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FTS International, Inc. (NYSE:FTSI)
Q1 2019 Earnings Call
May. 8, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the FTS International First Quarter 2019 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, May 8, 2019.

I would now like to turn the conference over to Michael Messina, Associate of Finance and Investor Relations. Please go ahead, sir.

Michael Messina -- Associate, Finance and Investor Relations

Thank you, and good morning, everyone. We appreciate you joining us for the FTS International conference call and webcast to review first quarter 2019 results. Presenting today are Mike Doss, CEO; Lance Turner, CFO, and Buddy Petersen, COO.

Before we begin, I would like to remind everyone that comments made on today's call that include management's plans, intentions, beliefs, expectations, anticipations or predictions for the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those expressed in any forward-looking statements. These risks and uncertainties are discussed in the Company's Annual Report on Form-10-K and in other reports the Company files with the SEC. Except as required by law, the Company does not undertake any obligation to publicly update or revise any forward-looking statements. The Company's SEC filings may be obtained by contacting the Company and are available on the Company's website, ftsi.com, and on the SEC's website, sec.gov.

This conference call also includes discussions of non-GAAP financial measures. Our earnings release includes further information about these non-GAAP financial measures as well as reconciliations of these non-GAAP measures to their most directly comparable GAAP measures.

I'll now turn the call over to Mike Doss, FTSI's CEO. Mike?

Michael J. Doss -- Chief Executive Officer

Thank you, and good morning. Operationally, we had a solid first quarter in providing our customers with outstanding service quality and efficiency. We completed 337 stages per fleet, the highest level we have achieved in the first quarter of any year, and 8% higher than in the fourth quarter. Our fleets also achieved the highest pumping hours per day they ever have with longer stage times and more sand per stage. Unfortunately, the soft market required us to give price concessions to retain work, which negatively impacted our financial results.

For the quarter, revenue was $222.5 million, down 10% from the fourth quarter. This is primarily due to a 15% reduction in pricing, partially offset by a slightly higher fleet count and higher efficiency. Adjusted EBITDA was $39.4 million or $7.9 million per fleet on an annualized basis, consistent with what we guided on our last call. Adjusted EPS was $0.05.

Looking ahead to the second quarter, we expect that annualized adjusted EBITDA will be $8 million to $9 million per fleet due to higher efficiency, offset by a full quarter impact of lower pricing. Our average fleet count was 20 in the first quarter and we ended the quarter with 21 fleets active. We expect to average 20 to 21 fleets in the second quarter.

The market environment remains challenging. However, we believe pricing has bottomed out as frac companies appear to be exercising greater discipline. We've seen a number of companies idle fleets in the first quarter. E&P companies also appear to be exercising greater capital discipline, contributing to the soft market, which is already oversupplied.

Visibility into activity levels in the second half is limited despite the rebound in oil prices since year-end. Our focus in the second quarter will be to rationalize lower margin fleets, targeting those with annualized EBITDA of less than $5 million, converting them to more profitable work through price adjustments or by high-grading. Opportunities to do that are few in number and very customer-specific.

As another operational update, we will be idling all of our wireline assets in the second quarter due to unfavorable economics. We've concluded that the wireline business is far too fragmented and commoditized to earn acceptable returns over time and have made the strategic decision to focus solely on frac, our core business. During the second quarter, we will evaluate the best options for selling these assets. We recorded $4.2 million in charges to write down those assets and related inventory in the first quarter.

A frequent question we get is about the composition of our customer contracts with the focus on the percentage of dedicated fleets. Currently, 70% of our fleet is working under dedicated arrangements with the other 30% working on a spot basis, but the distinction between those two contract types really doesn't say a lot about our customer strategy.

At the risk of oversimplifying, I'd say that there are three basic strategies in this business. The first strategy targets a long-term stable customer base with gradually improving margins. These include some private E&Ps and the majors. Examples of companies following this strategy are ProPetro and Keane. ProPetro has done an outstanding job.

