Exterran Corporation

Greetings and welcome to Xterra's first quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Blake Hancock, Vice President of Investor Relations. Thank you, sir. You may begin.

Good morning. and welcome to Xterran Corporation's first quarter 2021 conference call. With me today are Xterran's President and Chief Executive Officer, Andrew Way, and David Bardo, Xterran's Chief Financial 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 meaning of the 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 earlier today and a presentation located in 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. Xterra performed well in the first quarter as we remained focused on employee safety, operational efficiency, strong execution of our global backlog, and positioning the company to capitalize on a robust bid activity pipeline. The first quarter was a strong commercial start for the company in 2021 as we won and have begun execution of our first multi-year contract operations award for Xterra and Water Solutions worth approximately 200 million. While the effects of the COVID-19 pandemic are being felt globally, the rollout of the vaccination is starting to have positive ramifications. That said, part of the eastern hemisphere are still having outbreaks of the virus that could create additional timing challenges as we work with our vendors and suppliers to advance our projects. Looking at our growing pipeline of opportunities, We remain bullish on the commercial outlook for international markets. The recovery in oil prices and our customer needs continue to improve their natural gas production, which is paving the way for strong local demand for our traditional products and services. As I look at the addressable market opportunity over the next several years, we see over $2 billion for gas projects and over $1.5 billion of project award opportunities for water. As we've said before, we believe that natural gas demand will continue to grow and be an integral part of the energy ecosystem in the years to come. And clearly, the pipeline of opportunities we see demonstrates this thesis. We're excited to help advance the ongoing global energy transition. Even more important to our own transition is our external water solutions business. The win we had in the first quarter really underpins the confidence we have in this product line and its bright prospects for continued growth and value creation. I want to spend a little more time today on our water business, covering what we do and outlining our total addressable market across multiple industries. I also want to provide an update on how we see the business progressing. Our technology was initially developed in the municipal water segment for removal of iron and bacterial growth through mass transfer using a micro bubble reactor. The concept was then translated for environmental applications for aeration and pond management. The technology was further refined to address the harsh water conditions in the oil sands where extensive water treatment of large volumes of water was required. The growth of the oil and gas industry and the inherently high volumes of produced water presents a large market opportunity. Innovating with an application focus, we have now built a family of product lines that provide our customers a complete solution, covering primary, secondary, and tertiary treatment, which is scalable across different ranges of volume. We are proud to now be a leader in this space with a commercially proven and fully integrated solution. With over 70 patents, our core technology translates well into high flow and challenging fluids, and we are developing applications that extend into mining, utility waste water treatment, and produce water desalination. For the oil and gas industry, although all production is being forecasted to be flat until 2030, natural gas production is still expected to grow. Contrary to the flat production of oil, produced water volumes are rapidly increasing, which is attributable to the increase in water to oil ratio, as well as mature. In certain parts of the world where we operate, water cuts larger than 90% are now the norm. Industry sources expect to see 30% growth in produced water by 2025, and then potentially another 20% growth by 2030. It is a significant and meaningful opportunity for our company. Translating all of this to the addressable markets we serve, we see the produced water oil and gas industry as presenting a $30 billion opportunity with our micro bubble flotation technology being applicable to roughly $5 billion of this total market. But as I stated earlier, We see our technology as having applications across many industries, including petroleum, mining, where this technology originated in municipal water waste, to name a few. We are confident that our water business is poised for rapid growth that will drive enhanced financial performance and a compelling value creation. To wrap up this discussion on water, I want to provide some insight to how we see the business developing and growing over the next several years. Clearly, coming into 2020, EWX was a small part of our revenue and margin, but as we look out over the next several years and assess the pipeline of opportunities, we are confident that our annual revenue contribution from Water could exceed $150 million. Ultimately, given the tremendous market opportunity we're targeting, Water could drive more than 30 percent of the company's total adjusted EBITDA by 2023. And with that, I'll now turn it over to Dave.

