TETRA Technologies (TTI) Q4 2019 Earnings Call Transcript

TETRA Technologies (TTI 2.01%)
Q4 2019 Earnings Call
Feb 27, 2020, 10:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Jacek Mucha

Thank you, Brandon. Today's 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 of the company.

You are cautioned that such statements are not guarantees of future performance and that actual results may differ materially from 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 EBITDA margin, adjusted profit before tax or adjusted earnings per share, backlog liquidity, coverage ratio or other non-GAAP financial measures. Please refer to this morning's news release or to our public website for reconciliation 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, and good morning, everyone. Welcome to the TETRA Technologies fourth-quarter and full-year 2019 results conference call. I will summarize some highlights for the quarter and the full year and then turn it over to Elijio for some additional financial and operational details, which in turn, will open it up for questions. First, I'd like to start by thanking all the TETRA and CSI Compressco employees for delivering a very strong quarter while navigating a challenging energy services market, particularly in the businesses that are heavily leveraged to U.S.

land exposure. In the U.S., the fourth quarter of 2019 saw the land rig count declined approximately 25% year on year, and many of our customers implemented a disciplined approach to capital spending with a focus on cash flows. Although our water and flowback revenues declined 20% from Q3 and in line with market activity, we managed to have our best quarterly financial performance in over four years in terms of adjusted EBITDA. These strong financial results were driven by our CS Neptune project in the Gulf of Mexico, a near-record adjusted EBITDA from CSI Compressco and the diversity of our business portfolio with exposure to offshore, international and a strong industrial chemicals market.

I'm especially pleased that our strategies to leverage our vertically integrated business model and to differentiate either through technology, as in the case of CS Neptune, or our latest sand separation solution or through our service delivery strategy of automation and integrated water management were very evident in our strong fourth-quarter results. We achieved a consolidated $55 million adjusted EBITDA quarter on $259 million of revenue. The adjusted EBITDA was 18% higher than in the third quarter and the highest result since the third quarter of 2015. Completion fluids continue to benefit from improved activity in key offshore markets, and in the fourth quarter benefited from our CS Neptune project in the Gulf of Mexico.

Completion fluid products adjusted EBITDA margins for the quarter were 35.2%. And is the third quarter in a row for this segment to generate non-Neptune adjusted EBITDA margins over 20%. The Industrial chemicals business within completion fluids and products remain strong and helps offset some of the volatility in the North America land business. We continue to grow our international offshore business with the award of three major projects in Asia Pacific, West Africa and Brazil that are scheduled for completion in 2020.

These markets are good growth opportunities for us. We're also seeing the benefits of our completion fluids products in North America from our long-term raw material supply agreements, which we announced in December of last year that is helping us to reduce cost at several of our chemical production plants. Although the number of customer deepwater well completions with reservoir pressures that fall into the CS Neptune density range reached a 20-year low in 2019, we are seeing a growing pipeline of customer deepwater projects where we believe CS Neptune is the best solution. We're currently in various stages of testing and qualifying CS Neptune for seven different customer projects in multiple markets.

We have a high degree of confidence that we will be awarded Neptune work in the Gulf of Mexico and then Eastern Hemisphere in 2020. However, the timing of awards and well completions for specific wells is not yet determined. Our water and flowback business is heavily levered into the U.S. onshore completions market, likely the most difficult market across the energy services sector in today's environment.

We've seen some pricing pressure that began at the end of the third quarter and continued into the fourth quarter, as well as the reduction in overall completion activity. Our adjusted EBITDA for this division was $5.6 million, a decline of $5.6 million from the third quarter on $15.5 million of less revenue. Adjusted EBITDA margins were 9.8%. We continue to focus on integrated projects using our automation capabilities by driving efficiencies into our operations and to provide our customers with a fully integrated water management solution.

During the quarter, we peaked at 28 integrated projects with 20 different customers, up from 20 projects and 13 customers in the third quarter. Our BlueLinx automation control was deployed on 20 of these projects as we demonstrate to the customer base the advantages of this capability. We previously announced the introduction of our latest sand separation technology, which we have branded as SandStorm. During a major operator trial in the fourth quarter, SandStorm achieved greater than 95% sand removal efficiency compared to the more traditional sand cyclones of around 50%.

