TETRA Technologies (TTI) Q3 2019 Earnings Call Transcript

TETRA Technologies (TTI)
Q3 2019 Earnings Call
Nov 07, 2019, 10:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the TETRA Technologies third-quarter 2019 results conference call. The speakers for today's conference call are Brady M. Murphy, chief executive officer; and Elijio Serrano, chief financial officer; and Jacek Mucha, vice president of finance and treasurer. All participants will be in listen-only mode.

[Operator instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] please note this event is being recorded. I will now turn the conference over to Mr. Mucha.

Please go ahead.

Jacek Mucha -- Vice President of Finance and Treasurer

Thank you, Drew. This conference call may contain certain statements that are or may be deemed to be forward looking statements. These statements are based on certain assumptions and analysis made by TETRA and are based on a number of factors. These statements are subject to a number of risks and uncertainties many of which are beyond the control the company.

You are cautioned that such statements are not guarantees of future performance and that actual results may differ materially for those projected in the forward-looking statements. In addition, in the course of the call, we may refer to net debt, free cash flow, adjusted EBITDA, adjusted profit before tax or adjusted earnings per share, backlog, coverage ratio or other non-GAAP financial measures. Please refer to this morning's news release or go to our public website for reconciliations of non-GAAP financial measures to the nearest GAAP measures. These reconciliations are not a substitute for financial information prepared in accordance with GAAP and should be considered within the context of our complete financial results for the period.

I will now turn this over to Brady.

Brady Murphy -- Chief Executive Officer

Thank you, Jacek. Good morning, everyone. And welcome to the TETRA Technologies third-quarter 2019 earnings conference call. I will summarize some highlights for the quarter then turn it over to Elijio for some additional details which will be followed by your questions.

I would like to start again by thanking the TETRA and CSI Compressco employees for delivering another strong quarter and it's a challenging industry environment. For the second consecutive quarter, our EBITDA margins improve sequentially across all three business segments. And our management employees did a good job executing our strategies, while proactively adjusting our cost structure to rapidly changing conditions. Although the revenue for our businesses was flattish sequentially, we perform well relative to many of the macro market indicators, such as the U.S.

land rig count, which on average declined sequentially more than 7%. Again, we did a good job across both companies navigating this challenging environment. On a consolidated basis we achieved the $46 million adjusted EBITDA quarter this down 8% from the second quarter, but primarily as a result of the seasonal decline in our northern Europe industrial chemicals business that peaks in the second quarter. This is highlighted by the fact that our adjusted EBITDA was up 11% from third quarter a year ago while average U.S.

land rig count was down over 13% year on year. Completion fluid continues to benefit from improved activity and key offshore markets, as we've seen an uptick in our demand for products on top of a favorable product mix plus some pricing improvements. Our adjusted EBITDA margins improved sequentially by 130 basis points to 23.7% and are the highest EBITDA margins for this division since the fourth quarter of 2015. When we exclude any benefit of CS Neptune.

The industrial chemicals business within completion fluids remain strong helps offset some of the volatility in our North America land business. Completion fluids margins are further supported by our vertical integration advantage and long term burning supply agreements. In regards to CS Neptune, as previously announced in the second quarter, we signed a contract to provide TETRA CS Neptune completion fluids for deepwater Gulf of Mexico project that was expected to be material completed toward the end of the third quarter. Unfortunately, this project is delayed and is now expected to be completed during the fourth quarter.

I will remind everyone once again that these projects are ultra-deepwater complex wells that are prone to one for seeing challenges and are not guaranteed until the drilling is filling is completed and final pressures are confirmed. But based on the information we know today is our expectation to complete this project in the fourth quarter. During the third quarter, we also launched at the Society of Petroleum Engineers Europe conference, TETRA CES Neptune completion fluids, monovalent family of products. Monovalent completion fluids expand and increase the range of applications in certain reservoirs and provide lower corrosion rates in certain doubtful environments.

