Greg Rosenstein - VP, IR Andrew Way - CEO David Barta - CFO.

Mike Urban - Deutsche Bank Joe Gibney - Capital One Daniel Burke - Johnson Rice.

Greetings and welcome the Exterran Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only-mode. An interactive question-and-answer session will follow formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host Mr.

Greg Rosenstein, Vice President of Investor Relations. Thank you. You may begin..

Good morning and welcome to Exterran’s fourth quarter 2016 conference call. With me today are Exterran’s President and CEO, Andrew Way; and CFO David Barta. During this conference call, management may make statements regarding future expectations about the Company ‘s business, management’s plans for future operations or similar matters.

These statements are considered forward-looking statements within the meaning of U.S. Securities law and speak only as of the date of this call.

The Company’s actual results could differ materially due to several important factors including the risk factors and other trends and uncertainties described in the Company’s filings with the Securities and Exchange Commission. Management may refer to non-GAAP financial measures during this call.

In accordance with Regulation G, the Company provides a reconciliation of these measures in its earnings press release issued yesterday available on the Company’s website. With that I will now turn the call over to Andrew Way..

Thank you, Greg, and good morning, everyone. I will start with a brief review of our fourth quarter and provide some more color around the large project win in the Middle East. Dave will discuss segment results and outlook.

And I’ll conclude with some thoughts on the balance of the balance of the year and outlook before turning the call over to you for Q&A. For Exterran, the fourth quarter was a continuation of a playbook we ran all year, which was to generate cash, pay down debt, manage our costs and defer non-critical investments.

However, we also started transitioning to the future and saw signs of the market recovering. Our contract operations business continued to show strong margin results. We’ve often discussed the true cycle resiliency and stability of this business model, and the fourth quarter reflected just that.

Although revenue ticked lower as expected from Q3 levels, the benefits of our price management, scalable project scopes and cost productivity enabled us to actually increase our gross margin percentage.

In fact, despite the 16% decline in revenue last year which was mainly due to the early termination of a project early in 2016, we maintained our 63% gross margin percentage.

It’s also worth noting that the 16% revenue decline compares favorably to an estimated decline of 25% to 30% in global upstream spending by E&Ps, based on the various industry sources. While the business model showed resiliency, we expect 2017 to bring new orders, investments and continued cost efficiencies as we prepare for growth.

We announced in our earnings a new 10-year project award for a customer in the Middle East commencing in the second half of 2018. The project should generate revenue more than $250 million over 10 years. The scope of the project includes designing, building, installing, owning and operating a sour natural gas surface [ph] production facility.

The early development facility will enable the customer to monetize its natural gas earlier than competing solutions would commit.

This contract award touches on two major market trends we’ve highlighted in the past, which is the increase in amounts of sulfur and other contaminates in fields being developed in certain emerging international market arenas with us, as well as customers’ objectives to monetize their hydrocarbons on shorter cycles.

Although, market attention is on the cyclical upturn in certain U.S. shale plays, the project award in the Middle East reflects our leverage to the secular trend of midstream infrastructure requirements, which are necessary to support increase in demand for natural gas across multiple international market areas.

I mentioned earlier about transitioning to the future as we prepare for the market recovery and position ourselves to better serve our customers. Early last year, we aligned our sales force around key customer accounts, maintaining strategic levels of manufacturing capacity and focus our operating rhythms around better sales and operations planning.

This provided us the insight and confidence to invest earlier in the cycle by adding people, strategic inventory, and other resources during the latter half of 2016 in order to provide customer solutions quickly in a recovery scenario. Those decisions will be rewarded as we convert our backlog into revenue and margins in the latter half of 2017.

However, it resulted in margin declines of 2016 progress, cumulating in an oil and gas product sales gross margin in Q4 of 3%. Pricing, under absorption and mix contributed to the lower margins.

