Archrock Inc (AROC) 2006 Q2 法說會逐字稿

This is Universal Compression's earnings conference call. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Mr. David Oatman, Vice President Investor Relations of Universal Compression.

Good morning everyone. Welcome to the Universal Compression earnings conference call for the three months ended June 30, 2006. We have prepared a summary page of financial and statistical data about the quarter in our earnings release, which is posted to our UniversalCompression.com website under the Investor Relations tab.

As we have in the past, during this call we will discuss some non-GAAP measures in reviewing our performance, such as EBITDA as adjusted and gross margin. You'll find a reconciliation of these measures to GAAP measures in the summary page of the earnings release.

As a reminder, in addition to providing statements of historical fact, today's conference call will include certain comments that are not statements of historical fact, but instead constitute forward-looking statements. Investors are cautioned that there are risks and uncertainties and other factors that may cause the Company's actual performance to be significantly different from the expectations stated or implied by any comments that we make today.

These forward-looking statements are affected by, among other things, the risk factors of forward-looking statements described in the Company's transition report on Form 10-K for the nine-month ended December 31, 2005, and those set forth from time to time in the Company's filings with the SEC, which are available through the Company's website and through the SEC's EDGAR system website at www.SEC.gov.

The Company expressly disclaims any intention or obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise.

I will now turn the call over to Mr. Steve Snider, Universal's Chairman, President and Chief Executive Officer.

Good morning everyone. Joining me today is our Chief Financial Officer, Michael Anderson. And as in the past, I will provide summary comments about our results, operating highlights and outlook, and Michael will follow with more details about our financial results and guidance.

Business conditions remained favorable in our industry as worldwide markets for compression services and products continue to be very active. We see our customers taking a steady long-term approach towards meeting their natural gas production targets, and we have not seen any significant change in overall customer activity level based upon short-term fluctuations in commodity price and storage levels.

Our second quarter results reflect another strong performance from our domestic and international contract compression segments, which included another record revenue quarter for these segments.

Our domestic contract compression unit hit a major milestone, surpassing $100 million in quarterly revenue for the first time in its history. This is quite an accomplishment as our quarterly revenue for domestic contract compression was only about $22 million when we went public in 2000. Our domestic contract compression segment has been a particularly steady performer, having recorded sequential revenue increases in 14 of the past 15 quarters.

We also continue to be busy in our fabricated compressors sales operation, as continued strong levels of bookings have resulted in another record backlog. The recent expansion of our large horsepower fabrication capacity will allow us to better balance the strong demand for both fleet and sale units. Our fabrication operations are currently fully utilized.

For the three months ended June 30, 2006 we had record diluted earnings per share of $0.70, which represents a 25% increase over the prior year period results. Our outlook for the foreseeable future is positive, based upon favorable industry conditions, reflected by our healthy order and inquiry level from our customers. We continue to expect record levels of revenue and earnings per share in 2006.

Our guidance for earnings per share in 2006 is $2.85 to $2.95. It should represent a strong 33 to 37% increase over adjusted calendar 2005 results.

Now I will provide operating highlights for each of our business segments. Our domestic contract compression segment remains very active, as demonstrated by a strong 27% increase in revenue compared to year prior results -- prior period results a year ago. Domestic contract compression profitability has been enhanced by our price increases, which have helped to offset increases in fuel operating expenses. Domestic contract compression gross margin dollars in the second quarter of 2006 increased 7% on a sequential basis, and 27% compared to the prior year period.

As noted in our conference call in May, we have seen a moderation of domestic utilization rates as a result of our April 1st price increase. This development was not unexpected, and we now have more smaller and mid size units available to meet customer demand at current price levels.

In the second quarter of 2006 our domestic operating horsepower increased 3% compared to the year prior period. We had a small deduction in average operating horsepower compared to the first quarter of 2006, as growth from the activation of new large horsepower units was offset by returns of smaller and mid range horsepower as a result of the price increase, as well as the sale of some units contracted under purchase options. We have reactivated several of the idle units, and are optimistic about redeploying the remaining units at higher rates.

At June 30, our domestic fleet totaled 1,989,000 horsepower, with a spot utilization of 89.6%. Domestic utilization is currently 89.5%.