Feedback to-date from our customers has been very encouraging and we believe this new technology will open more opportunities to deploy our highly differentiated portfolio of Tetra Neptune completion fluids. We're very pleased to announce that TETRA was also a finalist for World Oil Magazine's Best Oilfield Fluids and Chemicals Award for TETRA Advanced Displacement Systems or TADS further highlighting our efforts and successful results in operating offering differentiated technology. Water and Flowback held up very well in the third quarter given our U.S. onshore footprint and the pullback in activity throughout the quarter, followed by pricing pressure during the latter part of the quarter.

Our adjusted EBITDA for this division improved sequentially to $11.2 million and slightly lower revenue showing resiliency across most of the U.S. basins. Our EBITDA margins of 15.4% increase 50 basis points. We continue to focus on integrated projects utilizing our automation capabilities by driving efficiencies into our operation and provide our customers with a fully integrated Water Management Solution.

We finished the quarter working on 20 integrated projects with 13 different customers. Four of the projects were with either new customers or a new basins. The penetration into new customers a new basins is encouraging, as more and more customers are realizing the value of these integrated offerings. Furthermore, to support our closed loop water management capability, we released our new BlueLinx Automated Control System, which provides remote control and monitoring for every aspect of our integrated water services.

We also made progress commercializing our Advanced Cyclone System, which is achieving proven sand recovery efficiency greater than 95%, which compares to traditional cyclones which are closer to 50% sand recovery. As mentioned on our press release this morning, we signed a contract with a major E&P operator in the Permian Basin, who was the first to run extensive trials with our automated cyclone system. This is a large order of units that displace our current technology on a take-or-pay contract. We've also been awarded the contract for multiple test separators in Argentina, our first Latin American contract for this type of technology.

TETRA was also a finalist for two World Oil Magazine Best Water Management Technology Awards, one for the TETRA SwiftWater Automated Treatment System, and the other for TETRA's Lowest Cost Per Barrel Water Management Solution. We were the only company that had two technology solutions in the finals for water management. So while we see a weaker fourth quarter for this segment due to declining E&P spend, we will continue to focus on leveraging our differentiation while managing our variable costs to be nimble and proactive with our cost structure, and to quickly react to changes in market conditions. The compression business yet again set records for compression service gross margins at 53.2% and utilization of 90.1% and continues to benefit from a long-term growth cycle of increased gas production and the use of compression for centralized gas lift in key shale oil basins.

This was the second quarter in a row where we achieve record highs in compression service gross margins and utilizations. While we have seen some customers slow down with a request of additional compressions services going into 2020, the overall fundamentals for the compression business have not changed, and the segments remains one of the strongest in the oil and gas industry. Our revenue in the third quarter decrease sequentially to $114 million from $136 million on lower new equipment sales due to the timing of shipments, while our aftermarket services and compression services revenue was up sequentially on top of improved EBITDA margins. Total compression adjusted EBITDA in the quarter was slightly down to $31.3 million from $32.8 million in the second quarter, but was up $6.7 million from this time last year.

While centralized gas lift continues to see the highest demand for our equipment, our increased focus on liquids artificial lift methods for aging on conventional wills, such as our Gas Assisted Plunger Lift or GAPL, combined with our Backside Auto Injection System or BAIS has resulted in a four-fold increase in the number of gas jack sets we have working for this application since the beginning of the year. We're very pleased with the amount of interest in demand these new applications are creating for the gas jack fleet. We've also received a large international order in the third quarter and have net orders of $29 million, increasing our backlog to $63 million, up $3 million from June of 2019. We expect to see one or two more large orders in the fourth quarter or in early 2020 to help fill our 2020 new order book for equipment sales.

While orders are slow in the first half of the year, our new equipment sales pipelines remained strong with over 250 million of identified opportunities. We added 14,300 active horsepower this quarter, utilization for 1,000 higher horsepower equipment focused on gathering in centralized gas lift was 97.4% as of the end of September, up 30 basis points from the end of June 2019. Overall utilization for the entire fleet is at 90.1%, up 100 basis points sequentially and again another record high since the acquisition of Compression Systems Incorporated. With that, I'll turn it over to Elijio to provide some financial comments on cash flow and the balance sheet, and then we'll open it up for some questions.