Thanks, Andrew. We have issued the press release, the investor deck, and later today we'll file the 10Q. So I'm not going to go through the usual recap of the financials. Rather, I'll talk about our outlook for 2021 and the next couple of years. While there are still uncertainties around global and industry business activities, our backlog, the relative stability of the eco-business, and the strong commercial pipeline gives us confidence in providing an outlook for the next several years. As we stated in the earnings press release, we see at least 15% compounded growth rate for EBITDA as adjusted over the next two years, with our updated guidance for this year of $150 to $160 million. This view incorporates the water business outlook Andrew provided. Along with this, we also expect gas product bookings to begin to improve later this year and into 2022, with revenue recognition beginning in 2022 and 2023 to help drive increased EBITDA as adjusted in cash flow. This outlook also incorporates the impact of the productivity improvements and cost savings we have realized over the past several years. We will have meaningful operating leverage as we can handle increasing volume with only small changes to the cost structure. With regard to our cash flow outlook, our guidance for 2021 free cash flow is negative $60 to $70 million. And as a reminder, this is driven by the working capital uses, deferred revenue, and CapEx. Turning to 2022, we expect deferred revenue to be similar to 2021, with higher capex given the current backlog and an expectation for at least one more sizable eco-win. Working capital usage for the Middle East project will be meaningful higher next year as we'll get further into the construction phase of this project. We have chosen to invest in these high-return and high-margin projects that further the transition to a more sustainable energy-focused company, And although it requires capital over the next several years, it will generate significant cash flow in 2023 and beyond. As we move to 2023, we expect strong positive pre-cash flow as deferred revenue is expected to decline to a more normalized level. EBITDA is expected to be above $200 million, and working capital will start to contribute with the conclusion of the Middle East project. However, the full offset to the working capital build will be realized over several years. We have also not assumed any company-funded additional growth capex. This all could result in a free cash flow in 2023 of over $100 million. Thinking about this forecast in terms of leverage for 2022, we expect to maintain a similar leverage ratio level to 2021 with leverage significantly decreasing in 2023. Even with this improving outlook, we have commenced a review of our capital structure strategy to ensure both near-term and long-term success. As we have talked about before, our longer-term strategy included in this process is external project financing. We have developed a structure that we believe works for the relevant stakeholders and are discussing this with several potential capital providers. All options are on the table, consistent with our commitment to driving improved financial performance and shareholder value creation. With that, I'll turn the call back to Andrew for his closing remarks.

Thanks, Dave. So as we progress in our transformation, it is important for us to make sure our leadership is aligned with many of the important metrics that we believe will create long-term value, including managing our balance sheet and cash flow by improving EBITDA, improving the margins in our backlog, which should result in improved longer-term returns, and also tying part of our total compensation to total shareholder return, which is a direct alignment with our shareholders. We've also added ESG into our leadership goals and objectives, again, tied to compensation to further our strategy in a sustainable energy world. We're incentivizing our teams to make the right choices for all stakeholders and help drive both near-term and long-term value. As you hear today, we're accelerating our company's transformation underpinned by our growing commercial pipeline. I'm really excited about the potential opportunities we see in our water business. I believe that upon the conclusion of the strategic review of our capital structure, we can come away with a solution or solutions that support both our near-term and longer-term needs. I want to take a moment to thank our employees, our customers, and vendors for their commitment to Extern over this time. And to all our stakeholders, we are committed to driving longer-term value. And with that, I'll now turn the call back to the operator.

At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. In confirmation, it will indicate your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the star keys. One moment while we poll for questions. Our first question comes from the line of Kyle May with Capital One Securities. You may proceed with your question.

Hi, good morning, everyone. Pretty impressive to see the 2023 EBITDA number in the outlook. Just wondering if you can provide any additional color around the business and its segments to help us frame up how you see things improving and changing over the next couple of years.

Yeah, I think, again, that those outlooks were really based on, as we said, the water project we won, another assumption for another significant eco project, and then a gradually improving product sales environment. So, again, not go through all the details today by segment, but That one ECO project will contribute, obviously, the water deal we signed in the first quarter we began executing will start contributing in the 2023, probably back half of 2023. So the product sale and then the outlook Andrew provided for water will certainly be a big contributor in terms of product sales in addition to this ECO project.

Got it. Okay. I was also wondering if you could talk more about the capital structure strategy review. Maybe, you know, what options are on the table and what time frame you have in mind?

Yeah, I think, you know, Andrew obviously talked about a pretty significant pipeline of opportunities. And I think on the gas product side, you know, very consistent, we continue to see a multi-billion dollar pipeline. And those are projects that we have The customers, the project, all of that's lined out. These aren't speculative type things. These are real things that our teams are engaged with customers on. And then for the first time, provided a water pipeline in total. Same story. We've got those lined out by project, by customer, and those are things our guys are engaged in some capacity. So we have a significant pipeline in front of us that we're currently working. And I think shorter term, We want to make sure we're doing the right things in terms of leverage as we kind of grow into the leverage, better leverage position. And certainly from the long term, to make sure that we're balancing both that short-term opportunity to engage on these products and a longer-term view of maintaining that type of success going forward. In terms of options, I'm not going to go into lots of details, but I would say we don't have biases, nor does our board. We're going to consider any option that makes sense to create value and to serve all of our stakeholders. So I would just say we're looking at a range of opportunities. And at this point, not going to probably predict a timeline other than to say this is a priority for our company and our board is to resolve how we get to this pipeline and engage with our customers actively.