Our international contract compression segment remains strong as well. As compared to the prior year period, our average working international horsepower increased by 7%, and our revenue increased by 16%. International contract compression gross margin dollars in the second quarter of 2006 increased 7% on a sequential basis, and 19% compared to the prior year period.

Our international fleet totaled 595,000 horsepower at June 30, and international utilization was 92.1% at June 30, and is now 91.7%.

We have several new international contract compression projects that are expected to commence operations, mainly in the last half of 2006 and early 2007. Subject to the usual scheduling issues, we expect to start generating revenue from new contract compression units in Latin America and Asia-Pacific in the third quarter. As a reminder, this growth is expected to be offset somewhat by the likely exercise of a customer purchase option on a compression facility in Latin America. Bid activities and inquiry levels remain strong for new projects, which would begin making financial contributions in 2007.

Looking at our total operating statistics, our overall spot contract compression utilization, including both international and domestic, was 90.2% at June 30, and currently is 90.0.

Our plans for new fleet growth remain unchanged. We continue to expect to build new units totaling approximately 200,000 horsepower in 2006 for our contract compression operations in domestic and international markets. These are larger horsepower, multistage units that are in high demand around the world. These new fleet units are long-lived assets that in today's environment generate an excellent return on investment.

Moving to our fabrication segment, our compressor fabrication backlog increased from $228 million at March 31, 2006 to $275 million at June 30. And is currently at a record $283 million. Our current backlog is roughly 70% domestic and 30% international.

Our healthy backlog reflects strong market demand, as well as customer commitments for delivery of new units further out into the future. These longer leadtimes have resulted in increased visibility for our fabrication operations.

As expected, our fabrication revenue declined in the second quarter as we allocated more scarce components to our contract compression fleet expansion efforts. With higher pricing and production efficiency improvements, fabrication margins were higher in the second quarter and are expected to improve further in the second half of 2006. We expect fabrication revenue to ramp back up in the second half of the year.

In our aftermarket service segment, revenue declined on a sequential basis, as growth in international markets was offset by lower revenue from our domestic operations, although overall revenue did increase compared to the prior year period.

Domestic activity levels had been impacted by reduced repair and maintenance work in the Gulf of Mexico, where many older production facilities were destroyed by hurricanes last year. Driven by these recent events, we are continuing our efforts to expand our domestic aftermarket service activities in other areas of the country in order to better balance our geographic coverage. Margins were a bit lower than expected due in part to the incurrence of certain out of period costs, as well as some lower margin jobs.

Our workforce is continuing to experience very busy times. I'm extremely proud of our team's ability to meet the growth challenges inherent in current strong market conditions. To help support our strategic initiatives we recently announced the appointment of Ernie Danner to the new position of Chief Operating Officer. Previously head of our International division, Ernie will be in charge of Universal's operations on a day-to-day basis. Ernie has been a huge part of Universal's success since 1998, and I'm confident he will be integral in taking us to the next level.

I will now turn the call over to Michael for more detail on our financial results and guidance.

Good morning everyone. I'm sure that by now you have all received and reviewed our press release that we issued earlier this morning. So in my summary of the financial results for the second quarter the primary comparison period again will be the first quarter that ended on March 31, 2006, as well as the guidance that we provided back in May. We will also talk a little bit about the year-over-year performance by comparing the three months ended June 30, 2006 to the three months that ended June 30, 2005.

Total revenue was $219 million for the quarter. That is a 5% decrease sequentially. It is also a 5% increase on a year-over-year basis. Now the big part of the revenue variance in comparison periods is really the expected reduced level of fabrication sales during the second quarter of 2006. Let's now look at each of our business segments.

In our domestic contract compression business revenue was $101 million in the second quarter. That is a little bit higher than our guidance, and it represents an increase of 8% sequentially and a 27% increase compared to the year ago quarter. This sequential growth was driven largely by our April price increases, while the year-over-year increase is due to both better pricing, as well as growth in working horsepower.

Gross margin percentage in the domestic segment was 65% in the second quarter. That represents another period of strong operating performance. And although we continue to see some operating cost pressures, mainly in labor, gasoline and lube oil, we have also been able to maintain gross margin percentages, and also significantly improve our gross margin dollars.

