Tetra Technologies Inc (TTI) 2016 Q2 法說會逐字稿

Good morning, and welcome to the TETRA Technologies second-quarter 2016 results conference call.

(Operator instructions)

Please note this event is being recorded. I would now like to turn the conference over to Stuart Brightman, President and CEO. Please go ahead.

Thank you, Bianca. Welcome to the TETRA Technologies second-quarter 2016 earnings conference call. Elijio Serrano, our Chief Financial Officer, is also in attendance this morning and will be available to address any of your questions, as well as Joseph Elkhoury, our Chief Operating Officer. I'll provide a brief overview of our second quarter results, then turn it over to Elijio for some additional details, which in turn will be followed by your questions.

I must first remind you that 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 analyses 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 profit before tax or adjusted earnings per share or other non-GAAP financial measures. Please refer to this morning's press release or 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.

In my remarks I would like to cover an overview of the second quarter and our perspective on the second half of the year. Overall, our results for the second quarter were consistent with our internal expectations. Sequentially we improved our EBITDA and remain on track to achieve our free cash flow targets for the year.

Some of the key highlights of the quarter that contributed to these results were continued reduction in demand in North America. During the quarter the rig count declined substantially and competitive pressures continued. We continue our process of adjusting our head count in taking the necessary cost actions to mitigate these market challenges.

Several of our Gulf of Mexico projects are on track to be executed during the second half of the year: receipt of several contract awards and offshore services and fluids that position us for improved results for the second half of the year; successful completion of a public equity offering for TETRA, raising $60 million in net proceeds to repay outstanding debt; amendment of our credit facility and debt agreement covenants providing enhanced financial flexibility; amendment of a CCLP debt agreement that increases the maximum leverage ratio.

Results for our fluids division in the second quarter were adjusted pretax income of $1 million, a portion of which was due to the normal positive seasonal impact of our European chemicals operations, which more than offset the continued decline and demand in North America. As noted on our last call in May, we have been awarded the largest produced water recycling project in the US. And we deployed our first pad at the end of the second quarter. We expect this project to continue through 2017.

As we look forward toward an expected continuation of slow demand in North America, we believe the technology we've introduced in our water management business will enable us to increase activity, particularly with those customers that will be most active. As we enter the second half of the year, we have good visibility on several Gulf of Mexico projects and believe the second half of the year will be a significant improvement in this business. Based on the combination of the backlog, signs of increased demand in North America and the awards of several projects, we expect the second half to produce better results for our fluids division.

Our production testing division had an adjusted pretax loss of $4.2 million in the second quarter. This sequential decline in earnings was driven primarily by a continued reduction of activity in North America and certain international markets. Similar to fluids, we expect this activity to increase in the second half of the year with a slight improvement in an earnings during that time period. Our continued focus will be to work with those clients in North America that are the busiest in whatever possible bundle our water management products with our flow back testing.

Our compression division reported second quarter adjusted EBITDA of $24.7 million, an improvement over adjusted EBITDA of $23.6 million in the prior quarter, primarily due to the continued benefit of aggressive cost reduction actions. Utilization of our compression assets in the second quarter decreased to 76% from 77% in the prior quarter. Consistent with prior quarters, our larger horsepower units continued to have much higher utilization. We've seen indications recently that we may have hit the bottom of the decline in lower horsepower utilization and we have several opportunities during the third quarter.

Overall, the cost actions we've taken at both the operational and SG&A levels have allowed us to maintain the divisions margins, significantly reduce SG&A and continue to generate EBITDA margins approximately 30% and maintain a coverage ratio of 1.19 in the second quarter. Our focus will be on the most active areas of western south Texas.

In addition, we continue to move forward with our ERP integration project and believe this will be implemented phase 1 at the beginning of 2017, yielding significant savings during 2017. With this integration, we are continuing the overall strategy of centralizing back office functions and realizing the full benefits of the CSI acquisition.

During the second quarter we finalized amendments to the CSI Compressco bank agreements. These amendments give us more favorable covenants as we go through the current cycle.