The second strategy is the pursuit of market share at all costs with a goal of recouping those costs in the future. Some frac companies followed this strategy in recent years, and because the market upturn was short-lived, they were unable to monetize that market share. The third strategy targets transactional customers at market prices, which includes most mid and large cap independent E&P companies. This is the strategy that we have followed.

These customers have high expectations for service quality and they expect to pay no more than market pricing regardless of whether the work is under a dedicated arrangement. Working for these customers gives us the opportunity to earn high margins when the market is tight. The flip side is that when we -- is that we have less contractual protection in a softer market like the one we are in now. This strategy has served us well in recent years, allowing us to generate significant cash flow that we have used to repay a substantial amount of debt. Given the trends we're seeing in onshore capital spending, particularly with the majors, we are devoting a portion of our commercial resources to developing longer term contractual business with select customers.

We believe the balance of supply and demand for frac horsepower will tighten at some point as more equipment falls out of marketable condition through attrition, even if that attrition is not permanent. Thanks to our vertical integration, we are exceptionally well positioned to respond quickly to these windows of opportunity. We have four fleets ready to be deployed on short notice with virtually no investment required. An additional three fleets could be deployed for minimal CapEx of $1 million to $3 million per fleet.

Before I turn it over to Lance, I have two pieces of good news. The first is a substantial reduction in our sand commitments as we disclosed in an 8K filed last week. We restructured a long-term agreement with our largest supplier, reducing our total commitments by over $160 million over the next six years. The reduction became necessary as more of our customers are providing their own sand. In the first quarter, 70% of our customer self-sourced, up from 60% in the fourth quarter and up substantially from a couple -- two or three years ago.

In connection with this contract restructuring, we took a $55 million charge in the first quarter to fully accrue for restructuring fees to be paid in annual installments of $11 million from 2020 to 2024. We'll also pay $11 million in restructuring fees in 2019, $10 million of which was accrued at year-end 2018. Our volume commitment going forward will be 1 million tons per year, equivalent to about four sand fleets, which we believe matches our current and expected needs.

Second piece of good news relates to our SinoFTS joint venture investment in China. We are selling our 45% equity interest back to Sinopec, our joint venture partner, for total consideration of $33 million. We will continue to provide limited support for the joint venture's operations. We concluded that this investment was no longer a strategic fit for us and offered little potential for cash distributions. The transaction is expected to close in the third quarter and we will use the proceeds to repay debt. We expect that we'll be able to reduce our net debt by over $100 million in 2019.

So far this year, we've taken important steps to make the Company more fit-for-purpose than it's ever been, which puts us in a great position to take full advantage of future opportunities.

I'll now turn it over to Lance.

Lance Turner -- Chief Financial Officer

Thank you, Mike. Revenue for the first quarter was $222.5 million, down 10% sequentially. Approximately two-thirds of this decline related to pricing and about one-third related to the higher volume of customer provided sand.

As Mike mentioned, we have 21 fleets active today. Our regional footprint consists of 11 fleets in west Texas, four fleets in south Texas, three fleets in the Northeast, two fleets in Oklahoma, and one fleet in east Texas.

SG&A in the first quarter was $23.6 million, including $3 million in stock-based compensation. The increased SG&A in the first quarter is attributable to incentive compensation and a legacy legal settlement during the quarter. Looking forward, we continue to expect our SG&A will be $21 million to $22 million in the second quarter, including stock-based compensation of approximately $3 million.

Net income adjusted to exclude the supply commitment charge and the impairment of our wireline assets was $5.8 million compared to $26.5 million in the fourth quarter. Adjusted earnings per fully diluted share was $0.05 in the first quarter compared to earnings per share of $0.24 in the fourth quarter.

Capital expenditures in the first quarter was $11.7 million, down from $15.6 million in the fourth quarter. As we look ahead to the rest of 2019, we are lowering our capital expenditures expectations to $55 million to $65 million for the full year. This primarily reflects a lower expected fleet count and will be lowered further if we do not activate additional fleets in 2019. Our maintenance CapEx in 2019 is still estimated to be approximately $2.5 million per active fleet.