For instance, we added about $4.5 million sequentially to domestic contract compression gross margin dollars. That was an increase of about 7%, again largely coming from the impact of our April 1 price increase. On a year-over-year basis, domestic contract compression gross margin dollars, they were up by about 27%.

Our international contract compression revenue was $35 million in the second quarter. That is a little bit higher than our guidance, led by strong results in Latin America. This revenue level is an increase of 5% on a sequential basis, and it is up 16% compared to the prior year period.

International contract compression gross margin percentage was 76% in the June quarter, a little bit higher than our guidance. We're doing quite well with margins right now, but do expect to face some continued cost pressures in certain markets, including Argentina.

In our fabrication operations revenue was $30 million in the second quarter, toward the lower and of our guidance range. As noted in last quarter's call, we had expected fabrication revenues to be down in the second quarter as we built aggressively for the contract compression fleet. And we do expect fabrication revenue to increase nicely in the second half of 2006.

The good news here includes that our fabrication gross margin was 12% in the second quarter. That was at the higher end of our guidance. In comparison, we recorded fabrication margins of 11% in the March quarter, and 5% in the year ago period. Fabrication gross margin percentage increased due to improved pricing in today's favorable business environment, as well as production improvements and efficiencies that we had had in our fabrication facilities.

In the aftermarket services business segment, second quarter revenue of $44 million was a bit lower than our guidance range. And it was down 4% sequentially, although it was up 4% compared to the prior year period. The aftermarket service gross margin was 17%. That was lower than guidance, and was down from the 21% in both the first quarter and the prior year period.

Gross margin percentages in the segment were actually impacted by some prior period costs of a little less than $1 million. If you were to adjust for those items, the AMS gross margin percentage for the second quarter would have been about 2 points higher, and similarly about 2 points lower during the first quarter when we had a 21.2% margin.

SG&A expenses increased from $26.5 million in the first quarter to $29.5 million in the second quarter, due to costs associated with the implementation of our ERP system, increased domestic ad valorem taxes, which are offset in revenues, increased international taxes, and also increased stock-based compensation expense.

Specifically, we spent about a little over $1 million in expense that we had not planned for related to focused efforts to enhance our ERP system and work through business processes system changes. Although it is unexpected, we do believe that these investments in our new system will benefit us going forward. Currently we are live in our ERP system in almost all of North America.

EBITDA as adjusted was 75.2 million in the second quarter. That is a decrease of 1% on a sequential basis, but it is an increase of 15% on a year-over-year basis. Interest expense was 14.6 million in the second quarter. That compares to 14.1 million in the first quarter and 12.5 million a year ago. Looking forward, we do expect that interest expense will be in the 14.5 to $15 million per quarter level for the remainder of 2006, as debt levels should be relatively unchanged.

Regarding income tax expense. We had a 28% effective rate in the second quarter. That is certainly down from the 36% we had in the first quarter and 35% we had in the June 2005 quarter. Now our tax rate was benefited from a number of recent tax law changes that were enacted in the quarter. These tax law changes related to the state of Texas margins tax, Canadian tax laws, and also federal income tax related to foreign income.

The lower tax rate in the second quarter benefited Universal by approximately 2 to $2.5 million as compared to our more typical tax rate of 35 to 36%. Despite this quarter's benefit on the tax side, we do expect that our tax rate should be around the 35% level going forward in the third and fourth quarter of this year.

We generated record diluted earnings per share of $0.70 in the second quarter, which was $0.01 higher than our guidance range. This earnings level represent increases of 3% from the first quarter, and 25% over the prior year period results.

Net capital expenditures were $55 million in the second quarter. That is an increase from $37 million that we had in both the first quarter, as well as in the year ago quarter. Capital expenditures during the quarter included $41 million in gross CapEx, $9 million in maintenance overhauls, and also $9 million in other miscellaneous expenditures, including costs related to our recent fabrication facility expansion.

As expected, gross capital spending in the second quarter was weighted about 60/40 toward the domestic markets. It also included about $5 million for the repackaging of existing units.

Debt to capitalization declined from 51.1% at March 31 to just under 50% on June 30 at 49.8%. Total debt, including capital lease obligations, was $899 million on June 30. That is basically flat with the 898 that we had at March 31.