Our offshore services segment reported adjusted pretax income slightly above break even for the second quarter. This is a significant sequential improvement from the first quarter, as expected, as we moved in to the seasonably favorable second and third quarters, which have historically been the busiest portions of the year for this segment. Our backlog through the end of the second quarter has increased and we have a very good backlog visibility of our major assets through the third quarter and into the fourth quarter.

We've also leased a third party diving vessel to support this backlog. This starts during the third quarter. This lease will be maxed to demand and treated as a short-term lease with the ability to exit as the work is completed.

The second quarter continues the evidence of our ability to reduce cost for this segment and reduce breakeven in a very competitive market. We still believe that over the intermediate term the regulatory climate, as well as the deferred spending by our customers, will ultimately translate to increased demand for the segment.

Also during the quarter, TETRA raised approximately $60 million of net proceeds associated with the public equity offering. This was further demonstration of our conservative approach to managing our balance sheet. In addition, we finalized amendments to our credit agreement and debt agreements to enable enhanced financial flexibility. These two capital structured actions also position us very strongly for the eventual recovery.

In summary, the quarter was consistent with our expectations. We saw seasonable improvement in the areas we expected. We saw increased backlog for several of our segments. We believe that the combination of our strong balance sheet and the strength of these businesses positions TETRA to have an improved second half of 2016, including achieving our pre-cash flow targets.

With that, I'll hand it over to Elijio.

Thanks, Stuart. TETRA revenue of $175 million increased 4% sequentially, reflecting our traditional seasonal increase by offshore services that offset declines by production testing and compression. We expect offshore to show another sequential increase consistent with our historical trends for the third party represent peak activity levels.

Fluids or subsidy [persist] sequentially on our traditional ramp-up in industrial activity in Europe. We expect a meaningful increase in fluids in the third quarter as the decline in industrial Europe activity will be more than offset with the Neptune project that we are currently working on in the Gulf of Mexico, in addition to the water management project that we are on in the Permian Basin.

Adjusted EBITDA excluded Maritech in the second quarter was $32.9 million, up $13.5 million from the first quarter, driven by a $7.9 million improvement with offshore services and a $6.4 million reduction in company-wide G&A expenses. The reduction in G&A expenses was combination of continued aggressive reductions and cost controls, including lower audit, legal and consultant expenses.

We have implemented several long-term sustainable cost reduction actions as we've collapsed back office support and filled G&A costs. In addition, we have implemented some temporary cost reduction actions to reduce cash incentive compensation, reduce work weeks, eliminated the 401K match and temporarily reduce salaries.

First quarter Company-wide SG&A was $33.6 million. As a result of all the actions I've mentioned, second quarter SG&A was $27.2 million, a reduction of 19%, or $6.4 million. Approximately $600,000 of unusual charges were incurred in the second quarter that were normalized when reporting adjusted EPS. We expect that in the next two quarters SG&A will be up approximately $29 million.

Consolidated adjusted EBITDA was 18.8% of revenue in the second quarter compared to 11.5% in the first quarter. The reconciliation of adjusted EBITDA to net income is included in the press release we issued this morning. We expect consolidated adjusted EBITDA to be up again sequentially in the third quarter from the higher offshore activity levels in the Gulf of Mexico Neptune project.

Adjusted earnings per share was a loss of $0.15, consistent with our internal expectations. Our press release includes a reconciliation of adjusted earnings per share to GAAP earnings per share. TETRA [only] free cash flow was the use of cash of $8.8 million in the second quarter, consistent with our internal expectations.

Historically, the first half of the year is weaker from a free cash flow perspective due to the lower offshore services in the first quarter and the ramp-up of business in the second quarter from Europe industrial and offshore in the Gulf of Mexico. As we collect receivables in the third and fourth quarters from the ramp up of those businesses, we generate stronger free cash flow in the second half of the year.