Working capital was relatively flat this quarter, but we expect to see a usage in the second quarter due to our biannual interest payment on our notes and the installment payment related to the amended sand supply agreement.

Despite the trend in pricing, we continued to generate positive free cash flow. In the first quarter, we generated $33.9 million in operating cash flow, including $6.1 million of working capital liquidation. We used this cash flow to pay down $27 million of debt in the quarter. This brought our principal amount of debt outstanding to $481 million at March 31st and cash was $172 million. Net debt at the end of the first quarter was $309 million compared to $330 million at the end of last year. Even in this challenging environment, we continue to make considerable progress on our main financial objective, to delever our balance sheet further.

With that, I'll now turn the call over to the operator who will open the line up for questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Connor Lynagh with Morgan Stanley. Please proceed.

Connor Lynagh -- Morgan Stanley -- Analyst

Thanks. Good morning, guys.

Michael J. Doss -- Chief Executive Officer

Good morning.

Connor Lynagh -- Morgan Stanley -- Analyst

Wondering if you could -- you mentioned some of your fleets being relative underperformers. Can you confirm the threshold there? You said it was about $5 million of annualized EBITDA per fleet.

Michael J. Doss -- Chief Executive Officer

That's right. Those that are coming in less than that, we're targeting to see what we can do to improve profitability.

Connor Lynagh -- Morgan Stanley -- Analyst

Okay. And so can you size for us relative to your 21 fleets you have active today, how big that opportunity is?

Michael J. Doss -- Chief Executive Officer

It's plus or minus about three fleets.

Connor Lynagh -- Morgan Stanley -- Analyst

Okay. That's helpful. That's helpful. Broadly speaking, if we exclude those, how are you thinking about efficiency, and just generally, how profitability should trend on the other fleets throughout the year?

Michael J. Doss -- Chief Executive Officer

Well, I think as far as second quarter, we expect it to be pretty stable. And like I mentioned on the call there, it's -- we don't have a lot of visibility into the second half. Obviously if we get an opportunity to tighten up pricing and work on efficiencies, we're absolutely going to do that.

Connor Lynagh -- Morgan Stanley -- Analyst

Understood. So on the pricing front, some of your competitors have suggested the pricing should be stabilizing or increasing later this year. How do you guys see the market evolving? Is there enough capacity attrition to get pricing higher or is it going to require more than that?

Michael J. Doss -- Chief Executive Officer

It's hard to know when that attrition is really going to start having an impact. We don't expect that in the second quarter. And I just think there is just uncertainty as it relates to the second half, but we're definitely going to keep close tabs on it and we'll act accordingly.

Connor Lynagh -- Morgan Stanley -- Analyst

All right. Understood. Thanks for the color.

Operator

Thank you. Our next question comes from the line of George O'Leary with TPH & Company. Please proceed.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Good morning, guys.

Michael J. Doss -- Chief Executive Officer

Good morning.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

From a geographic standpoint or a basin standpoint, where is the lowest hanging fruit in terms of fleet deployments? You said maybe the opportunity to deploy three-ish fleets. It seems like the Marcellus where you guys have historically had a beachhead has heated up as we've started the year. Are there other basins as you look forward where you're seeing opportunities to deploy fleets?

Michael J. Doss -- Chief Executive Officer

Well, just to clarify on the three fleets that I was talking to Connor about, those would be fleets that we would target for improvement in profitability, so perhaps a price adjustment or just replacing that fleet with additional work. And I would say those replacement opportunities are few in number, but probably the strongest market for that is the Permian, and then maybe some additional possibility, very customer-specific, in the Northeast and south Texas, but I wouldn't take that as a read on the overall market situation in those basins, just our opportunity set.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Okay. That's helpful and thanks for the clarification. And then there's been a decent wave of consolidation last year in the E&P space. You now have a marquee transaction where you see a number of large players potentially getting together on the E&P side again. What do you guys think about consolidation in the services space? Where does bid ask sit and is FTSI willing to participate in that in some form or fashion?