Our debt to trailing EBITDA ratio declined a little bit to 3.1 times as of June 30. Our working capital investment, which excludes cash and debt in our calculation here, was $139 million at June 30. That is up from $106 million at March 31. We have seen receivables and the inventory levels move upwards over the past quarter, due largely to increased business activity, including fabrication activity. Our cash position at the end of the quarter was $25 million.

Our revolver, which extends into 2010, had $66 million drawn against it on June 30. And we also had approximately $112 million in unutilized credit availability at June 30.

We do expect that we will file our 10-Q for the three months ended June 30, 2006 either later today or tomorrow.

Let me now summarize our guidance for the third quarter ending September 30, and also update guidance for the full year 2006. As is typical for us, these figures and expectations do not include any potential impact of acquisitions, dispositions, equity offerings, or other material transactions that could occur in the future, and of course it does not include any impact of the previously announced initial public offering of Universal Compression Partners.

Revenue is expected to be between 240 and $250 million in the third quarter. This would represent a healthy 33 to 38% increase over the prior year period. Specifically, domestic contract compression revenue is expected to be 102 to $103 million in the quarter. That would give domestic contract compression business a 24 to 26% year-over-year growth rate.

International contract compression revenues is expected to increase to approximately $36 million in the third quarter. This would give international contract compression business a 16% year-over-year growth rate.

Gross margin percentages should be around 65% domestic, and again in the low to mid 70% range for the international contract compression segment.

Fabrication revenue is expected to move up significantly during the quarter to between 60 and $65 million in the third quarter, with a gross margin percentage in the 12 to 14% range. Aftermarket service revenue is expected to be in the 43 to $47 million range, with a gross margin percentage again around 20%.

Finally, that brings us to diluted earnings per share, which is expected to be $0.73 to $0.77 in the third quarter. This EPS guidance would represent an increase of 35 to 43% compared to the year ago period.

Let's now move to the guidance for the full calendar year 2006. We have not altered our revenue expectations, and we still expect total revenues to be 950 to $970 million. And that would be an 18 to 20% increase over calendar year 2005 revenues. We now expect earnings per share for 2006 to be $2.85 to $2.95 per share. That is up somewhat from our prior guidance, which was $2.80 to $2.95 per share.

The new guidance represented a 33 to 37% increase over adjusted earnings per share of $2.15 in calendar 2005. We continue to expect net capital expenditures after sales of PP&E of approximately 210 to $240 million in 2006. New gross capital for the year is expected to be split about two-thirds domestic, one-third international.

I would like at this point to now turn the call back to Steve for some closing comments.

I will close our prepared remarks with a brief update on the MLP. As you may know, in late June we announced the filing of a registration statement for the initial public offering of Universal Compression Partners LLP. A subsidiary of Universal Compression Holdings would be the general partner of this new entity. In addition, as currently filed, Universal Compression Holdings will retain a 2% general partner interest and a 55.4% limited partner interest, or a 49% limited partner interest if the underwriters exercise their full overallotment option.

At this stage in the process, there is still very little we can share about the MLP because of the SEC rules that govern initial public offerings. We will not be offering any additional information about the MLP today, nor will we be taking any questions about the MLP until completion of the offering. Of course you can view the registration statement on the SEC's website.

That concludes our prepared remarks. Operator, would you please open the call to questions.

(OPERATOR INSTRUCTIONS). Thiru Ramakrishnan of Simmons.

On the domestic compression side, the price increases that you did in April, have those completely flowed through to your customers?

Yes.

They accepted it?

Yes. All except the ones that returned their equipment.

Could you -- what percentage of those customers returned their equipment?

A small percentage. We've got a 2,000 horsepower back.

What does the pricing look like for the second half of '06?

The price increase we put in in April, we said at that time we were going to go ahead early with it. And that would probably do us for '06, and we would reassess toward the end of the year.

On the international side, could you give us a feel for how many projects you're currently bidding on internationally?

That would be tough. We're getting on so many projects.

I guess in terms of horsepower.

Bidding on? At any point in time there is hundreds of thousands of horsepower under discussion and consideration. I really don't have a number for that.

This project that you touched on that the customer may exercise the right to buy the equipment. When you guys structure incremental international contracts are you guys going to take those clauses out?

Yes, for the most part we have. This is the culmination of a seven-year contract that had (technical difficulty) option at the end. And it would be coming out at the end of this year.