We believe the fourth quarter will represent trough margins as we anticipate improved margins in the first quarter and gradually getting stronger as the year progresses. I referenced the cyclical market upturn in the U.S.

and in the fourth quarter, we were the beneficiaries of a higher demand in the Permian, SCOOP/STACK and Marcellus in the form of higher orders. We booked $231 million of oil and gas product bookings with much of that coming from the regions I just mentioned. Our book-to-bill ratio was near 300%.

And in fact, our oil and gas product sales bookings in the fourth quarter was the highest since the fourth quarter of 2014. We saw a strong demand across our entire product suite with the largest increases coming from processing and feeding plants as well as compression equipment.

In 2016, we focused a great deal on improving our planning processes across our delivery chain from sales to engineering to supply chain and to manufacturing. This will benefit us this year as we plan our production schedule later in the year understand where potential supply chain bottlenecks could take place as orders ramp up.

The positive growth in bookings reflect the few key trends.

First, customers are largely depleted their equipment inventory; second, we’re seeing the benefits of compression intensity or the higher amount of horsepower required per unit in some of the shale plays as a result of lower wellhead pressure; and third, a strong liquids market is driving the need to process and treat associated wet gas.

Overall, while our fourth quarter results came in as expected, there is a broader story developing about our ability to capitalize on the cyclical trends in the U.S. and the secular fundamentals in certain international markets.

Our ability to participate in both arenas, should provide us stable and recurring cash flows with the opportunity to capture upside in the form of incremental U.S. product sales. Let me give you a quick update on the Belleli EPC business. We remain on track in terms of project execution and run-off the backlog.

We’re currently negotiating with customers to compensate us for variation orders and to remove certain clauses, and expect that most of these negotiations will conclude over the course of 2017. At the end of 2016, the Belleli backlog to go stood at approximately $64 million.

I’ll now turn the call over to Dave for our fourth quarter financial review and first quarter outlook..

Thanks, Andrew. And as I discuss our segment results and the drivers, I’ll principally make comparisons to the sequential quarterly performance. Starting with the contract operations segment. Revenue decreased 5% to $94 million and gross profit decreased 3% to $61 million. Our gross margin percent however increased to 65% from 64%.

In Q3, we benefited from contractual recoveries that did not repeat in the fourth quarter and we incurred a contractual project stop. We were however able to protect our margins through cost productivity in the form of supplier negotiations, re-scoping of projects and gaining efficiencies.

This was a theme throughout the year and was quite evident in the fourth quarter results. Aftermarket service segment revenue was $29 million or 9% higher than the third quarter, while gross margin was $7 million, a 5% decrease. This resulted in gross margin percentage of 25%, down from 28%.

Mix impacted our margins in the fourth quarter and we saw an uptick in lower margin part sales in Eastern Hemisphere. Revenue in the oil and gas product sales segment increased 5% to $78 million; the gross margin was down 32% to $2 million.

And Andrew has discussed the factors which resulted in 3% gross margin, which was down from 5% in the third quarter. Oil and gas product sales revenue in the fourth quarter breaks down as follows, 70% was compression and 29% production and processing.

And geographically, the revenue split was roughly 80% North America and 20% from international markets. Our oil and gas product sales backlog was $306 million at year-end as compared to $153 million at September 30th. The backlog is the highest since the third quarter of 2015.

Quarter-end backlog was roughly 80% for North America and 20% for international markets. Andrew mentioned our strong oil and gas product sales bookings of $231 million, an increase of 75% from the third quarter. From a geographic standpoint, 89% of our oil and gas product bookings were from North America.

The Belleli EPC product sales segment revenue was $31 million. We anticipate that the gross margin of segment should remain near zero as we exit the non-core business during the next several quarters.

If you recall, as part of the restatement, we accrued loss provisions in the prior years, which base-lined the gross margin for most of these projects at or near breakeven. SG&A expenses in the quarter were $42 million, up 10% from the third quarter but down 21% from the fourth quarter of 2015.