This pattern has been consistent in recent years. In fact, if you go back to the last couple of years, in 2014 and 2015 approximately 70% of our free cash flow has come in Q3 and Q4. In 2014, $61 million of our $85 million of total year free cash flow was generated in 2014. And in 2015, $83 million of our $120 million of free cash flow was generated in the second half of the year. We will also be aided in the second half of this year by the Neptune project in the third quarter that should monetize late in third quarter or early in the fourth quarter.

Year-to-date free cash flow for TETRA is $10 million. We continue to track toward the previously issued guidance of $30 million to $50 million for the year. We remain focused on keeping capital expenditures low, aggressively managing our cost structure and staying on top of our receivables.

Despite the financial challenges from many of our operators in the industry, our day sales outstanding remain very low. TETRA-only DSO was 61 days at the end of June, down from 79 days at the end of last year and has been on a consistent downward trend as our staff remains very focused on timely and accurate invoicing and persistent followup calls with our customers. [CSI] Compressco's DSO was an impressive 47 days at the end of the June compared to 49 days at the end of last year, also reflecting a focus effort by our organization.

During the second quarter we completed a restructuring of our balance sheet to better prepare us for the impact of this downturn that has persisted much longer than any of us expected. The restructuring was done through a series of actions that we methodically laid out late last year and began executing early this year. This included the [tender for] and retirement of $100 million of private notes, an amendment to the covenants in our credit facility without reducing the size of our $225 million revolver and the issuance of $60 million of equity. The cumulative impact of this action has left us with a solid balance sheet to weather the continued impact of lower spending by our customers.

TETRA-only net debt has been reduced to $212 million. Our leverage ratio was 2.27 times compared to the bank covenant of 4 times. We have liquidity in excess of $120 million and, as I mentioned earlier, we expect to generate free cash flow this year of between $30 million and $50 million. The impact of actions to strengthen the balance sheet and aggressively focus on cost and manage working capital has positioned us to manage through this extended downturn and has prepared us to respond rapidly to any upturn in the market. Stu?

And with that, I think we're available for any questions.

(Operator instructions)

Our first question comes from Jacob Lundberg with Credit Suisse.

Good morning, guys.

Good morning.

So we heard a little bit earlier in the earnings season from some of your competitors on P&A activity in the Gulf of Mexico. I was wondering, can you just comment on what you've been seeing there, anything abnormal beyond sort of typical seasonality?

I think we've seen certain areas where we've had some pickup and other areas have been challenging. I'd say overall our heavy lift demand has been good and we have a good backlog going in to the fourth quarter. Diving has been about as expected. And I'd say the P&A side with the wells has been lower demand than we had thought.

In the cutting side we have introduced a new abrasive cutting system that we are getting good reviews on. And we've got a couple projects out there we're looking that possibly could help us next year. And also, as I've said, we've got demand on the diving side where we felt confident to bring a short-term lease on a diving vessel.

And I think overall, the wild card in all this is on the regulatory side with the NTL that [Bessie] brought out on increased bonding and financial security. So I think there's going to be a lot of choppiness in the short-term as our customers work through the impact on them and the timing of getting that work done, given some of the challenging balance sheets that are out there.

Okay, great. Thank you. That's helpful. And then for a followup, I'm just wondering -- so after the balance sheet restructuring actions in the second quarter, it had been to maintain ample liquidity in case there was a renewed downturn or prepare for the upturn. Just wondering if, with those restructuring actions, if we don't have another leg down in activity -- has that changed at all the way you're thinking about how to handle the Maritech liability?

I think our approach on Maritech has been fairly consistent and I would expect that would stay there. We're in good shape with what we've done, what we need to do. And our plans are to not spend a lot on that -- the balance of the year if we feel we don't need to. If the market picked up faster and the world got a little bit better, we may revisit that. But I think at the moment we're comfortable where we are.

All right. Thanks, guys.

Thank you.

The next question comes from Marc Bianchi with Cowen.

Thank you. Good morning. I guess just thinking about the outlook for the fluids business here in the back half of the year, you've got the Neptune projects coming on, some water recycling business. Could you maybe talk in a little bit more detail about the timing of the Neptune projects? Is there one or two? How many are we talking about here -- and perhaps something on the order of scale?

