating guys and ask them, they're going to not give me a number -- that's just the way it is, but I believe there's more to come. And I can't give you a quantification of that, but we're pressing hard on that.
Selman Akyol
Got it. And then also very nice sequential growth in aftermarket services, and I know you characterize this as longer and stronger for the cycle. So should we continue to expect aftermarket services to continue to increase?
Robert W. Price
Yes, I believe so.
John Earl Jackson
This is Rob Price.
Robert W. Price
It's Rob. Yes, we're extremely focused on project execution in the service business, chasing appropriately jobs, as John referenced, that fit within our expertise, skill set and really trying to eliminate lesser performing jobs from our run rate. So we have a lot of focus on chasing profitable jobs and executing efficiently.
John Earl Jackson
And I think the backlog, at least what we're seeing the quote backlog is -- continues to be pretty robust, isn't it?
Robert W. Price
It does. As John referenced in the contract services space that customers tend not to want to own their units because of lack of manpower trying to identify manpower. So that gives us an opportunity in the units they do own to perform services to those units and perform overhauls and maintenance activities and restaging. So generally, those are a little bit higher margin jobs that we're chased and focused on and project managing better.
Selman Akyol
Got it. Since you talked a little bit about manpower, I'm just curious, we had heard of sort of bringing people 2 weeks on, 2 weeks off. Are you guys seeing anything of that trend, bringing in labor from other parts?
Robert W. Price
Yes, absolutely. In the basins that are growth that are growing and deploy more horsepower, there's not a local population to draw from. So the use of rotators for week all, [week-odd], 2-week on, 2-week off type schedules is absolutely mandatory.
Selman Akyol
Got it. Got it. I know it's early to be talking about 2024, but I was just kind of curious in terms of the CapEx, should we -- and more just directionally down from here, sort of flat? And then just the other question on that is this year, you have sort of $3 million to $4 million related to technology. Should we expect that still to see dollars in '24 being allocated there as well?
Jonathan W. Byers
Yes, that $3 million to $4 million is some technology as well -- I mean, I guess it could be lumped in there as well with telemetry and some shop move costs consolidation. So I would expect that to come (inaudible). I think our growth capital will be in the range of where we are for 2023.
Operator
Our next question comes from Brian DiRubbio from Baird.
Brian Vincent DiRubbio
Just when we think about the change -- this constant change in the size of the fleet in terms of horsepower and the horsepower and service, obviously, you had the sale of the Egyptian business and you said you had some movements of units. Can you quantify maybe or just give us a general idea of what the impact of those 2 were?
John Earl Jackson
Well, the Egyptian sale was just shy of 6,000 horsepower, and it was 3, what we would call large horsepower units over 1,000 horsepower, 1, it was a little bit smaller. So the customer just exercised their purchase option there, and we negotiated a little bit of an early exit there. So that just came out of our large horsepower fleet, and we were still able to grow that in. As far as the horsepower that's moving we've made a conscious effort to try and get our horsepower with the right customers in the right place, the way they want them and the way we want them.
And what I mean by that is -- we have customers that contract will come up for renewal. And the other side, I just want to renew for a year. I just want to stay month-to-month. And if it's larger horsepower in this market, we want to chase duration. And we want to chase density. So we want to get it longer and closer where we can.
So we've made a very conscious effort to try and price our product in a way that forces the customer to determine if they need this long term. And I don't mean that as a negative to the customer, but if they just need it for 6 more months, we want to know. And so the way we find out is by saying, here's a 3-year rate, here's a 2-year rate, here's a 1-year rate. and we find out where they are. We price the 3-year much more attractive than 1 or a month-to-month rate.
And so we've had some customers let's say, resized their fleet. Maybe they're building electric or maybe they're saying, "Well, I really don't need a 1,300 horsepower. I need a [7] -- or 630-horsepower unit coming up. So I'm going to do this short duration and pay you higher and then we'll work out of transition plan. With that, and we've been doing that fairly actively over the last 6 months. With that, we've had some churn in our fleet that's not really not contracted.
It just goes off revenue for 3 months or so. It may come off the unit of the side of the customer. We take it through the shop, have to do a little bit of work to it, get it back out to someone else's site or we ship it to a side, it's just not on revenue for a month.
So again, probably a lot more than you want to know. But when we look at our large horsepower fleet I'm trying to give you a quantification. I don't have a good quantification of where we sit at a spot moment in time at June 30, but we've probably got another 10,000 to 15,000 horsepower easily that's in transition that's the large horsepower at any 1 point in time that we're moving off 1 side to another, that's not on revenue. We expect that to kind of settle out over the next 6 months to 8 months or so and be less disruptive to the utilization numbers that we're seeing right now.
But this is all -- we call it positive churn. It's all positive churn in our mind because we're able to get these things termed out with someone who really wants them for the next 3 to 5 years, not the next 3 to 6 months. Hopefully, that's helpful.