The sequential increase was primarily due to personnel related expenses resulting from staff and structural changes. Other expense is just under a $100,000 as compared with other income of $3 million in the third quarter, primarily driven by currency fluctuations, specifically in Brazil. Turning to capital expenditures in the fourth quarter.

Total CapEx was $27 million, up from $17 million in the third quarter but down from the $35 million in the prior year’s quarter. For the full year, total capital expenditure were $74 million.

For 2017, we would anticipate total expenditures to be in the range of $150 million to $180 million, which includes assumptions on contract operations projects awards. Looking at the balance sheet, total debt at the end of the quarter was $349 million with undrawn and available credit of $227 million.

And our leverage ratio, which is debt to adjusted EBITDA as defined in our credit agreement, was 2.3 times at year-end, and our net debt stood at $313 million. Before I provide further outlook on Q1 guidance, I want to briefly update you on our remediation activities related to restatement findings.

We continue to address and improve the control areas we identified as deficient during the restatement process. We remain focused on people and processes, and the related controls. To that end, we have made some changes to our finance and accounting structure and added some very talented people to team in recent months.

We are addressing business and account process and making sure that the processes and controls are appropriate and being followed 100% of the time. We will continue to address the issues we identified with the goal of being best-in-class in financial reporting. Now, I’ll turn to the outlook for the first quarter of 2017.

We don’t expect much change in our contact operations segment with revenue remain in the low $90 million and margins also staying in the low to mid-60s. For our aftermarket services business, we expect lower revenue, most likely in the low $20 million range as part sales are off to a slightly slower start this year.

The mix should improve leading the margins in the mid to high 20s or up some from the fourth quarter. Our AMS business is in the transition phase. We have new leadership in that business and we’re in early stages of building our pipeline of work. We have a good line of sight on some additional AMS opportunities in Asia and the Middle East.

In our oil and gas product sales segment, we’ll start to see the flow of the higher orders in both revenue and margin terms in Q1. We expect revenue to increase significantly from Q4 levels to $120 million to $130 million with gross margins improving from Q4 trough to mid single digit levels.

Although margins are trending higher, they’re burdened by couple of factors. The first is pricing. The backlog is now converting the revenue in Q1 and is comprised of some products which reflect those prices at lower levels. The second factor is on the cost side.

As noted on our last call and as Andrew mentioned, we maintain a certain manufacturing footprint and structure to manage the higher expected orders. As a result, the margin percentage is likely carry between 100 and 150 basis points of inefficiencies. We anticipate margins will trend higher as the year progresses.

For the Belleli EPC run-off, based on the backlog Andrew mentioned, we would expect $20 million to $30 million in revenue in Q1 with revenue decreasing each quarter as we exit the business. Gross margins we modeled at zero. Our outlook however does not take into account any recoveries we might receive from customers.

So, net of all this is a sequential increase in total revenue to lower mid-teen increase, however driven by the large -- lower margin oil and gas product sales business.

To add to the themes Andrew said earlier, we’re investing in transitioning to the future; we are investing in compliance -- infrastructure to improve our compliance culture and ensure the successful implementation of our remediation plan following last year’s restatement.

In addition, we are reinstating certain incentive compensation that was suspended in 2016. As a result, we anticipate G&A in the first quarter will be in the range of $43 million to $46 million; but beyond Q1, I would anticipate our normalized G&A rate to be in the low to mid $40 million range.

Depreciation in the first quarter should be in the high $20 million range and interest expense should be approximately $8 million. Cash taxes are estimated to be $9 million in the first quarter and $52 million for the year. I’ll now turn the call back to Andrew..

Thanks, Dave. So, to summarize our outlook in the first quarter, we’ll experience higher revenue and slightly lower margin percent due to mix. Our G&A will be a bit noisy with some of the G&A costs not repeating in subsequent quarters. Overall, revenue and growth are picking up.