Yes, I think we've got Neptune that will go -- certainly start it in the third quarter. Will most likely go into the end of the third quarter, possibly into the fourth. And we've got some other business right now. We have one Neptune project that we're executing on, several others that we're looking at.

And then on the water side, as I mentioned on my comments, we've got the project in west Texas that we started that we think goes well into, and possibly through, 2017. And we're looking at how do we leverage that capability with some of the other major operators out there. We've always been focused on being the industry leader around the well site for produced water, recycling it and saving cost. And we've gotten very good response.

Joseph, you've spend a lot of your time in that area recently. You may want to give a little bit more commentary just on the water on the fluid side.

Marc, this is Joseph. We regards to TETRA CS Neptune, we continue to expand and put some effort on R&D to expand the application and the envelope of CS Neptune. So we have several ongoing discussions with customers in the North Sea and the Gulf of Mexico to review the application of the fluid.

We started the work on one of the projects. We are in the middle of conversations to see whether or not we pull the trigger on another project moving in to 2017. But we feel optimistic about the application and the background effort on R&D.

With regards to fluids overall on land, we have continued to expand our water management capability through either the introduction of new technology with the patented automated blender and a few other additions that allows us to win this big project on recycling produced water. We have expanded that. Like Stu mentioned, we deployed the first pad. We are in the middle of the second deployment.

We hope that our achievements so far with that particular customer expands the scope and utilization of that project and eventually impact positively the returns of that particular project. But also enable us to sell that solution to other customers in the US land operation.

So that gives you a little bit of an idea about the Gulf of Mexico CS Neptune and some of the water management projects we're currently on. Overall, in international we have continued to basically battle the top [oversea] services behavior, respectively the big oil [sea] services companies in the international market.

In Q2 we have managed to reclaim some of the market share we lost early in the year and we hope that will significantly impact our international margins. We believe that we can still do more on that space and we're taking many actions to expand our market share in the North Sea, particularly, and in the Middle East and Africa.

Okay. Thanks for that, Joseph. Maybe just a followup on the water recycling project that you're doing in west Texas. When would you expect that to be sort of on its full run rate? And then in terms of expanding the scope of it, when would we know when you would have the opportunity to expand scope on that project?

So when we won the tender, it was for 160 wells. When we deployed the first pads that scope expanded 259 wells. So we've already seen the commitment from our customer to expand the scope in terms of wells that we would treat.

And the second deployment we've been asked to double the size of what we call the oil separation. So we're already seeing demonstration of the customer being happy with what we have delivered. The second pad will be deployed fully in Q3. We hope to start the third pad in Q3 moving into Q4. And then we will be fully operational based on the original scope by the beginning of Q1 2017. So all those give you an indication of how we expect to impact our results moving into the second half and into 2017.

Very good. Thank you.

The next question comes from Marshall Adkins with Raymond James.

Good morning, Stu. Let's come back to the fluids, particularly the Gulf of Mexico. You mentioned the Neptune stuff. I wanted to get a broader sense of your view for recovery in the Gulf of Mexico. And not just for the next couple quarters but into 2017. What is the outlook for your Gulf of Mexico fluids business?

I think it's going to be like a lot of others. Clearly there's been a lot less drilling this year. Most folks expect that to continue out through next year and hopefully start to see improvement in 2018. So I'd say our perspective is obviously the completion side we lag.

The drilling side we do have several projects we're chasing that have already been funded. To me, kind of the way we bifurcate it is areas that have already been funded that are going forward and then new investment. The new investment is obviously going to be slow to come.

So our view is we do see some visibility in the second half of the year. We feel good. We see some opportunities next year that we feel good about. The overall general activity is going to be challenging just like this year.

So at a high level, it's probably going to be somewhat similar to what we've seen in 2016 in the Gulf. Overall activity -- much less than last year. A few projects that are material and our ability to win those will drive the results. Obviously the longer-term, out a couple three years, we remain bullish in that space above our position but we think next year will probably look like 2016.