Got it. Understood. Thanks for taking the questions this morning. Thank you, Colin.

Our next question comes from the line of Doug Becker with Northland Capital Markets. You may proceed with your question.

Thanks. I was wondering if you could give a little more context around the timeframe and wind percentage you expect out of that pipeline, the $2 billion of gas, $1.5 billion of water projects, just over the longer term.

Yeah, so I think the guidance that we gave today handicapped, certainly over the next couple of years, the timing of the projects. Varying projects in different countries and different locations are at different stages. So some are early feed and we're designing equipment and the specifications on the actual application. Some of these projects would be a second train where we already have the first train. Some of these projects are replication of what we've already designed, built and we currently operate and we currently own and so it's a question of local timing And others are speculative in as much, you know, we've built into our plan the designs that we're currently working through with our customers and the various applications, but it still has to pass certain local tests. So it's a real difficult task. As I've said every quarter, really trying to predict the absolute order bookings in certain countries and certain locations has been tough. But we're very confident with the size of the pipeline that we have and our win rate within the applications and the product lines, we're confident with the guidance that we've provided. So our teams globally have been working hard over the past six to nine months interacting with a lot of customers in a lot of places. And as we look at the pipeline, we tend to build that into our overall resource allocation from starting off with application all the way through to engineering and then ultimately you know, how we're going to manufacture the product or how we're going to interact from an overall global supply chain. So we constantly run what we call our S&OP planning process that takes into consideration near, medium, and longer-term planning, and we'll build in the applications into that pipeline. So over the course of the next couple of months, we'll continue to keep you posted on both the size and scope of the pipeline, and hopefully here in the next few months, some of the wins that come through that allows us to start putting that into backlog to realize the forecast that we just provided.

And maybe I would add that that pipeline includes both eco-type opportunities and product sale-type opportunities. And so Andrew provided some view on the water business. And in that horizon, it would be like a 10%, 15% type win rate. But again, there's projects in there that could be 10-year eco. There's some projects that could be 20-year eco. And then probably 20% to 30% kind of win rate on the rest of it with the horizon we provided. Again, some of these projects go out for quite a number of years.

That makes sense. It seems like the U.S. infrastructure bill might include a sizable portion for upgrading aging water infrastructure in the U.S. Is this something that Extern is going to be targeting?

Yeah, we've started actually pre-Biden, I'd say, started working with state level uncertain customers on various regulations and potential implications of what the technology that we have can provide in terms of some solutions. And so I'd say those discussions are progressing. I wouldn't say they've accelerated. They're certainly progressing. We feel pretty good at the pace and the level of intensity that we're seeing here in North America. Clearly, the larger projects we see for our water business is overseas. And so we're certainly seeing a correlation here with new finds, new production, additional gas output equals some of the water cuts that we talked about in my prepared remarks, which drives a real need for additional volume and quantity of water reuse that we see in parts of the Middle East. But in North America, we're certainly seeing early signs of various legislations, not just on the water side that I see also on the gas side, and I think that can only help and play into the strength of what Exterrin does. We're very comfortably working in that environment, and certainly the technologies and solutions we have, both on the gas side and on the water side, plays into the overall narrative that we're seeing come forward.

Got it. And there was a press release that the Kerr-Moore force majeure had been lifted in Iraq just Any context about the implication for Xtern?

Yeah, so important project, one that we've been working for some time. I'd say internally we've made incredible progress on everything that we can control with regards to all of the designs, the engineering reviews, the supply chain, the logistics aspect of planning. This is a project that will be managed and is being managed out of our Middle East team. with support from our headquarters team here in Houston. The force majeure that we also read was in relation to our customer with the end user, and we've been working hand-in-hand with the three parties over the last couple of months, and really we've built that into our guidance today and built that into the overall outlook that we see. It's an important project. I will say you know, cautiously as I made a remark in my opening comments that we're still not seeing a perfect world as it relates to COVID and as a global company with a global need for both people, parts, logistics, supply chain that comes from various parts of the world. We're continuing to monitor the challenges that we see in countries and the COVID implications of what could happen in various parts and we're reading them We're reading about that, and we're seeing that on the news daily. So whilst the force majeure is being lifted, we feel confident that the project is in a good place, and we've made a ton of progress really in line with what we anticipated at this stage with everything that we can control internally. And I think it comes back to some of the things I talked about in previous calls where we've invested technology and infrastructure and allow us to have seamless engineering and our visibility on the projects globally. So really our engineering teams have been able to remotely manage this project in an incredible way. So we're excited about the project and we hope that there are many more to come.