Upon completion of the trials, we were immediately awarded a large service project in the Permian Basin, which we are now deploying in the current quarter. Since that award, we are currently negotiating an additional volume with that same customer and have penetrated three other shale plays in North America with the SandStorm solution. We also deployed more test separator units in Argentina on our first Latin America contract for this type of equipment. While we expect the E&P operator budgets to be challenged through 2020, with an expected 10% to 15% drop year over year, we continue to invest in technology and automation that will help us achieve our longer-term objectives.

We have also launched several key initiatives to rightsize this business by scaling back nonprofitable operations and adjusting our cost structure to nimbly respond to the changing market outlook for this business. The compression business yet again performed extremely well, benefiting from continued trend of improved utilization for centralized gas lift as a cost-effective and efficient means to drive liquids production, which drives demand for our high horsepower equipment. While customer drilling activity in new well capital expenditures are expected to decrease in 2020, we see applications continue to grow with our key customers in our core basins. Our adjusted EBITDA of $32.6 million was a sequential improvement of $1.3 million from the third quarter and only $200,000 less than our record high of $32.8 million accomplished in the second quarter of 2019.

Our compression services gross margin slightly declined to 51.6% from a record high of 53.2% last quarter due to increased labor in parts from weather-related outages. Utilization of our compression services fleet was 90%, second quarter in a row in the 90% plus range. The overall fundamentals for the compression business have not changed, and this segment remains one of the strongest in the oil and gas industry. However, we expect a slower pace of growth from the past two years, which is reflected in our guidance we gave yesterday on the CSI Compressco earnings call.

We expect the first quarter of 2020 for our compression business to be much softer than the fourth quarter of 2019 primarily due to decreased equipment sales and aftermarket activity, which typically has a slow start to the year. Our revenue for the fourth quarter increased sequentially to $124 million from $114 million as each product line within the compression segment improved its top line. In particular, we had a very strong finish in our aftermarket business as the demand from our core customers remain strong. Given the timing of shipments and consistent with our expectations mentioned on our last earnings call, we ended the quarter with new equipment sales of $34.3 million, which were higher sequentially by $5.9 million.

However, fourth-quarter awards for new equipment sales were only $4 million, leaving our backlog as of December 31, 2019, at $36 million. We continue to see a healthy pipeline of new unit sales opportunities, but we have seen several large projects that were expected to be awarded in the fourth quarter of 2019, pushed out with delayed awards. We still expect to receive those large orders but not likely until the second half of 2020. We added over 26,200 active horsepower this quarter and ended the quarter with a total active horsepower of 1,059,590.

Utilization for the 1,000 and higher horsepower equipment was 97.9% as of the end of December, up 50 basis points from the end of September 2019. So in summary, we had a very strong quarter in a challenging environment, and we believe in the strong fundamentals behind each of our businesses. We will continue to stay the course on the strategies that we have highlighted and our employees continue to rise to the challenge, including a strong commitment to excellence and year-over-year improvement in our safety performance. 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 questions.

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Thank you, Brady. In the fourth quarter, TETRA-only generated free cash flow from continuing operations of $1 million. Our free cash flow from continuing operations was below our expectations and some key receivables, including full payment from the large CS Neptune project was received in early January. This receipt in January will positively impact first-quarter 2020 cash flow.

Over the last two years, due to the timing of payments, the first quarter has been a significant use of cash. Last year, we consumed $35 million of cash in the first quarter. This year, we expect first quarter of TETRA-only free cash flow to be more than $25 million better than a year ago, reflecting the timing of collections in early January. For the full year, TETRA-only free cash flow from continuing operations with the use of cash of $21 million, significantly below our expectations due to the timing of the aforementioned key collections that slipped into January.

And as a reminder, in 2019, TETRA funded almost $15 million, one-five, of equipment purchases on behalf of CSI Compressco to meet key client demand. For TETRA-only, total year 2019 capital expenditures were $47 million, inclusive of the $15 million of equipment we agreed to buy and lease to CSI Compressco. For 2020, we expect TETRA-only capital expenditures to be between $20 million and $30 million, almost a 50% reduction from 2019. TETRA-only net debt at the end of June was $189 million, with cash on hand of $15 million.