Elijio Serrano -- Chief Financial Officer

Thank you, Brady. I'll spend a few minutes on free cash flow, capital expenditures, the balance sheet, then CSO Compressco's capital allocation strategy. In the third quarter, TETRA only generated free cash flow from continuing operations of $9.7 million. This compares to $3.1 million generated in the second quarter of 2019 and $35 million consumed in the first quarter of this year.

We have historically consumed cash in the first half of the year and generated free cash flow in the second half of the year. So we are trending along those lines. We expect to generate positive free cash flow from continuing operations in 2019 and exceed the $3 million that we generated last year. For TETRA-only, we expect full year capital expenditures to be approximately $25 million to $30 million in addition to $15 million of equipment that we've agreed to buy and lease to CSI Compressco supporting their high return opportunities.

TETRA-only capital expenditures in third quarter were $8 million in compared to $20 million in the first half of the year. TETRA-only net debt at the end of June was $192 million with cash on hand of $21 million. Our debt structure does not include any material maintenance covenant, which provides us the flexibility to maneuver volatility in the market. As always, I like to again remind everyone that TETRA CSI Compressco's debts are distinct and separate.

There are no cross default, cross collateral, or cross guarantee from the debt between TETRA and CSI Compressco. I will spend a minutes now on CSI Compressco. CSI Compressco, cash flow from operating activities was $27 million, a significant increase from $8.7 million generated in the second quarter of 2019. At the end of September, CSI Compressco's total gross debt outstanding was $657 billion, of which $350 million of secured notes that don't mature until the year 2025, and $286 million are unsecured notes that mature in August of the year 2020.

CSI Compressco's net leverage ratios the end of September was 5.2 times. When annualizing our third-quarter adjusted EBITDA CSI Compressco's net leverage would be approximately 4.8 times, well on their way toward a 4.5 times target that we have set. From high as seven times at the end of Q2 2018, CSI's net leverage ratio has improved to 5.2 times. Yesterday CSI Compressco reconfirmed their prior total year EBITDA guidance represent a year-over-year improvement of between 26% and 31%.

We are encouraged that the comparison business as they navigate a challenging North American market with declining rig activity. So far the weaker market activity in the broader oil and gas North American market has not had any effect on our compression business. And in fact, the business fundamentals have continued to improve in the last quarter amid all this uncertainty. At the midpoint of CSI Compressco's 2019 full-year's adjusted EBITDA guidance and after accounting for cash interest expense, maintenance capital expenditures and cash taxes, CSI Compressco expects to generate approximately $57 million of free cash flow.

This year slightly over $30 million of the free cash flow was directed toward cash redeeming the Series A preferred units, a small amount for distributions and the rest was toward growth capital. CSI Compressco remains capital disciplined. Their growth capital investment in 2018 and 2019 are obtaining 20% returns on capital. CSI Compressco are targeting more than 50% of next year's distributable cash flow toward the reduction of debt, to further strengthen their balance sheet.

They expect 2020 investments and growth capital to be below the amount that we expended in 2019. And further expect to continue to generate 20% returns on capital. It is our goal to improve CSI Compressco's leverage ratio to 4.5 times by the end of 2020. Back to comment from TETRA.

In the last downturn, TETRA remained free cash flow positive each of the downturn years. We have the playbook to manage during difficult times and we'll again execute on the actions necessary to remain free cash flow positive during periods of reduced activity level. Our diverse business model, which includes industrial chemical sales, the international onshore and offshore activity, vertical integration in chemicals and compression, and the proprietary Neptune technologies, all contributed toward generating free cash flow in the last down cycle. And we fully expect that we will continue to generate positive free cash flow in periods of a weaker market.

I encourage you to read our news release on this morning and CSI Compressco's news release from yesterday with all the supporting detail. I'll now turn it back to Brady.