Lastly, on the aftermarket side, Steve, you touched on some lower margin jobs that you took in the quarter. What is the outlook going forward on that?

In some areas it is still a very competitive market, and it is a very diverse market. We did lots of jobs. And sometimes we take jobs that I don't think are at margins that we are very proud of, and that occurred in this quarter. We're going to try to maintain some more discipline around that. And then also spread out our base of operations to get less dependent on Gulf of Mexico operations.

What percentage of your aftermarket is Gulf of Mexico?

Probably, domestic I would say 25 to 30%.

Martin Malloy, Southcoast Capital.

Could you talk a little bit more about SG&A and where we can expect that to be over the next quarter or two? It is up quite a bit when you look at it, both sequentially and year-over-year.

Yes. Sequentially we were a little surprised by the number. But we think it was a good number to be able to spend on our ERP system. That is probably where we had the biggest increases and surprise on the SG&A.

As we were looking forward, we're still going to be refining that ERP system. We will still have a lot of the things -- the big changes on a year-over-year basis, which includes things like the reallocation of the ad valorem taxes, 123R in terms of stock-based compensation, etc. Those things are going to keep moving forward.

As we get into 2007, we do anticipate that we will see some moderation with regard to the ERP spending. However, we would also anticipate that we're going to still spend on SG&A dollars from a growth perspective. We've got a lot of things going on right now. The international business continues to grow. And we see international revenue taxes that are included in SG&A. Those will continue to go up. I really don't anticipate SG&A really moving down here over the next couple of quarters. We will continue to be spending for growth initiatives that we've got.

Could you talk about leadtime for some of your key components, and if that has changed much in the last couple of months.

No, it is pretty well stabilized out where it was at the last conference call. Depending on size and type of equipment, it can take anywhere from 30 some weeks up into 60 or 70 weeks to get components. And not really any change as the manufacturers are still pretty loaded and it appears orders are keeping up with production.

Mike Urban, Deutsche Bank.

I wanted to follow-up on the aftermarket business a little bit. The weakness or slowdown in the Gulf of Mexico, at least hurricane-related, has been out there for almost a year now. Is there anything that has changed incrementally, or is it just something you're highlighting now, or is it also a function of just the activity levels continuing to come down there and just the high operating costs that are out there?

They have come down a little bit. The activity levels I'm speaking of now in the Gulf of Mexico -- you know, we have a little bit of a rebound after the hurricanes for cleanup and revamp of compressors. That is behind us now, and we're settling into steady-state operations. We're realizing a lot of the old equipment that was out there that we did a good deal of service work on is no longer in commission. These have been taken out or it is not functioning. Some of the old stuff is gone in the shallow water areas, and that was a pretty active area for us for operations and maintenance.

Is there any sense -- again kind of thinking about something -- things that may have changed recently in the last few months -- is there a sense that at least in the short-term this is a reaction to natural gas price? Obviously you're not seeing it on the contract compression side, which that makes sense. But is there an attempt to maybe slowdown some gas production in the near term, or even just take off some of that higher cost production on a stable basis?

None whatsoever. I almost go to the opposite side. Our producers seem to be producing everything they can to get out of the ground, or up from under the water in this case. No, I haven't seen any slowdown in that. And I have been talking to many of the customers over the last couple weeks, and they're all still going full ahead. No, I think it is merely inefficient production that was destroyed and the cost to repair wasn't worth what was still there.

That's helpful. The last question is -- I know you have mentioned this in the past, but could you remind us what the size of the purchase option is -- internationally how many horsepower that you represent?

25,000.

Geoff Kieburtz, Citigroup.

A couple of questions. I may have missed it, but the 28% tax rate in the quarter, how does that come about?

It was really tax law changes that came into place and being during the quarter. We had three different things. We had in the state of Texas a margins tax enacted to replace the franchise tax. We had the foreign tax law changes in the U.S. And then we also had some Canadian -- basically tax rate changes that went into place during the quarter as well. So we has some changes there, which included going back to the first quarter and making adjustments for first quarter income.

This is a first-half adjustment?

That's right.

But you still expect the second half tax rate is going to be 35%?

Yes. We had talked about 35 to 36% at the beginning of the year. We think we will be down towards the lower end of that because of these changes.