Our debt structure does not include any significant maintenance covenants, which allows us the flexibility to maneuver through the volatility in the market. I'd also like to again remind everyone that TETRA and CSI Compressco's debt are distinct and separate. There are no cross defaults nor cross collaterals on the debt between TETRA and CSI Compressco. CSI Compressco's net leverage ratio at the end of December was 5.1 times.

When annualizing our fourth-quarter adjusted EBITDA of CSI Compressco's net leverage ratio would have been approximately 4.6 times, well on our way toward 4.5 times target that we've been communicating. From a higher seven times at the end of the second quarter of 2018, CSI Compressco's net leverage has improved significantly given our capital disciplined policy of not allowing for additional debt to fund growth capital requirements and reflecting the 20% return on capital we are attaining with our investments. We will continue to improve our leverage ratio as we navigate through 2020. Yesterday morning, CSI Compressco released its 2020 revenue, adjusted EBITDA, capital expenditures and other key financial metrics or guidance.

2020 revenue is estimated to be between $430 million and $460 million, with adjusted EBITDA to be between $125 million and $140 million, which includes the noncash cost of compressors sold. The Compression business has been one of the least affected businesses in the broader U.S. land, oil and gas market, which has experienced volatility in the recent quarters. While we have seen some slowdown, it's been minimal, and we are very encouraged for this business heading into 2020.

At the midpoint of CSI Compressco's full-year 2020 adjusted EBITDA guidance and after accounting for cash interest expense, maintenance capital expenditures and cash taxes, CSI Compressco expects to generate approximately $56 million of free cash flow. We expect to use between $20 million and $25 million of that distributable cash flow to fund growth capital for our core customers at strong rates with 20% return on invested capital targets, and we expect to use the remaining to reduce outstanding debt. When comparing 2019 to 2020 for CSI Compressco and when taking the midpoint of guidance into account, we will be reducing growth capital expenditures from $47.8 million to $22.5 million. We'll be reducing the amount of horsepower we're adding to the fleet from 98,500 in 2019 to slightly under 30,000 horsepower in 2020.

The $48 million of growth capital we added in 2019 excludes $15 million that was funded by TETRA. Out of the 29,900 horsepower that we expect to add in 2020, only 10,600 is currently on order. We are being very diligent and committed to capital investments and will maintain our 20% return thresholds in our only ordering equipment on the back of customer commitments. I encourage you to read our news release from this morning and CSI Compressco's release from yesterday for all the supporting details and additional financial and operational metrics.

With that, I'll return it to Brady.

Brady Murphy -- Chief Executive Officer

OK. We'll open it up to questions.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Our first question comes from Stephen Gengaro with Stifel. Please go ahead.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thanks and good morning gentlemen. I guess two things. I would sort of just start with, can you comment at all on the first-quarter EBITDA consensus of around $41 million and maybe the puts and takes that we should be looking at in 1Q versus 4Q?

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Let me give you a few data points as you build out your model, Stephen. The fourth quarter had a really strong impact from the Neptune project. Brady also mentioned that we ended the year with some solid international offshore Completion Fluids projects. We don't expect that those will carry over to that extent in Q1, but Brady also mentioned that we picked up some projects that will benefit the total year.

So sequentially, expect that the Fluids business will be down, reflecting Neptune. We think that the onshore market ended the year slightly better than what we were expecting. The ramp down was not as bad as we had anticipated, and therefore, the ramp-up is not having to be as aggressive, so expect those to be flat to up modestly. And then on the compression side, we had some big equipment sales that occurred at the end of the year.

We had some very large aftermarket services projects that also will not repeat. The fleet performance will continue to steadily increase, given that we are deploying more equipment into that sector and getting good pricing, but we will see a sequential decline Q4 to Q1 due to the new equipment sale of the aftermarket services. The one positive that I'll highlight that I think we're going to be very pleased with is first-quarter free cash flow. I mentioned that last year, we consumed over $30 million of free cash flow.

The year before that, it was somewhere in the same range. We expect that to be significantly better this year, given a lot of the receivables have slipped into the first week in January. So I hope that gives you a little bit of color as you try to lay out your progression of the businesses.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Yes. And we can look back historically, we can get -- you can obviously clearly see the quarters where you have CS Neptune jobs. Are there any plan right now for 2020?

Brady Murphy -- Chief Executive Officer

So Stephen, we've mentioned that we're in discussions qualification and testing for seven different projects. These are longer-term projects. We have a high degree of confidence that we will be awarded some work in 2020, but we really don't have a definitive time for the specific wells and dates that we could speak to at this point.