Michael J. Doss -- Chief Executive Officer

Well, in terms of consolidation, there's certainly a lot of talk in the financial community and at the companies themselves about it. I think it makes a lot of sense. It seems like we're primed to do consolidation as an industry. There is always social issues that can get in the way of actually making a deal happen, but I would say that we're very interested in doing it. And I think for the right opportunity, we would pursue it. We think we've got a low-cost platform as we are vertically integrated especially on the CapEx side of the business and we think that's something that has a lot of scale-up potential. And so like I said, we're interested, but it's hard to know when a transaction may occur, but it does seem like the industry is primed to do it.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Great. That's helpful color. And then on the wireline side, interesting commentary there. Maybe I should know this, but I don't. Can you remind us how many fleets -- I mean, wireline fleets you run alongside your frac crews versus how much is third-party and then just speak to the quality of the third-party wireline providers? Historically that's been an area that some completion services providers have pointed to as the cause of inefficiencies in the field. So how do you work to align yourself with the right wireline providers going forward?

Michael J. Doss -- Chief Executive Officer

Well, sure. Just general thoughts on that. So we have six trucks working currently, and so it's not a substantial portion that are paired up with our fleets. But in terms of third-party service providers, I mean, that space is incredibly competitive and I think the E&P companies are very much aware of their preferred service providers and can shop the market and get good pricing and can demand good service given the state of the market. And so I think the E&P companies are well positioned to handle that. If we had an opportunity to make recommendations to an E&P company, if that was requested, we certainly can provide some ideas for them.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Thanks very much guys.

Operator

(Operator Instructions) Our next question comes from the line of Stephen Gengaro with Stifel. Please proceed.

Stephen Gengaro -- Stifel -- Analyst

Good morning, gentlemen. If you don't mind, when you think about long-term arrangements and you're looking at different basins, and I know you mentioned the Permian, how do those discussions go? And so can you give any color to -- say, to the progress you've made and maybe relative to peers in getting people to sort of go with your fleets over others? Because I know you're efficient, you're vertically integrated, those are positives, but how are those discussions going?

Michael J. Doss -- Chief Executive Officer

Well, a lot of it is the customer base that we're targeting. And so the mid and large cap independent space is -- they're generally -- most of them are not interested in long-term contractual arrangements. I mean, there is some exceptions, but for the most part, they tend to play it short. So for us, developing and spending commercial resources and developing relationships with other types of customers is going to take time, and so -- but we're definitely dedicated resources to that and what we hope is to convert a couple of these to longer term arrangements.

Stephen Gengaro -- Stifel -- Analyst

Thank you. And then just as a quick follow-up, the CapEx cut, was that just geared toward some potential growth opportunities or was that related to a reduction in sort of maintenance CapEx expectations or fleet size operating?

Lance Turner -- Chief Financial Officer

Stephen, this is Lance. It is mainly a lower fleet count assumption and lower reactivation CapEx based on where our fleet count is today and where we expect it to be in -- during Q2.

Stephen Gengaro -- Stifel -- Analyst

Okay. Thank you. I appreciate the color.

Operator

Thank you. Our next question comes from the line of Chris Voie with Wells Fargo. Please proceed.

Christopher Voie -- Wells Fargo -- Analyst

Good morning, guys. Just a question on the dynamics for EBITDA per fleet in 2Q. I know you mentioned some pricing concessions over the course of the first quarter, which impacted EBITDA per fleet, and then conversely, you have the fleet rationalization efforts. Do you expect average pricing in 2Q to be lower overall or higher given the guide for $8 million to $9 million EBITDA per fleet?

Lance Turner -- Chief Financial Officer

We think it will be flat. We think those things will likely cancel each other out and so there could be some slight improvement, but not significant.

Christopher Voie -- Wells Fargo -- Analyst

Okay. And you also mentioned efficiency as a component to the improvement. What kind of -- I think typical seasonal efficiency gains 2Q are, I don't know, low to mid-single digits in terms of stage count per fleet. Is that about in line with expectations?