Thank you.

Our next question comes to the line of Tim Monticello with ABT. You may proceed with your question.

Hey, good morning, guys. I'm checking the question here. Just to do with the outlook for 15% EBITDA growth over the next couple of years, you get to, you know, over 200 million by 2023, which is, you know, definitely encouraging. And thanks for providing that. I'm curious within that outlook, how much growth capital would you need to allocate in 2022 to get there?

Yeah, we've got the one project that we announced in the first quarter has an assumption for capital spending this year and next. And then we made the assumption, I think, as we said, one more eco project than that. So there's not a, you know, we don't give specifics on by project what the capital is going to be, but that's it. So there's no other assumptions beyond that in terms of other eco projects. that will sell funds.

Okay. And it sounded like you were alluding to in your commentary, Dave, that 2022 free cash flow could also be negative. I would assume some sort of improvement from the 2021 levels, but do you have any commentary around where 2022 free cash could fall out based on your guidance for EBITDA?

Yeah, so I think some of the variables, and we didn't go through all the details, but again, this eco project that we won in the first quarter on the water side will have more of its capital spending next year. And then the big change versus this year will actually be an increased use of working capital for the project we just discussed with Doug. So that project, just based on the schedule, And it's still a little bit fluid, as Andrew mentioned. It will actually be a larger use of working capital. Deferred revenue will be at a similar level to this year. Cash taxes, similar level to this year. Interest, again, will depend on debt balance, but you calculate that. So it actually will be an increased use of working capital next year versus this year, and probably a similar type of CapEx number. So it will actually be a... a larger use of cash next year than this year on higher earnings. Okay.

Got it. Okay. That's, that's helpful for sure. And then just in terms of the capital structure review, you said you're not ruling out anything. Do you think the board would be supportive of issuing equity at these prices?

Yeah. Again, I'm not going to, answer for our board, and I would just say that our board is absolutely 100% committed to serving all of our stakeholders. And you think about a comment like a capital structure review, it's not just investors, but they're obviously an important stakeholder group. It's customers as well. When you've got a pipeline like this, our customers look to us and want to know that the project will be executed flawlessly, even behind the scenes. I would say our board is very open and would consider any type of option that makes sense for that stakeholder group. As you said, we're not ruling out anything, and that would be true. All right, I'll turn it back.

Thanks for the commentary and impressive growth outlook.

Our next question should be from the line of Samantha Ho with Evercore ISI. You may proceed with your question.

Hey, thanks, guys. Dave, maybe just to stay on that line of questioning, you know, I had thoughts when you guys brought this up last time that, you know, a lot of the work was going to be sort of project-driven in terms of, you know, different maybe creative ways to finance it. It sounds like you're talking about a more holistic approach now. I'm curious if this is going to be a hindrance in terms of booking this preemptive second EcoWater project or... Do you need to have some sort of structure in place for that to put on the books?

No. We said in the remarks that it assumes one more eco project that we would fund ourselves. So whether that's a water project or a gas-related project, that's already contemplated in the guidance we gave. So not going to be a hindrance to that current ongoing tender process of the water deal. And in terms of project financing, it is certainly potentially an important longer-term solution to resolve or to provide us extra capital. So that's certainly a priority as we look. Okay.

And then maybe just to go back to the outlook, you know, Just in terms of the water piece, I mean, it definitely sounds like you guys are expanding the market opportunity with different customers. Curious if you could sort of rank in terms of, you know, where that opportunity is coming from. I think I heard $150 or what was it, like $30 billion in opportunities from around gas. But I'm just kind of curious what other in-markets you guys are targeting or how the in-markets rank there. within their various opportunities.

