Greetings. Welcome to the Exterran Fourth Quarter 2018 Earnings Call. [Operator Instructions]. Please note that this conference is being recorded. I'll now turn the conference over to Blake Hancock. Mr. Hancock, you may now begin..

Good morning, and welcome to Exterran Corporation's Fourth Quarter 2018 Conference Call. With me today is Exterran's President and CEO, Andrew Way; David Barta, Exterran's Chief Financial Officer; and Girish Saligram, Exterran's Chief Operating Officer.

During this conference call, we 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 meanings of the U.S. securities laws 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 and the presentation that's located on the Investor Relations portion of the company's website. With that, I will now turn the call over to Andrew..

Thanks, Blake, and good morning, everyone, and thanks for joining. To kick things off this morning, I'd like to update you on the operational improvements and strategic progress we laid out a year ago before Girish and Dave take you through the operations and the financials.

One of the key transformational changes we initiated was the evolution of Exterran from a domestic fabricator with an international service business to being a true global systems and process company. This supports the organization's transition away from a cyclical business to one with more stable and recurring cash flows.

As the lines between traditional upstream and midstream companies become less distinct, the need for a well-thought-out integrated solutions that bridge these traditional gaps have become more prevalent.

The once noncore areas of water and power are becoming central themes for our customers as they are -- as they become significant factors to operational costs and reliability.

Exterran has set -- has a set of process solutions and services that covers the entire midstream product value chain that offers comprehensive engineered solutions and service operations with a proven best-in-class operating performance in oil, gas, power and water. Over the past 12 months, we've improved our product portfolio in a number of ways.

The first was the sale of our lower-margin PEQ business; second was driving margin expansion through a balanced mix of productivity and pricing; third was to invest in new product development with a focus on operational efficiencies, emissions and enhancements of our existing products; fourth was the development of new technology for our water business; and finally, a greater emphasis on driving services growth.

While improving margins, we have also focused on increasing penetration within each customer account. We are seeing a market need for a fully integrated plants, designed with a systems approach to ensure process integrity and efficiencies.

We have successfully designed and deployed three complete plants in the Middle East region in the last 15 months and have another two projects that we're currently working on while simultaneously developing an integrated compressor station in Latin America.

All of these ECO projects have long-term stable cash flows and provide solid returns on capital. I'm happy to announce that the largest project since our spin is now producing sales gas and condensate. This project was executed with over 3 million man-hours with no lost time and in line with our budget and with no cost overruns.

As we know, the industry, especially in the Middle-East region, can suffer from execution challenges due to the complexity of projects in difficult environments. Our performance serves as an industry benchmark and a competitive differentiator for us.

We're also seeing a similar need in the product sales segment both domestically and internationally with four major fully integrated plants awarded last year and currently in execution.

Our focus on the water business has started to pay off with the first ECO project incorporated in our mobile RevoLift unit using our patented microbubble technology in the U.S. Besides reducing operating costs, we have provided a total produced water treatment solution that is simpler to operate, has smaller footprint and uses less chemicals.

We've also been awarded a project for 750,000 barrel a day produced treatment plant with a large customer in the Middle East region that incorporates our patented EGFT technology. This project results in significant benefits for our customer, a 50% reduction in footprint, leading to a 40% reduction in CapEx and a 65% reduction in operating expense.

With our total solutions approach and a strong product portfolio, we have started building a pipeline of projects in both the conventional and unconventional space.

Over the course of 2018, we were awarded several ECO projects, totaling over $350 million of new contracts, adding to our growing backlog of $1.4 billion and continuing the portfolio mix to more stable plant-based contracts.

In the AMS segment, we won and extended several O&M contracts over the course of the year in each region, totaling over $40 million. We also had record bookings within our product segment of $1.1 billion over the year, leading to a record year-end backlog of $706 million.

Financially, we continued to improve on all our key metrics as revenue grew 12%, EBITDA, as adjusted, grew 19% and EBITDA, as adjusted, margins were up 85 basis points over the previous year. At the same time, we lowered our working capital to 8% of revenue from over 24% at the start of 2015.