Brady Murphy -- Chief Executive Officer

Thank you, Elijio. And before we open to questions, I just like to summarize and reiterate a couple of key message to leave with you. Again, overall I'm pleased with our results this quarter as demonstrated by our second consecutive quarter of increased EBITDA margins for each of our three business segments and a 250 basis point improvement in overall TETRA EBIT on margins over Q3 of last year. We're confident we'll be able to complete the Gulf of Mexico well, which is scheduled for our CS Neptune completion fluids in the fourth quarter.

While North America land market is experiencing pricing pressures and potential budget exhausted by our customers, we're committed to optimizing our flexible cost structure to adapt any new market conditions. Although North America land businesses we resilient in the third quarter, we don't expect to be immune from the potential budget exhausted in industry macro indicators that point to a weaker fourth quarter for our water and flowback business segment. Our successful strategies to differentiate from our competition is validated by a large TETRA pay contract to work for our latest descending flowback technology, introduction of monovalent CS Neptune and TETRA's first ever nominations for World Oil awards. Our compression division continues to achieve operational and financial record highs.

And we continue to see this business strengthen even amid sign of weakness throughout the industry. Lastly, we remain very focused on cash flow generation and still expect total year TETRA only free cash flow to exceed $3 million that we generated in 2018. We generated free cash flow in the second and third quarter this year and looking forward to ending on a very strong note. With that, let's open it for some questions.

Questions & Answers:

Operator

We will now begin question-and-answer session. [Operator instructions] The first question comes from Praveen Narra of Raymond James. Please go ahead.

Praveen Narra -- Raymond James -- Analyst

Hey, good morning, guys.

Brady Murphy -- Chief Executive Officer

Good morning, Praveen.

Praveen Narra -- Raymond James -- Analyst

I guess, when we think about the CS Neptune well, it sounds like you guys are pretty confident and that getting completed in 4Q, but can we talk about how the 2020 schedule may play out? Do you think we could see any of the kind of Halliburton co-works coming through in that timeframe or how should we think about 2020s profile of that?

Brady Murphy -- Chief Executive Officer

Yeah, thanks, Praveen. As I mentioned, we've had a lot of really good interest in our monovalent completion fluids. Introduction and we are expecting, you know, some business in the particularly the North Sea for our monovalent CS Neptune's in 2020. It's a little early to predict.

You know some of the larger deepwater projects for our generation one Neptune at this point for 2020, but we hope to have a little more clarity as we you know see the budgets for our customers into the new year.

Praveen Narra -- Raymond James -- Analyst

OK. And then I guess just thinking about the fluids markings ex-CS Neptune without having the project in 3Q were still fairly strong. Can you talk about the ability to hold that if we if we don't see the CS Neptune projects or how do we think about 3Q as a kind of normalized margin?

Brady Murphy -- Chief Executive Officer

Yeah, we've communicated before. We think our base completion fluids business was holding up very well. We think consistently, we can achieve 20% or above EBITDA margins for that base business without CS Neptune and based on what we see right now as we look at the market Q4 and beyond for next year, we believe that's still very much intact.

Elijio Serrano -- Chief Financial Officer

And Praveen remember that we are vertically integrated in the bromine market that the long-term agreement to get the elemental bromine. That vertical integration contributes to our door steady margins.

Praveen Narra -- Raymond James -- Analyst

Right. OK. If I could squeeze one more in just think of capex for 2020. Obviously, CSI talk about that yesterday, how do you think about TETRA-only capex for next year?

Elijio Serrano -- Chief Financial Officer

I would suggest that we're early in the process right now. We're gathering feedback from our customers in terms of what their plans are for 2020. Once we complete that information, we'll do our internal budgeting process. I would suggest that it's early in the process for us to volunteer any 2020 capex.

OK. Thank you.

Operator

The next question comes from John Watson of Simmons Energy. Please go ahead.

John Watson -- Simmons Energy -- Analyst

Thank you. Good morning.

Brady Murphy -- Chief Executive Officer

Good morning.