Yeah, Samantha, it's very hard to hear. I think there's some background noise on your end, so maybe I will try to answer what I think you asked. We're seeing a number of opportunities arise in various markets, and as I mentioned in my prepared remarks, the technology was originally developed in segments that we're going back to, water municipalities, We're looking at areas that have different applications in markets, in mining. And so as we've been developing the technology for the oil and gas industry, we've also been talking to people and customers in that space. And we're very excited about the productivity benefits that we can bring to that industry that started with the original technology but really have just left it to play out. And so the benefits that we've seen from our customers that's already using the technology, predominantly in the Middle East, but also here in North America, the productivity benefits that we see, we're able to reapply back to those spaces. And so I wanted to give a little bit of a color today because, you know, as I've talked for a number of quarters about the transformation that we're on, you know, we started off back in 16, sold multiple product lines, exited a lot of the low margin commodity business, and really started to focus on water as a product line. And what we see going forward, as I mentioned in my prepared remarks, water is going to be a significant part of the company going forward. And with the initial success we've had, at least with the discussions underway with customers, it's too early today to say what that will look like from an absolute industry segment perspective. But we're very confident that over the course of the next you know, few quarters, we'll get some success putting this technology and the application back into other segments. So, you know, making Xterra even less reliant in the space that we're predominating in today, which is oil and gas. And so, very excited by the work that's taking place by the team. It's multi-region. We have opportunities that we're working in Latin America. We have some applications that we're working currently in Asia. And obviously, the Middle East has been a big market for us and will continue to be in the future as well. And over the course of the last 18 months, as we built our capabilities in the regions, both commercially and technically, we're very confident that those applications will come to fruition and excited about the prospects that we see.

Okay. And just one last one about the Middle East. It looks like revenue had a nice little step up sequentially this quarter. Is everything operating on a more normal basis out there now?

Yeah, I didn't catch the first part of your question.

Just the Middle East revenue had a nice sequential improvement there. I was just wondering if that all the work and activity is sort of operating normally now, like everything's recovered from COVID.

Yeah, no, I think as Andrew said, maybe in response to Doug's question, you know, the COVID challenges still aren't over. The good news is our facility, our manufacturing facility, engineering facility in the UAE, has recovered well and we're performing well, but I would say we continue to face some challenges, frankly, coming from places like India where we have engineering resources and a supply base that ultimately reaches into areas like that. So I would say it feels a little better, but I think the caution that Andrew provided is I think the world is far from past this, and as we've all seen, India has become a real challenge, and we're seeing regionally across the Middle East There are some countries that are still kind of under the radar in terms of U.S. news, but are still dealing with some pretty challenging situations. But I would say we're getting through those. It's not affecting our operations. It hasn't affected the large projects there at this point because it's been predominantly engineering and manufacturing and getting ready things in our control. But far from being something that's over and it's part of our past, we're going to Probably continue to have to work through challenges for some time yet.

Okay, that does it for me. Thank you.

Our next question comes from the line of Brian DeRubio with Baird. You may proceed with your question.

Good morning. Just a couple of cleanup questions. What's the current availability on your revolver?

I don't know if I have that in front of me. It's over 100 million. Yeah, like 110 approximately.

Okay. And we're going to see increased availability as EBITDA recovers, correct?

Right. So, you know, nice thing is with the outlook we gave for second quarter year over year, that's a nice improvement. So that's going to continue. And that was part of our outlook is for growing EBITDA. That's certainly going to help. I mentioned, you know, similar leverage levels next year, this year, which would imply, you know, higher debt level on EBITDA. higher EBITDA, but yeah, we're certainly now at a point where growing EBITDA is going to certainly help in terms of availability.

Okay, that helps. So as I'm looking at it right now, you have approximately, give or take, about $152 million total liquidity. You're going to burn about $60 to $70 million this year. So the challenge really comes in 2022 as you sort of hinted multiple times about your strategic review of the capital structure.

Yeah, and as I said, similar leverage levels next year to this year, so it's not a situation that we consider at all dire or extreme, but I think we have to be prudent as a company looking forward to make sure that we're trying to anticipate growth Any challenges, but also the bigger motivation is the opportunities we see, again, having a pipeline of over $3.5 billion just on things we're currently working. It's really as much being prepared for that, if not more. But again, growing EBIT obviously solves some of those challenges.

Nope, understood. And I guess as you think about this review, are you going to look to address the mismatch that you have in terms of where you're generating EBITDA and all your interest expense here in the U.S. and all your EBITDA outside of the U.S.? Are you going to try to resolve some of that mismatch?

I would say, again, a very encompassing review. Everything's on the table, being thoughtful, working with our bank partners, and thinking through all the options that just will, you know, solidify the foundation of the company. So, you know, again, there is quite a range, as you can imagine, of things that we'll consider and look at and see if it fits into the part of the solution.

Okay. That does it for me. Thank you.

Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Andrew Way for closing remarks.

Thank you, operator, and thanks, everyone, for dialing in today. We look forward to updating you at the end of the quarter, and be safe out there. Thank you.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.