Cost absorption in our factories is improving and momentum is certainly building. As a result, we expect our operating results to increase as the year progresses. We don’t typically provide bookings guidance, but since we’re in early March, we currently see a path to bookings of more than $200 million for the first quarter.

While customer sentiment and activity are on the upswing, customers continue to focus on efficiency, which is still driving a competitive environment. The trends driving investment in midstream infrastructure globally are resulting in more enquiries for our contract operations business model, certainly more than we had at this time last year.

In addition, I anticipate that we will renew a high percentage of our contract this year as we have historical done. Renewals are key to protecting our recurring revenue stream and cash flow, and maintaining our utilization. On the oil and gas product sale side, we should continue to see a healthy flow of new orders to midstream infrastructure.

Beyond what you see in our financial statements this year, 2017 for Exterran will also be a year to develop and grow our multiyear strategies. After a year of market challenges and the financial restatement, we look forward to collaborating and creating a vision and a path forward with our new management team to increase shareholder value.

Exterran is more than just about participating in cycle recoveries and maximizing profitability with our current product and service portfolio and geographic footprint. We’re about leveraging secular growth in midstream infrastructure and creating differentiated customer solutions through increasing efficiencies and lowering customer operating costs.

By accomplishing these objectives, we can create long-term stability and high returns for both our customers and our shareholders. We will look at adjacent markets and end users, we will create a business transformation initiative that yields a greater collaboration, sharing and internal alignment.

Project execution and delivering solution safely and efficiently will be at the very core of what we do and how we do it. We also want to build out our aftermarket service strategy with clear solutions and focus, and leveraging our global synergies to improve our efficiencies. As a result, we expect 2017 will be a multifaceted year for Exterran.

And we look forward to sharing the progress with you. I’ll now it back over to the operator for questions. Thank you..

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Mike Urban from Deutsche Bank. Please go ahead. .

So, very nice contract win for you and presumably, there was a pretty good bit of negotiation and lead time on that.

Is that indeed kind of somewhat idiosyncratic and chunky by its nature or is it indicative of just kind of a broader bottoming in the international markets or do you expect as we typically see, some of the activity depending -- especially where you play, to lag the North American recovery?.

Well, Mike, great question. I think, first of all, if you look over the last six months, we’ve announced over $400 million of ICO revenue, 10-year contract, so that’s $40 million a year. We’re certainly seeing the contracts that we’ve been working for some time coming through and are getting booked.

And I’m pleased to say that the ICO pipeline is growing. And so, by nature, that is lumpy for sure. We’re seeing more opportunities, confidence in the pipeline growing. And it’s the last six months is anything to go by, we’re excited about the future..

Okay. And on the manufacturing side, you’ve talked about retaining some excess cost and capacity there, which looks like a prudent move, given that the bookings are picking up. You talked about the margin impact in terms of under-absorption, I think it was 100 to 150 bps of margin impact.

What’s the revenue associated with that? In other words, in order to get proper absorption, how much would -- would revenue have to improve or maybe put another way, what’s the level of throughput that you could see before you would have to adjust capacity again or add some capacity?.

So, Mike, we consolidated a couple of facilities in the middle -- early part of 2016 and built a new flow in how we manufacture some of the capacity. So, there is going to be training, there is going to be an element of bringing new people onboard.

We started bringing new people onboard in the fourth quarter as we started to see in the second quarter enquiries really picking up. Third quarter, we started to see a nice pick-up in bookings. The fourth quarter, we clearly saw it and we certainly see strength in the first quarter.

So, Dave already mentioned that we’ve indicated in the first quarter, significant increase in revenue from the fourth quarter between $120 million and $130 million of revenue, which is significant from fourth quarter. And we continue to see that trend in the third.

So, I think by the time we get into the third quarter, we’re going to start to see our margins normalized as it relates to the manufacturing implications of 100 to 150 bps.