That is probably as far as I want to go on that one. Steve, you had mentioned that you were encouraged by the order and inquiry rates that you were getting in the domestic market. Could you quantify that at all? Is there some numbers that you could give us to get a sense of what you're talking about?

No, I -- well, we certainly have a fabrication backlog, which has always been kind of a proxy for overall activity. And as you see that is up pretty high again. And then contract compression -- contracts waiting for equipment to get started are also up in a lofty range. We look at that versus what we see coming in, and we see steady continued activity and absorption of new units coming out of the fleet.

I also think that as we are getting these units back from the price increase, and the ones we got back, we are refurbing those and putting them back to work. That is a matter of catching up with ourselves there, getting shop space, (technical difficulty) getting them back out to run.

I guess not to split hairs here, but given that the April price -- the price increase was instituted in April, I was a little bit surprised to see that margins fractionally declined sequentially in the U.S. market. Could you just explain that dynamic a little bit?

The margins hung around 65%. They have been bouncing 64% to 66% in most quarters, depending upon where expenses might be in that given quarter. They stayed where they were, but that is kind of standard with our other increases, as we are tending to raise prices at about the same level that our costs are going up, so our margin percentage stays the same, but our margin dollars increase nicely.

Okay. Fine. You mentioned that you are still on track to fabricate I guess 200,000 new horsepower for the fleet, correct?

Correct.

How much of that was completed and deployed by the end of June?

50,000, so about 25% of it.

I guess -- help me a little bit here. You expect to have fabrication revenue rebound, but you have still got three-quarters of your fleet expansion to complete in the second half of the year. But I think Steve said that your fabrication operation is already at full capacity.

I meant having all that production in the schedule was included in keeping it at full capacity.

Okay, so now you are in the full capacity.

We are. And our expansion is now fully functional, and it is up and running. It has been for probably six or eight weeks now. We have a little bit bigger facility and that is booked solid.

And also, in the second quarter you noted our capital -- our gross capital $40 million, we were spending a lot of those dollars to build for the fleet during the second quarter. Those units weren't necessarily finished and coming out of as completed horsepower. They will be doing that this quarter and even into the fourth quarter.

Okay. You're still giving a 12 to 14% gross margin. I just thinking that the full utilization of the fabrication facility I would have thought that maybe margins had a little upward potential.

I would point to two things. It wasn't so long ago we were talking about 6% margins. And I said, God willing, we can get this thing up to 12, 13% margins. I am actually pretty happy with those. We do have a certain amount of our production allocated to alliance partners that are negotiated margins. So it does reduce the combined margin that we get from sale of products to one off jobs versus the line.

Could you give us some idea of how much of your third-party -- your sales out of fabrication are alliance today?

Probably about 25%.

(OPERATOR INSTRUCTIONS). Robert Christensen, Buckingham Research Group.

If you could, a little more on the comments about smaller units coming in and bigger units coming out. I kind of was lost on what you were trying to convey there.

On the price increases that we had in April 1, a lot of those were targeted to small and mid range horsepower users. Our prior price increases have been targeted more to big horsepower. So we went back and targeted the mid range stuff. Some of those were released and replaced by competitors' equipment or just released and not replaced. That has come back to us, and we are now refurbing those to go back to work.

On the large horsepower that is what we're building new. All of our large horsepower essentially is working, but our CapEx program is building large horsepower equipment to go out and fill incremental need in that segment of the market. We have a little bit of two sites going on right now, mid range horsepower and large horsepower from different sources.

What is the -- I guess larger margin opportunity, big horsepower or small horsepower? How does one think about that?

Actually amazingly close when you talk about margins. About the same.

Of your fleet, I guess what proportion when you consider small, mid to large? Remember I am a newcomer to your Company.

You mean proportion as in what size -- where do we cut off the numbers?

No, of your horsepower outstanding domestically, how much is small, and how much is -- small mid, and how much is large?

About 40% is greater than 1,000 horsepower. That is our big horsepower. So the other 60% would be mid range and small.

At this time there are no further questions. I would like to turn the call back over to Steve Snider for closing comments.

Well, I thank everybody for your participation and attention today. And we will be back a quarter from now and talk about the next one. Bye-bye.