All of these actions drove operating cash flow from continued operations of $153 million and generated positive free cash flow in the second half of the year. Over the past several years, we have built a growing business that is able to make choices on how to deploy capital.

We have always invested capital with the key focus on building long-term shareholder value by balancing growth, deleveraging the company and returning capital back to the shareholders.

With the confidence on the market -- microenvironment and our company's ability to generate solid returns and positive cash flow over the coming years, our board has approved a $100 million share buyback program, which is effective until February 2022.

We have continued to discuss the flexibility we have within our capital allocation plans as over the past several years, we've been able to pay down debt while significantly invest in the business. This buyback authorization provides us greater optionality in driving shareholder value.

I'll now pass the call over to Girish, who'll discuss some operational specifics and global demand dynamics..

Thanks, Andrew. I will start with a few dynamics in each of our segments and then transition to a regional view of demand signals. Over the course of the year, in our product sales segment, we have had significant success in growing our backlog through key strategic wins and ended the year with a backlog over 50% higher than year-end of 2017.

In 2018, we had international orders at the highest level since the spin, including a large order for integrated NGL plants from Basrah Gas Company in Iraq that was part of our Q2 bookings. This single order for the first two trains with the framework for additional trains is a major strategic initiative for Iraq and our customer.

It is wins like this, both internationally and domestically, that showcase our ability to be a strategic partner to customers and provide a fully integrated plant solution, like Andrew mentioned.

Our belief is that as we take on a bigger portion of our customers' needs, we will be able to grow margins through a combination of value creation and the natural productivity we get in our project execution with these larger orders.

In our ECO segment, we have signed over $800 million of new contracts since the spin, and over $350 million of that was in 2018 alone. That leads to an annualized revenue of over $130 million as these projects come online.

While a significant portion of this growth is offset by factors like FX and start-stop style contracts coming to an end due to field declines and gas unavailability, the new book of business is dramatically different.

It is characterized by more predictable contracts, higher returns and generally more in the nature of an integrated plant versus pure compression packages. Additionally, we continue to see a large pipeline of projects that we are focused on.

The nature of these projects is to be longer cycle, but we remain very confident in executing to a similar win rate and volume over the next couple of years. Finally, in AMS, we have talked about our focus on longer-term O&M contracts, and that is starting to pay off.

We booked close to $50 million of new orders in the fourth quarter, highlighted by multiple O&M extensions and one key new contract in the Middle East/Africa region. The path to the O&M contracts typically starts with transactional parts, and those are characterized by lower margins.

As we are building up our customer base, this can have an effect of lowering margin rates for the segment, but we expect that in the longer term, it will lead to more lucrative services and upgrade opportunities that will bring us back to a mid- to high 20s level.

We have proven this concept this year by signing new O&M contracts with customers that started off with a transactional parts relationship. On a regional dimension, I will start with North America where we secured some significant wins with key customers for P&T plants as well as compression.

Overall demand continues to be structurally sound, with timing being a little uncertain to start off the year. We secured P&T wins in the Bakken and the Marcellus, reflecting the continued strength in these basins.

A lot of our customers are large public companies, and you are aware that most are still spending at high absolute rates this year as they look to bring on projects in the next two years.

From a basin perspective, the Permian continues to be the largest source, but we are also seeing strong demand in the SCOOP/STACK and Marcellus/Utica, along with a notable uptick in the Bakken that is likely to continue.

As additional capacity comes on in the Permian, there is some potential pressure on appellation producers on natural gas pricing that is leading to greater planning on their part.

This, coupled with a slight reduction in drilling rigs that is delaying producer commitments, is causing a slight degree of timing uncertainty in the demand for new gas plants.

Over the past few years, we have seen our traditional midstream customers plan farther ahead and place orders for gas plants prior to having all producer commitments locked in.

With this current environment of tentativeness, we have experienced a slight delay with a few customers who are waiting for these commitments to get locked in prior to placing orders.

We do, however, expect that when this resolves, there will be an expectation of faster cycle times, and we are focusing our advanced supply chain planning to address this. With the expiration of our noncompete, we are now capable of offering about customer service agreements with their product orders.