And as we come out of 2017, I would expect us to be in much better shape and interact with our forecast that we’ve talked about, which is pushing this Company to a 10% or greater gross margin in product. So, all the indications right now are moving in a right direction. The team is working hard and we’re making progress every week..

Okay.

So, it’s as much a function of time as it is volume?.

That’s right..

Our next question comes from Joe Gibney from Capital One. Please go ahead..

Thanks. Good morning. Andrew, just a question on aftermarket. So, just trying to understand where we are. I understand you have a bit of recalibration phase here, new management in place. I guess just trying to big picture understand what you’re trying to do with it here over the next year or two as you grow.

And I know closer collaboration with your customers is certainly core. Just trying to understand where we’re going.

Is it more of a shift in focus on parts versus service, particular regions, or just maybe hitting the high points here what you’re trying to accomplish in aftermarket because we are in a bit of a shifting zone here over the next certainly in the first half of 2017 as you recalibrate a little bit?.

Yes. So my thoughts here have been pretty consistent since I arrived. We have an AMS business that’s been embedded inside of our ICO model. We pulled out some of the operating functions and now have dedicated leadership globally for AMS.

When you think about the very nature of AMS, it’s everything from supply and spare parts to providing full O&M activity in our customer asset.

And so, everything from my compressor or my widget is broken and can you provide me with a part, all the way up to and including what we perform on our ICO model, which is we own the assets and we provide a full O&M with capabilities to run our customer assets.

And so, ultimately, that is the vision to take advantage of the install base that we have in the field, work through more of an O&M contract and upgrades.

We have key initiatives that we’re focusing on right now to develop reliability services and really leveraging some of the efficiency gains that we’ve taken in the past 12 months in ICO and take that offering to our AMS customers. And so, by nature, it’s relatively small in comparison to the ICO business, so it’s going to choppy by nature.

And we’re going to move from more of a break fix model to more of an integrated service solution. And we’re seeing some traction. We’ve already started to win some new business in various markets.

We’ve got some good traction in Asia; we’ve got a very good pipeline in the Middle East; and we feel good about the work that we’re also doing right now in Latin America. And so, I think this will continue to be a strong story for us over the course of the next 12 months..

Okay, helpful. And then, Dave, maybe this question is for you. As we think ICO pricing, the expectation here to renew sort of a high percentage of contracts as they roll over.

I don’t know, are you seeing, continuing to see pricing pressure on legacy contract renewals as we get to this for the first half of 2017 as the market is stabilizing? And then maybe what percentage of your contract base here is rolling over in 2017? It’d be helpful on recalibrating the model a little bit. Thanks..

Yes. I would say, on the last part of that and just how things roll off. If you can imagine, when you have contracts of various links and so forth, you’ll every year have contracts rolling off. So, it was pretty much in line with our historic amount of sales running off.

And our assumptions are, our historic renewal rates will carry into the future as well. And I think on the pricing side, and I think it’s safe to say, in this industry a lot of them is competitive, it always is.

And as the folks that we serve look for increased value, obviously in tough macro environment for them, there is always a lot of I would say more of a collaboration approach on how to take costs out.

So, our focus is and I think Andrew alluded to it is, how can we do things better, more efficiently, how can we help them reduce, for them is OpEx costs, and that’s focus. So, that remains. I don’t think that’s different, and I would tell you it’s probably not going to be different 10 years from now either..

[Operator Instructions] And our next question comes from Daniel Burke from Johnson Rice. Please go ahead..

I appreciate the indication on inbounds here in Q1.

And I guess, is it also fair to assume that that mix of inbounds, domestic versus international will look similar to Q4?.

Yes, it certainly will. And similar trends, processing, treating, compression, certainly seeing activity in SCOOP and STACK area, and the Permian, a little bit in the Marcellus. So, similar trends that we’ve seen, a big demand for processing, capacity right now which plays to our strength..