John Watson -- Simmons Energy -- Analyst

Brady, on the Neptune side, can you remind me how long it takes to typically complete one of the projects? And has the project you expect to complete in Q4 already begun?

Brady Murphy -- Chief Executive Officer

We really don't want to get into any more specific details about our customers' well operations for the completion phase of this well. As you can imagine it's a very major project for our customers and we prefer not to give any more details. On the timing after a well is drilled and the well log data is taken for the pressures, then then we're typically mobilized to the rig site for the completion phase of the project, which can run from a few days to a month.

John Watson -- Simmons Energy -- Analyst

OK, thanks for that. Secondly, water and flow back revenues were impressive relative to completions activity in the third quarter. Can you give us some more detail on what you attribute that out-performance to and maybe expectations for it to continue or not continue into 4Q?

Brady Murphy -- Chief Executive Officer

Yeah, I think in the third quarter as I said, I think our team has executed very well in our integrated projects that help us, we believe to streamline costs, providing some automation, reducing some labor cost as part of our operations, introducing some new technology, our margins, our pricing on our sand cyclones, the new technology hold up very well. Having said that, and very pleased with what we did in Q3, clearly we see Q4 activity pulling back and more pricing pressure in the fourth quarter. So, we expect that will be weaker for Q4.

John Watson -- Simmons Energy -- Analyst

OK, understood. Lastly, Water Treating Specs, have you seen those become less intensive of late and are we coming closer to reaching a consensus water spec among ENP customers and if so, that does that benefit TETRA?

Brady Murphy -- Chief Executive Officer

I wouldn't say we've seen a major change with the customers that we are working with, with our water specs for you talking about produced water for reuse and frac operations, John.

John Watson -- Simmons Energy -- Analyst

That's right. Yes.

Brady Murphy -- Chief Executive Officer

Yeah, I wouldn't say with the customers that we are operating with. We have seen any, any real major change. Now, I'll leave it at that.

John Watson -- Simmons Energy -- Analyst

All right. Thank you, Brady? I'll turn it back.

Brady Murphy -- Chief Executive Officer

Thank you.

Operator

The next question comes from Brian [inaudible] of the B. Riley FBR. Please go ahead.

Unknown speaker

Hey, good morning, guys.

Brady Murphy -- Chief Executive Officer

Good morning.

Unknown speaker

Sticking with water for temporary transfer. How did pricing evolve over the third quarter and what's your outlook for 2020?

Brady Murphy -- Chief Executive Officer

So, I think during the first two months of the quarter, pricing held up fairly well. We definitely saw some more pricing pressure along with some of the customer pullback in the last month of the quarter in September, which, in that pullback we also saw from more pricing pressure. I think it's a little early to predict what's going to happen in 2020. as it relates to pricing.

Obviously, we'll be paying close attention to our customer's budgets, as they're announced for 2020 and how we position ourselves. Along those budgets, we do like the customer base that we have. We do like the differentiation that we have with TETRA Steel, with our automation and with our sand flow back. So, we do believe we can achieve premium pricing and what's in the market.

But to give an overall, I guess, number at this point, our expectation at this point, I think it's a bit early for 2020 for us.

Unknown speaker

That's fair. Thank you. And then could you perhaps share rough range of how much the industry's supply of lie flat hose were likely grown in 2019? And maybe could continue to expand here?

Brady Murphy -- Chief Executive Officer

I'm not sure I could answer that with a fair degree of accuracy. Elijio any comment on that?

Elijio Serrano -- Chief Financial Officer

I would suggest that we've been disciplined and we focus on our high end proprietary hose that's double jacketed that -- we believe represents a competitive advantage. However for the traditional single jacket hose, I can comment or we can comment on what the others are doing. We're focused on technologies that represent a differentiator.

Unknown speaker

Got you. Thank you for that. And then just one more on Water and Flowback, could you share a percentage of revenue that -- or percentage of project that entails BlueLinx so far and maybe a target that you guys have a year from now or so?