Right. Obviously enhanced with the recovery in oil price, which we certainly expect. What about US land? Are you seeing any trends there where people are using more of your type fluids on land in the US?

Well on the water side, I think Joseph gave you -- (inaudible -multiple speakers) On the product side, we continue to look at areas where we can put nominal footprint that helps us get to the market faster and quicker. And we've done some of that in south Texas successfully. We'll continue to look at that. We think with our manufacturing footprint, we've got all the basins covered and we've been able to maintain our market share on the downside.

I would say I haven't seen indications that there's any unusual demand or unique demand of specific fluids as we move into hopefully a little bit higher activity. The way I look at it is we've got a great position as the market comes back. We'll continue to be positioned well with our manufacturing footprint but nothing that's demonstrably different than we've seen recently.

I'll just slip in one last one here on the production testing side and the US land, any indication of response and demand for your stuff from completing some of the [DUCs] that are out there? Or I guess customer conversations -- how is it looking on the production testing side?

Marshall, this is Joseph. We continue to effectively manage what we can control in this market, to be honest with you. We've introduced the salary reductions, the reduced work week, schedules limit, the structural damage we have to our footprint in US land. We expect that this will help us moving into the second half as the market stabilizes and hopefully modestly rebounds.

Our customer base is really made out of the more active customers and the more economical base. Those actions we have taken have allowed us to increase that market share. We believe that the DUC inventory has continued to decline somehow in the first half with the lack of drilling. But over the last few weeks we've seen signs that that DUC inventory may have stabilized and started to increase again. So that's really why we're building a little bit of confidence into saying that there will be a modest growth in completion activity in the second half of the year.

At least in US land we have also managed to work with our customers to pick up a few of their most favorite crews and we hope that that will improve our market share positions in the Permian Basin, the [scoop] and the [stack]. So that gives you a little bit of why we're saying that we will see a modest improvement in the production testing.

On the international side we have deployed highly customised Optima cooling solution for an international customer. We continue to drive that value for opposition with other customers. And to be honest, we mentioned in the earnings calls earlier that we have few visibility to -- or we have visibility to a few early production facility projects, but with the [head fake] we've seen, the commodity reverse to 40. We are becoming less optimistic that those customers and customer budgets are going to be spent this year.

All right. Thank you all.

Our next question comes from Jason Wangler with Wunderlich.

Good morning. Maybe just to dovetail on that last question, how are you seeing, specifically in the US, the pricing discussions go? Are we starting to see some easing on that side of the production testing? Or is it still pretty much a dog fight out there?

I think overall, the customers have really pushed us with a 23% drop in rig count in Q2. With -- this is on top of a 40% rig count drop in Q1. So the pie has shrunk significantly.

We will see the impact of these price concessions moving into Q3 and we hope that those conversations, as the activity recovers a little bit, will be in the past. And we hope that towards the end of the second half that we may be able to start raising some prices to operate in a more positive environment.

In fact, we have had a couple discussions with some of our key customers and they've allowed us to meticulously rise some pricing and some [crew] charges so that we work better and partnership. So if those conversations continue, we hope to see some impact towards the end of the year.

That's great color. Thank you, Joseph. And then maybe, Elijio, if I could ask, looking at the free cash flow plans, should we just kind of think about as at least in the near-term something to continue to pay down some of the revolver? Or just kind of your thoughts about where we should see the use of that free cash flow as it comes in the second half.

Yes our plans are to continue to pay down the revolver until we see a little bit of clarity where the market is going. And just continue to be very conservative in the process.

Great. I'll turn it back. Thank you.

(Operator Instructions)

Our next question is from Sean Meakim with JPMorgan.

Hi. Good morning.

Good morning.

Thinking about your margin profile, given all the changes to your cost structure and then some of the new initiatives, perhaps like in fluids, how do you think about incremental margins in a recovery scenario? Are you expecting to see something larger than what you've seen in prior cycles or does the slower recovery in offshore mute some of the impact?