Brian Vincent DiRubbio
No, that's extremely helpful because it shows that you're basically upgrading the fleet in terms of customers in the region.
John Earl Jackson
Yes. Indeed.
Robert W. Price
Longer term, in 1 spot gives ability to plan the work more, which gets back to raising operational margin. The short-term disruption in make ready.
John Earl Jackson
People, staffing, parts, inventory, just knowing what you're going to be dealing with is very helpful. And we're trying to use this environment to really figure that out with customers.
Brian V. DiRubbio
Got it. No, got it. Do you say -- I know this is just temporary, but these 10,000 to 15,000 horsepower transition. Are we going to be then experiencing some make-ready costs during this 3- to 6- to 8-month time period?
John Earl Jackson
We still are, yes. And I think we make ready's come down some this year compared to last year a little bit, but I would expect that to continue to abate as we get this done. You're always going to have units that are coming up and moving around on your midsize to smaller horsepower, but we're really trying to put our large horsepower fleet largely away.
And when you think about coming out of COVID and you had an enormous amount of horsepower set around for 1.5 years, and then all of them make ready to get that out over a year or so, 1.5 years or so and now trying to optimize where it is and with who it is, that's taken a lot of dollars. But I expect that to -- towards the end of this year, early next year, get to normal, I'd say status -- steady state.
Brian V. DiRubbio
Got it. No, that's very helpful there. So then just as we're thinking about the fleet today and going back to some of the comments you said before, 70% of the fleet on the term with only 40% of that greater than 1 year. Just rough numbers, what percent of your total fleet in terms of horsepower do you think is on a price card within the last -- generated in the last 3 months?
John Earl Jackson
I mean coming up over the next 3 months or last?
Brian V. DiRubbio
The last -- how much of your fleet been repriced over the last 3 months?
John Earl Jackson
Well, we have probably 20% or so of our fleet revenue, I would say, of our revenue, not our fleet. We had -- when I think about revenue, we had a we have some significant customers that had a lot of units come up for renewal that just got renewed effective July 1.
And so when you put all that in, it's probably 20%, 15% to 20% of our fleet just got repriced in the last quarter.
Brian V. DiRubbio
Okay. So in theory, we should maybe start seeing acceleration of revenue per deployed horsepower?
John Earl Jackson
Correct.
Jonathan W. Byers
Yes.
Brian V. DiRubbio
Okay. Perfect that I was looking for. And then just a final question for me. Just SG&A costs up 12% year-over-year. Anything there that's notable?
Jonathan W. Byers
No, I don't think so. It was really timing of costs between the quarters. If you look at first half last year to first half this year, we're pretty much in line. We're up a couple of hundred thousand dollars. So I don't think there's anything notable there.
Operator
Our next question comes from Jay Spencer from Stifel.
Jay Spencer
Congrats on a good quarter. Some of my questions have been addressed. But just taking a step back and looking at contracted but not revenue-generating part of your fleet. I mean it sounds like naturally, you're always going to have some that's in transition. So utilization of 100% is just not achievable. But when you think about that 87% utilization rate, if we were to include contracted but not revenue generating, what would that utilization rate look like? Is that over 90%?
John Earl Jackson
I think it gets close. I think the other thing, it gets right around 90% because we have a fair bit of horsepower that's contracted, but not out yet. I think the other thing that you have to think about with us relative to our competitors is we have about almost 100,000 horsepower that's rotary screw that's the utilization in the 50s. 55%, give or take. And we have about 90,000 horsepower that's gas jacks and [v-jacks] that are -- we have 2,400 of those units that are 46-horsepower or less per unit. So that utilization sits in the low 50s and has really come down over the last 2 quarters from near 60.
So that probably drags our utilization a little bit. So full utilization for us when you factor in those 2 components of our fleet that make up maybe what, $200,000 out of $1.2 million, give or take in round numbers, it's always going to drag you a little bit to the 90% versus 95%. When you look at our reciprocating fleet, we're over -- we're well over 90%, and our large horsepower is over 95% right now, 1,000 horsepower up, which is kind of in line with what you would see from the other public company peers.
So that's just a little bit of color I want to give you there that is the reason why we view full utilization as around 90 because of the rotary screws and the gas jacks just not going to hit the 100% or 95% utilization.
Jay Spencer
Great. And when it comes to your guidance of finishing the year with leverage of 4.8 to 5.2. What are some of the key variables you think about that would lead the company to be on either side of that guidance?
Jonathan W. Byers
I think probably the key variable is going to be managing our working capital to our net debt number. Yes. Obviously, EBITDA is a big component of it, but that's 1 of the areas we're focused on.
Operator
This concludes our question-and-answer session. I would like now to turn the conference back over to John Jackson for any closing remarks.
John Earl Jackson
Appreciate everyone being on the call today and look forward to speaking with you next quarter as we continue to march ahead and delever the company and grow profitably. I appreciate your time. Thank you.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