Lance Turner -- Chief Financial Officer

Yeah, I would say about 5% is a reasonable expectation. And we had a better first quarter than we expected in that regard. So looking sequentially, a number in that range is what we are thinking.

Christopher Voie -- Wells Fargo -- Analyst

Okay. And then just last couple of detailed ones. I don't think you called out the percentage of zipper frac work or the percentage of sand you're supplying. I was wondering if you have those numbers.

Lance Turner -- Chief Financial Officer

Yeah. The percentage of zipper fracs is about 70%, and then the amount of sand we are providing is kind of in the 25% to 30% range.

Christopher Voie -- Wells Fargo -- Analyst

Thanks a lot.

Operator

Thank you. (Operator Instructions) And we do have a question from the line of John Daniel with Simmons & Company Energy.

John Daniel -- Simmons Energy -- Analyst

Hey, guys. Mike, you guys have done a phenomenal job on the balance sheet. How much more do you want to go? And when would -- where do you think we could see you kind of go on the attack mode versus, call it, defensive mode in terms of growth?

Michael J. Doss -- Chief Executive Officer

Well, partly I would like to get through this soft market before I start thinking about those things. So I think in the -- at least as far as the near-term, just focus on continued debt repayment. I still like to take our net debt down further, closer to $100 million or $200 million, maybe even zero, if we get the opportunity to do that. And so balance sheet repair is still a top priority for us.

John Daniel -- Simmons Energy -- Analyst

Okay. I've got sort of a big macro question for you, but as I'm sure you're seeing there's increased interest on the part of some to add electric fleets, and I'm just curious, do you think we're about to witness an arms race, if you will, and pressure pumping where there is a race to go build new? How broad-based do you think that will be?

Michael J. Doss -- Chief Executive Officer

I still think it's fairly nichey, and so we've seen the announcements, we're following developments. We think it's relatively early innings. And so I think once it gets to a part where a lot of it's been kind of debottlenecked and is more -- is proven to run more efficiently, I think you could see us get interested in that. I think we look for some customers to -- that's probably the one investment opportunity that we could consider, tying into your first question, if we could get a customer to agree to a longer term arrangement to give us some support to make that investment, we're definitely interested in doing that. But as far as steadying the electric fleets, we're talking to three competitors -- three firms that are in the business of generating those units, are building those units and is -- just like I said, we're following it closely and I don't -- like I said, I don't think there is going to be an arms race, but I think you'll see some announcements here and there. And I guess at a macro level standpoint, it's not particularly helpful because it is additional capacity coming into the market.

John Daniel -- Simmons Energy -- Analyst

Okay. And then a last one is just for Lance. Just as we think -- I know you don't want to give a formal Q4 guidance here, but what's your gut tell you to expect for Q4 seasonality, budget fatigue, what's a good placeholder in your mind?

Lance Turner -- Chief Financial Officer

Q4 of '19?

John Daniel -- Simmons Energy -- Analyst

Yeah.

Lance Turner -- Chief Financial Officer

Well, my rule of thumb is we typically see a 10% reduction, call -- 10 -- little bit more than 10% reduction in efficiencies. We probably won't see any pricing impact in Q4. We don't -- typically don't see a lot of deployments in Q4 around the holidays. So I usually build the assumptions around those parameters.

John Daniel -- Simmons Energy -- Analyst

Fair enough. Thank you very much.

Operator

Thank you. Mr. Doss, I'm showing no further questions at this time. I will now turn the call back to you.

Michael J. Doss -- Chief Executive Officer

All right. Well, thank you everyone for your interest in FTS. And we look forward to speaking to you next quarter. Thanks.

Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

Duration: 27 minutes

Call participants:

Michael Messina -- Associate, Finance and Investor Relations

Michael J. Doss -- Chief Executive Officer

Lance Turner -- Chief Financial Officer

Connor Lynagh -- Morgan Stanley -- Analyst

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Stephen Gengaro -- Stifel -- Analyst

Christopher Voie -- Wells Fargo -- Analyst

John Daniel -- Simmons Energy -- Analyst

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