Right. That’s helpful. And then, Dave, you spoke or -- and Andrew, you both spoke about overcoming some of these absorption impacts on the product sale -- oil and gas product sales side as the year advances. Can you characterize how pricing is trending at the present on the U.S.

side for inbounds?.

Sure. I think it certainly feels a lot better than it did this time last year. It certainly stabilized. I’d say, the market is still competitive, and we’re finding ways to be able to offer advantage through faster cycle times and better reliability. And we’re winning deals right now on cycle time, which I couldn’t have said this time last year.

And so, I’d say, it’s gotten better. But the market is still competitive. And I think all of us have to figure out how to be competitive in this environment. And so, I’m not sure the market is going to completely rebound to the days where we all enjoyed pre-2014.

And so, we spent the last year trying to find ways to be more competitive and to take cost out of our systems and help our customers get a better commercial offering but protect our margins.

And so, as we go through the year, we’re definitely going to see improvements from both efficiency and our input prices will be a little stronger than what we saw last year..

Okay. That’s helpful. And then, maybe one other one, just on the CapEx budget for this year, which I know essentially supports the ICO business.

Is there a way to talk about maybe what portion of that $150 million or $180 million budget reflects the spend associated with the three Middle East awards? Or I guess, the converse I’m trying to ask you is, what portion of that budget is a hold for sort of opportunities that you all see that could emerge as the year goes on versus the portion that’s already committed as we sit here today?.

I guess, I would maybe take one step back. If you look at year-over-year, our maintenance and kind of other CapEx is pretty consistent. So, we’re not seeing a big surge there. Frankly, the entire increase in our outlook is really due to the ICO opportunities.

And again, with these most recent announcements, pleased to say that a lot of that now is more committed. But there still is a placeholder in there for -- probably somewhere around 30% of that number is still placeholder for opportunities that we’re focused on now and trying to drive to conclusion.

So, the piece of that at this point I would say is not committed. And I think the last -- and probably I should mention Dan is just on these deals, particularly the one we announced last night that our work there will span two years; there will also be a carryover impact of that in the next year as well.

So, we’re seeing a part of that this year; we’ll see the rest of it next year, which is often the case with these projects that take 12 to 18 months to complete..

Okay, Dave. That’s helpful. And then, I guess maybe just a last one and also maybe it’s a little early in the year to ask a question like this. But, you obviously had a lot of success in 2016 pulling dollars out of working capital.

Is there a decent assumption, or I mean, is it reasonable that we sit here right now and think working capital is neutral in 2017 or does it begin to absorb some cash? Is there a way to think -- even just drawing that one bright line at neutral or not?.

So, I think it’s the right question to ask. And I would say the tone in the Company right now is that we’re running a cash flow focused company, growth second. And those two combined are really important as we think through 2017. We do not want to give up the good work that we did in 2016.

And so, when I think about the work that we did 2016, I’d say, we still have some opportunity to be best in class. If you look at all the key metrics whether it’s DPO, DSO even inventory turns, there are many industries that we can learn from to drive more efficiency.

And so, first and foremost, we don’t talk in Exterran as though our working capital was a 2016 initiative. It’s a continuation. The company is aligned to it. Our incentives are aligned to it. And so, we’re going to continue to make progress and focus in that area. But of course, as the Company grows, you will have some absolute dollars.

And so, we’re trying to make sure that we focus the Company on the efficiency of the working capital and ultimately work towards best in class on many of those metrics. And so, I still think we have some ways to go. And I feel good with our overall cash plan this year for the balance or the rest of the year as well.

So, I think we’re in pretty good shape..

Thank you. This concludes our question-and-answer session. I’d like to turn the floor back over to management for any closing comments..

Okay. Thank you. So, once again, I’d like to thank everyone for your interest in Exterran. And have a good day. Thanks..

This concludes today’s teleconference. Thank you for your participation. You may disconnect your lines at this time..