We sold seeds in 2018 and realized roughly $4 million of AMS business in North America. This was primarily commissioning services and parts sales for P&T. As we grow our focus, we expect to grow our AMS business in the U.S. this year, but it will remain a relatively small number in terms of global contribution as it will take time to fully build out.

In addition to the win that Andrew highlighted regarding our water solutions business, we are also pursuing agreements to begin additional trials with other E&Ps this quarter. Moving on to Latin America. We still see multiple opportunities in Argentina, Brazil and Bolivia.

While there has been a lot of discussion on a temporary pullback in Argentina with the gas subsidy dynamics, the development of the Vaca Muerta will not stop in our opinion. As Argentina develops into a stable exporter, we believe there will be demand for gas processing plants as well as compression stations.

In the Middle East and Africa region, we have talked in the past about prospects in Oman, Bahrain, Iraq, Kuwait and other countries, and we continue to see those progress and develop. During the quarter, we had success in both ECO and AMS throughout the region.

Finally, in Asia-Pacific, not only are we having success for our AMS business but we are seeing opportunities for ECO projects in the longer term. The pipeline for FPSO upgrades is getting strong, and we are pursuing opportunities to convert this year.

We continue to look for additional opportunities in the region and to leverage our capabilities and enhance our customer base. I will now pass it over to Dave to discuss our fourth quarter financial results..

Thanks, Girish. We had another solid quarter with EBITDA, as adjusted, of $51.5 million on revenue of $332 million. The quarter came together as we had expected.

Our base business progressed nicely, leading to operating cash flow from continuing operations for the quarter of $65 million and free cash flow of $2 million, our second quarter in a row of positive free cash flow.

From a segment perspective, contract operations posted revenue of $88 million, while gross margin was $62 million, resulting in a gross margin rate increase to 70% compared to 67% in the third quarter. The sequential increase in margin was due to the productivity gains and commercial negotiations.

In AMS, revenue was $32 million and gross margin was $7 million. This resulted in a gross margin percentage of 22%. Revenue exceeded our expectations given some of the commercial success that Girish discussed. The gross margin sequentially declined due to the mix between parts sales and O&M.

Revenue in the product sales segment was $212 million and gross margin was $27 million, resulting in the gross margin rate of 13%. Our Q4 bookings were $159 million, and full year bookings were $1.1 billion, putting our full year book-to-bill at $1.3 billion.

The decline in revenue from product sales sequentially was largely due to timing of process and treating orders along with the incremental shop hours committed to the ECO projects. Margins for the segment were negatively impacted by a mix shift towards compression.

That being said, our compression margins for the quarter were the highest they have been since the spin, driven largely by our cost out initiatives. Our product sales backlog was $706 million at the end of Q4 compared to $461 million at the end of 2017.

SG&A expenses were $45 million, flat sequentially as we continue to manage costs while investing in revenue-producing initiatives, such as our water business, and new product development. Moving to the balance sheet. Total debt at the end of the fourth quarter was $404 million with available credit of $578 million.

Our leverage ratio, which is debt to adjusted EBITDA as defined in our credit agreement, was 1.8x, which is flat with the third quarter. If you look back, since the end of 2015, we have paid down over $100 million of debt, which is impressive given the amount of ECO and other capital investment.

I'm now going to turn to 2019 and provide some guidance for the year, and then I'll talk about the first quarter. From a big picture perspective, EBITDA, as adjusted, for 2019 should be between $215 million and $230 million, representing another year of adjusted EBITDA growth.

The ECO outlook includes a start-up of two new projects, one this quarter and another in the second half of 2019. FX translation will continue to be a -- the primary revenue headwind, and we expect the rest of the business to be in line with our historical performance.

Within AMS, the commercial success, as Girish discussed, led the segment up to show a nice revenue increase of mid-single digits year-on-year with margins in line with the second half of 2018. The biggest variable in our opinion is the product segment where bookings for the next couple of quarters will dictate the strength of the second half.

With the backlog in hand and expectation for orders to improve the next couple of quarters, we expect this segment's top line to improve the most year-on-year compared to the other two segments. We continue to stay focused on productivity to help offset mix impacts.