That's a pretty complicated question there, Sean. I would say on fluids we've said a couple things. One is obviously the second half of the year will be better than last year. We had record margins that will take us a while and a much better market to get to.

I think as you look at the profile going forward on how this market compares to prior cycles, you've got the new technology we have in both the water and the Neptune that we didn't have the last cycle. So I think that mix of business will be good.

I think it's going to take us a while, as Joseph said, to kind of get some of that pricing back. I think that's going to be the real question is with which customers and which products and what geographies are we able to do that?

Clearly you've heard some the larger service companies feel somewhat confident that they're on a path to do that. I think we know where those actions are required. We have a game plan that timing is going to be really a function of the specific customers and demand and the capacity.

But overall, I don't know that I can compare it to prior other than to say we have a very low cost structure. I think our exit rate after this cycle on a Company-wide cost structure, both at the field level and the corporate level, is going to be lower than the exit. So I think there will be some structural advantages to that. That kind of gets done in tandem with how fast the pricing is going to change.

Only to add to Stuart, in the Gulf of Mexico you're on point, Sean. I think 2017 moving any pricing in the Gulf of Mexico with the lack of activity and the [press] commodity price would be very difficult. But on land, the same comment we made on production testing would be applicable to land operation.

Got it. That makes sense. And then just maybe thinking about compression, you noted maybe some stabilization there as we get to the middle part of the year. Maybe could you give us some of the puts and takes for the second half? And just thinking about the type of contingency planning that you're doing around the covenant for CCLP, if second half EBITDA maybe doesn't pick up as much as you'd hope.

I will take the first question on operations then pass it to Stu (inaudible) to talk about covenants. The focus in that division has remained on cost control, like you have seen, utilization, pricing management with our customers, overall the working capital and the CapEx reduction. And we have significantly focused on market share.

In the second quarter, the request for price concessions remained high. We believe that we may be at the bottom of the cycle with compression. Our head count has really dropped by 20% since the beginning of the year through the end of June. We have restructured our sales organization to focus on [authority] and accountability and customer relations so that we can prop the revenue and many of where we are -- many basins where we are active.

The natural gas prices, Sean, have improved in the second quarter and have remained over $2.50 -- touching a couple of times close to $3. So we believe that this trend should improve our near-term demand for the lower horsepower segments. We've seen an increased interest from numerous customers for gas lift and vapor recovery applications.

[Tim] mentioned this during the earnings call Friday and those inquiries are coming from places like the Permian, the Delaware, the scoop and the stack. We believe that the gas prices remain positive and improve as we move into the second half. We believe that several customers will increase their budget spend over the near-term and, in terms of maybe capital utilization, going into 2017.

And, Sean, with respect to CSI Compressco, we had the earnings conference call on Friday and announced the results of CSI Compressco. And we mentioned that EBITDA for bank covenant purposes in the second quarter was $26 million. It was an improvement over where we were in the first quarter. And obviously that annualizes to a very attractive number if you take current activity levels.

We believe that we've got an excellent relationship with our lender group that includes three of the largest banks that are also in the TETRA revolver. If we thought that we were going to have issues in the second half of the year, we believe that we would have the support of our banks to take a look at the covenants again. But at the current run rate that we're at, we think we're in good shape.

Again, Sean, this is, as we said earlier, we've been very transparent with our banks. We have a lot of great relationship and I think, as Elijio said in his comments, we've kind of laid a path out last year of how to deal with an extended cycle. And we've continued to execute with the full support of the financial community. So we feel good about that and we tend to be conservative when it comes to managing the balance sheet.

Understood. Thank you for all that detail.

Thanks, Sean.

We have no further questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Stuart Brightman for any closing remarks.

Thank you. And as always, we all appreciate the good questions and the support. And we'll look forward to updating the group in early November on the actual results from the third quarter. So thanks again.

Thank you for attending today's presentation. The conference is now concluded. You may now disconnect.