Elijio Serrano -- Chief Financial Officer and Senior Vice President

And I will mention, Stephen, that even without Neptune, we've been hitting some very solid 20% plus EBITDA margins on the fluid side, the vertical integration, our long-term supply agreement, the ramp-up of activity internationally. That core business is holding up incredibly well in this market.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

OK. Great. And you mentioned a number as well, so I'll ask around it. But that 20%-plus level is a reasonable gauge if we exclude Neptune, and we exclude the second-quarter European chemicals business.

Is that fair?

Brady Murphy -- Chief Executive Officer

Yes. Yes, that's fair, Stephen, correct.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

OK, great. Great. Thank you, gentlemen.

Brady Murphy -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Praveen Narra with Raymond James. Please go ahead.

Praveen Narra -- Raymond James -- Analyst

Good morning, guys. I guess I wanted to follow up on the pipeline for the CS Neptune projects. Can you kind of talk us through on the seven, how we should think about the timeline? Are they mostly 2020 -- when you say long term, are they mostly 2021 and out? And then also, are these projects that are being worked on through the Halliburton alliance, or are these separate from that?

Brady Murphy -- Chief Executive Officer

Yeah. OK, Praveen. So of the seven, currently, three of them would be through our -- Halliburton has the contract, and it would be through their integrated-project activity that they have. The other four, currently, we are in direct contact with the operators for the testing that is ongoing.

It doesn't mean when the potential award comes that it wouldn't be through Halliburton or perhaps one of the other service providers, but we are engaged directly with the operator to qualify CS Neptune on the other four. Of those seven, you can think of it as half Gulf of Mexico and the other half of the Eastern hemisphere in terms of the split.

Praveen Narra -- Raymond James -- Analyst

OK, great. And then when I think about -- you guys mentioned the softness in water and flowback services for at least the first half. How are you guys thinking about managing costs according to that? Are you guys collecting down? Are you guys holding for potential second-half improvement?

Brady Murphy -- Chief Executive Officer

Yes. So if you look at the progression of our water business through 2019, we were still clipping along very well through the third quarter. Obviously, by the end of the third quarter, we started to see the activity decline. We started taking cost measures at the beginning of the fourth quarter, but we're a little bit through October before we were able to get a lot of the cost out.

So our actual November, December results, we were fairly encouraged with, but we did have some cost in October that impacted our overall quarter. Now as we head into 2020, we're seeing a little -- mainly flattish activity at this point from Q4 activity levels. But we do expect the second half of the year to improve at least under today's environment, which is difficult to predict. But we do expect the second half to improve from where we are today.

Praveen Narra -- Raymond James -- Analyst

Thanks, guys.

Operator

Our next question comes from Ryan Pfingst with B. Riley FBR. Please go ahead.

Ryan Pfingst -- B. Riley FBR -- Analyst

Hey, good morning, guys.

Brady Murphy -- Chief Executive Officer

Good morning.

Ryan Pfingst -- B. Riley FBR -- Analyst

Just a follow-up on water and flowback. I know you're expecting a challenging first half. But I just wanted to ask where you think you can get your margins back up to by midyear and maybe it picks up a little bit.

Elijio Serrano -- Chief Financial Officer and Senior Vice President

So Ryan, the challenge that we have is trying to predict customers' spending levels. If it remains depressed, you've got competition out there trying to keep their crews active and putting pressure on the market. That's why we're trying to differentiate ourselves, and Brady mentioned several of our technology initiatives. Whether it's our automation on the pump side, whether it's our integrated business model or the SandStorm that we're introducing, those will try to differentiate ourselves and try to protect us a bit from competition with very generic product offering.

We are trying to hold our EBITDA margins in the low double digits. But I think in the first half of the year, we're going to be high single digits, right, 8%, 9%, 10%. But in the back half of the year, once our technology gains traction, we think we can push it up to the mid-teens again.

Ryan Pfingst -- B. Riley FBR -- Analyst

That's helpful. And then on SandStorm, I know it's a new technology that you've just introduced. But will that business have similar margins to the base water business or maybe a little bit better?