Full year SG&A is expected to be between $180 million and $185 million as we continue to look to drive efficiencies within the organization. Full year DD&A is expected to be around $165 million, driven by our ECO projects coming online, along with commercial negotiations and the impact of the new lease accounting standard.

And we expect cash taxes for 2019 to between $30 million and $35 million, with interest expense relatively flat year-on-year. Gross CapEx for the full year 2019 is now expected to be around $205 million to $215 million, with committed growth CapEx currently estimated to $170 million and maintenance and other CapEx to be $35 million to $45 million.

We also expect to receive additional advanced payments of around $115 million for the full year, which we account for as deferred revenue, but that would put our net CapEx at around $90 million to $100 million. Now I'll turn to Q1. Adjusted EBITDA should be similar to Q4 but will be slightly impacted by negative mix.

This should also represent the low point from an EBITDA perspective for this year. So starting with contract operations. Revenue should be relatively flat sequentially, with gross margins moving back to a more normalized level in the mid-60% range. For AMS, first quarter revenue will be in the mid-$20 million range.

Margins for the segment should be in the low to mid-20% range. In our product sales segment, Q1 revenue should be up mid-teens sequentially, with margin rate holding relatively flat sequentially. SG&A should be between $43 million and $45 million. I'll also touch on another topic this morning.

The new lease according standard, which we've talked about before, will go into effect on January 1, 2019. As a lessee, we'll be required to record long-term leased assets and related liabilities for future payments on our balance sheet. Currently, this is estimated to be no more than $13 million upon adoption of the new lease guidance.

With respect to impacts on us as a lessor, any new contracts entered into or modified after January 1, 2019, will be assessed in accordance with the new lease standard ASC 842 and/or the ASC 606 revenue-recognition standard.

We do not believe that the adoption of these standards will have a material effect on our statements of operations or cash flow. I'll now turn the call back over to Andrew..

Thanks, Dave. So 2018 was a solid year for Exterran as we transitioned the organization into a globally connected team, greatly improved our commercial capabilities, expanded our engineering focus and launched a new product within our water business, all while achieving solid financial results. So looking ahead to 2019.

First, this year will be a year of delivery and execution of the backlog that we have in place while maintaining a keen eye on cash flow. On time, on budget and in a safe manner are our goals and have been the key differentiators for Exterran.

We have several large ECO project we are completing along with a historic high products backlog where continued strong execution drives value.

We are extremely focused on the build-out of our North America service business, and this may be achieved both organically and inorganically, but we understand the importance of growing this business to improve our financial metrics. And as Girish said, this year should show substantial growth in the region versus 2018.

Now that we've had early wins in our water business, it's time to scale the segment to have a distinct impact, both domestically and internationally. Our pipeline of opportunities is growing, and customer feedback has been very promising as we leverage our strong relationships globally.

With the improved engineering capabilities brought on in 2018, we are now looking at expanding new product development to bring technology and innovation into our offerings to allow for differentiation versus some of our peers and drive greater penetration of our fully integrated plant offerings.

The macro landscape for our business remains robust, with timing being the biggest question. We see demand across the globe, driven by LNG, desires for countries to be gas independent, along with needs for additional in-country power supply. All this leads to a year of selective capital allocation.

We have invested heavily in ECO over the past several years and even into this year, and we remain focused on capital allocation discipline, positive free cash flow and returns.

We have confidence in our ability to deliver on the year ahead, and with our new buyback in place, we are demonstrating to investors that all uses of capital are available to drive long-term shareholder value. I would personally like to thank all employees at Exterran for their hard work and dedication that led to the success we had in 2018.

I look forward to updating you all next quarter on our progress for this year. Operator, if we can now open the call for questions? Thanks..

[Operator Instructions]. Our first question is from Tim Monachello with AltaCorp..

My question is just around the contract operations margin expansion. It was up to nearly 70% in the quarter. I'm wondering if that was mostly price driven, and if that's something that we should expect to be sustainable going forward..

So, Tim, over the past 12 month, we've been working on a number of initiatives to drive further productivity in the factories, both from a overall operating costs, how we're manufacturing components and parts and also in the actual field service area itself. So we have seen that move into the ECO business.