Brady Murphy -- Chief Executive Officer

So we're targeting as two different assets to that. For all of our jobs we are targeting to have pump automation. 100% is our objective. We're not there yet.

But BlueLinx is part of that solution. Anytime we have a piece of automated kit on a particular job, for the fully automated jobs where we have integrated offerings, BlueLinx is a critical part of managing that whole close loop network. And I think we mentioned, we had 20 jobs this quarter. So, between all of our transfer jobs with automation and our integrated projects is where BlueLinx plays a key role for us.

Unknown speaker

Got you. If I could just sneak one in on compression, I know in the compressor call, you guys said you plan to direct 50% or so future distributable cash flow toward growth capital but could you possibly share, how much horsepower you currently have on order for delivery in 2020?

Elijio Serrano -- Chief Financial Officer

The amount of horsepower scheduled for delivery equates to in dollar wise less than $3 billion at this point. We're being very selective in terms of what opportunities we respond to and only responding to those that are either with existing, concentrated customers and are generating 20% returns on capital. So at this point, only $3 million of next year's capital that will be funded with cash flow from operations, is committed.

Unknown speaker

Great. I appreciate the answers. I'll turn it back. Thanks, guys.

Brady Murphy -- Chief Executive Officer

Thank you.

Operator

The next question comes from Steven Gengaro of Stifel. Please go ahead.

Steven Gengaro -- Stifel Financial Corp. -- Analyst

Thanks. Good morning, gentlemen. I doubt that I touched late, so I apologize if you answered this. Anymore traction from the Halliburton Alliance and what are you seeing as far as expectations on the CS Neptune side, as you look into 2020?

Brady Murphy -- Chief Executive Officer

Yeah. We talked a little bit that earlier. But I'm happy to answer your question. I know the Halliburton traction.

We'd be very positive. I think last quarter we announced that we were engaged with six super major operators on some of their key deepwater projects. Three of those six we were brought in by our Halliburton relationship. We introduced our monovalent technology at SP and Europe this quarter.

And again, Halliburt has a very strong presence in some of these markets even some integrated drilling type projects. Whether they are lead and they have introduced monovalent technologies into those clients. And we feel very good about that pipeline and business revenue for 2020. So overall, very positive gain traction, some of them longer term than others, but still very positive from our perspective.

Steven Gengaro -- Stifel Financial Corp. -- Analyst

Thank you. Give a gas based on what you're seeing the deepwater market, one of the things that I think ultimately will be helpful for the just for the consistency writings, but some other factors and returns et cetera is sort of a more normal pattern of these projects where becomes maybe a little less, episodic and a little more consistent. I mean, some of that's based on just to be for the market in general. But any sense for kind of how that plays out over the next couple of years?

Brady Murphy -- Chief Executive Officer

Yeah, I think the deepwater market is still fairly suppressed from obviously the peak days that we saw perhaps in 2013 and 2014 levels. So I think there are still a lot of upside on the deepwater. I think the overall offshore market and again monovalent solution is not specifically tied to deepwater. I would say it's more tied to offshore, North Sea type markets or even Middle East markets.

And we're seeing that activity fairly robust not back to peak levels by any means. But certainly better than the troughs that we saw in the last few years.

Steven Gengaro -- Stifel Financial Corp. -- Analyst

OK, thank you.

Operator

[Operator instructions] This concludes our question and answer session. I would like to turn the conference back over to, Mr. Murphy for any closing remarks.

Brady Murphy -- Chief Executive Officer

Well, thank you. We appreciate your interest in TETRA Technologies. And thanks for taking the time to the joining us on our call this morning. This concludes our call.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Jacek Mucha -- Vice President of Finance and Treasurer

Brady Murphy -- Chief Executive Officer

Elijio Serrano -- Chief Financial Officer

Praveen Narra -- Raymond James -- Analyst

John Watson -- Simmons Energy -- Analyst

Unknown speaker

Steven Gengaro -- Stifel Financial Corp. -- Analyst

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