Brady Murphy -- Chief Executive Officer

Our margins on that particular technology will certainly be additive to our current base business. We're getting reasonably very good pricing on our SandStorm technology. And as we deploy more and more of those kits to replace either our existing sand cyclones or our competitors in the case where we gain share, that should be beneficial to our margins.

Ryan Pfingst -- B. Riley FBR -- Analyst

Thanks, guys. I'll turn it back.

Operator

[Operator instructions] Our next question is a follow-up from Stephen Gengaro with Stifel. Please go ahead.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Thanks. I guess two more quick ones, gentlemen. The first, the cost savings initiatives you've talked about recently, how are they progressing?

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Repeat the question, Stephen. The cost what?

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

I'm sorry, the cost savings initiatives, I think you talked about $8 million to $10 million in cost savings that you're expecting.

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Right. So we issued a press release at the end of last year, outlining several initiatives, including a writedown of our El Dorado facility. But we have continued to very aggressively pull cost out of the system. We're focused on those areas that create some pressure out there, such as the Northeast and the MidCon market, but our field organization automatically adjust week to week based on activity levels.

Then at the corporate level, between Brady, I, and our Executive VPs, we didn't start taking structural changes. And part of the $8 million to $10 million that we referenced last year were those kind of structural changes to pull out. I would suggest that we're more than halfway toward implementing all those cost initiatives.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

And then just -- I know this question comes up a lot, but I'll ask it anyway. When you think about the corporate structure and the product lines and some of the -- basically, just the way the TETRA's now organized, are there product lines that you'd like to add, you'd like to get rid of and clean up the structure? Where do you stand on that whole thought process as it pertains to sort of shareholder value and debt levels, etc.?

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Well, I'll start off, and then I'll let Brady add incremental color to it. I think we and the board have demonstrated that whatever actions we need to take to create shareholder value, to create an entity that can generate consistent free cash flow and get better, more predictable margins, we're willing to take it. We did that with the disposal of our offshore decommissioning business. We did this with the investment and the acquisition of the SwiftWater and the GRGO businesses that we did to strengthen our water and flowback testing business.

And at this point, we will continue to evaluate all our segments. If we believe that there's an opportunity to enhance shareholder value, simplify the structure, we will not be shy about launching those initiatives.

Brady Murphy -- Chief Executive Officer

Yes. I don't have much to add to that. I will say we do like the business segments that we're in, our water business in North America, we believe, is fundamentally sound long term, particularly as we introduce new technologies and focus on the produced water side of the business, and that ties in very well from a technology standpoint to our capabilities on the completion fluid side. And of course, the compression business still very strong for us right now.

But as Elijio said, we will continue to discuss with the board, what are the appropriate strategies for us to either divest or acquire as we look forward.

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Very good. Thank you.

Operator

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

Thank you. So I'd like to just reiterate a couple of key messages to leave you with for our fourth quarter and total year. First, we talked about the Gulf of Mexico Neptune completion project that aided our already strong results, generating EBITDA margins of over 35% for our completion fluids product segment. Even without Neptune, that segment reduced EBITDA margins above 20% for the third straight quarter, and we expect that to continue.

Second, we continue to see the U.S. land market as a challenging market, facing some pricing pressures and lower operating budgets in 2020. But we're committed to investments in technology to differentiate our businesses and right-size our cost structure. We've seen our U.S.

land leverage business declined some in the fourth quarter and expect a challenging start to the year, but we do feel good about the long-term capabilities of this business and our resilience. And third, our compression division continues to achieve operational and financial record highs and hitting the key financial metrics we've laid out for them. Despite the weaknesses of the broader oil and gas industry, this business continues to stay strong. While some slowdown in equipment sales are likely, we still project our adjusted EBITDA to increase year over year in 2020, assuming the midpoint of our guidance, as we've laid out.

Lastly, while we were somewhat disappointed at the year-end and are generating negative key cash flow, it is only due to timing of some key receivables. And we remain very focused on cash flow generation going into 2020 and expect to generate considerable cash flow in the full year. Thank you very much for participating on our call. I will end our call today.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Jacek Mucha

Brady Murphy -- Chief Executive Officer

Elijio Serrano -- Chief Financial Officer and Senior Vice President

Stephen Gengaro -- Stifel Financial Corp. -- Analyst

Praveen Narra -- Raymond James -- Analyst

Ryan Pfingst -- B. Riley FBR -- Analyst

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