And in the fourth quarter particularly, we had a lot of productivity and also some commercial negotiations that were favorable. So I think you'll see over the course of the full 12 months, we'll continue to improve margins in the business, and we should expect to see over the longer term that ECO margins continue to improve.

It's a little lumpy based on -- depending on how things work through the quarters from an overall repair and maintenance, but directionally, I think you're on the right topic..

Okay.

So are those contracts generally open for pricing renegotiation?.

They typically open up as we get to the end of the contract as we renegotiate extensions.

So as we think about the work scope changes, there are times where if a particular well is producing at a certain configuration, if there are any changes that we have to make throughout the life of the contract, there can be negotiations that take place in order for us to make sure that we're equipped and that we have the right people producing in the right way.

So there are some opportunities throughout the life, but it tends to be a fixed contract, as we said. But there are sometimes where you can open back up to renegotiate, yes..

Okay, that's helpful. And then second question is on the share repurchase program.

So how would you rank your capital allocation priorities between growth projects and share repurchases?.

Yes, I think, Tim, I guess, I would maybe summarize it by saying I'm not sure our priorities or strategy have changed. This is really just, I think as Andrew said, a vote of confidence by the company in our ability to drive cash flow and just another option to deploy capital.

But we're still committed, I guess, overall long-term to doing what is in the best interest of driving shareholder value. So if that's investing organically in the business, it will be. If it's inorganic opportunities that drive that value, we'll head down that path. Or again, this gives us another revenue to improve shareholder value creation..

Okay.

So you're looking at it more as an option, not necessarily something that's a capital priority at this point?.

I think that's the way to look at it. This just opens up a toolkit for us so we can, again, invest in the business organically, inorganically. We've got the bonds outstanding, and we've, obviously, got the buyback authorization. So we'll look at this opportunistically and with a long-term view to shareholder value creation..

The key, Tim, is that the business has -- we've put ourselves in the position to have optionality. Over the last few years, we've ran a pretty intense process around generating cash. We will file later today and you'll see the operational metrics. We've really focused hard on working capital, and now we're lower than 9%, in the 8% range.

All of the key operating foundations we've put in place, and so, really, it's the quality of our EBITDA and over time continuing to drive further operating leverage so that we can create more cash to have optionality.

And so I think the pipeline, as Girish mentioned, for ECO projects is still very large, and we're very confident in that pipeline over the course of the next 12 to 18 months. And as Dave said, the real question in the short-term will be the timing of some of the orders that we see in North America.

But we're very focused on growing the company, and growth is important based on our long-term goal of driving shareholder value.

And if we have projects that are in the right returns, and some aren't, and some come along that we bid on and that were not in the right ballpark because it's not the right returns for Exterran and it's not the right returns for our shareholders. And so we -- nothing has changed in terms of that strategy.

But as Dave mentioned, this just gives us an extra option to think through how we allocate the right capital going forward..

Okay. And then just final one on the buyback.

Would you guys be open to using leverage for that buyback? Or would you just stick within organic cash flow generation?.

I think the focus, as Andrew said, is really around surplus cash generation..

Okay. All right, understood. And then just one question on the water solutions business.

Will all of these projects going forward be ECO projects? And do those -- do the margins on the water contracts so far line up with typical ECO margins?.

Yes, Tim, this is Girish. We expect there's going to be a little bit of a mix. Some of these that use our RevoLift, typically, will be more along the lines of a services contract under the ECO model. However, when we have large tanks and fairly large project execution cycles, they'll be more in the product sales.

And what we expect is within the services segment, the margins will be commensurate with our overall portfolio. So we won't see any issues there. And then on the product side, we expect it to be accretive to our overall product portfolio..

[Operator Instruction]. At this time, I'll turn the floor back to management for further remarks..

Okay. Well, thanks, everyone, for dialing in this morning, and appreciate your interest in Exterran for the full year, and look forward to updating you at the end of Q1. Thanks a lot..

Thank you. This will conclude today's conference. You may disconnect your lines, and thank you for your participation..