Tetra Technologies Inc (TTI) 2016 Q3 法說會逐字稿

Good morning and welcome to the Tetra Technologies third-quarter 2016 results conference call.

(Operator Instructions)

Please note, today's event is being recorded. I would now like to turn the conference over to Stuart Brightman, Tetra's President and CEO. Mr. Brightman, please go ahead, sir.

Thank you, Rocco. Welcome to the Tetra Technologies third-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 will provide a brief overview of the third-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 third-quarter, our perspective on the fourth quarter and the markets in general as we move into 2017. Overall, our results for the third quarter showed positive trends in many areas and were consistent with our internal expectations and assumptions.

We've seen a significant increase in fluids EBITDA and adjusted EBITDA margins, each of which approximately doubled. Our offshore services business continued to improve sequentially, however the operating environment for offshore service continues to be very challenging, due to the continued deferral of spending by our Gulf of Mexico shelf customers.

We have seen the beginning of increased activity in North America that has favorably affected our fluids, testing and compression segments. And during the quarter we continued to take appropriate measures to strengthen our balance sheet with the additional capital raised for CSI Compressco.

During the third quarter we've seen the expected increase in our fluids profitability, primarily associated with two factors as previously stated in August earnings call. We continue to execute the backlog of Gulf of Mexico deepwater activities, which includes Tetra CS Neptune. We executed one project during the third quarter and expect to start another during the fourth quarter.

The successful execution of Tetra CS Neptune product in 2015 and 2016 has been a major contributor to our ongoing earnings. We continue to feel confident of this going into the future and continue to focus our R&D group on expanding the capabilities of Neptune.

In addition, with increase in North America production and rig count, we have seen significant ramp-up in our water management business. A portion of this is due to the proprietary technology we have introduced associated with Tetra steel, automated blending and recycling and reuse of produced water capabilities, as well as increased market share in active areas such as the Permian and MidCon basins. We continue to believe water management will be a big part of our business as we move into 2017.

Overall like others, we will be impacted in 2017 by the expected lack of activity in the Gulf of Mexico, particularly in the deepwater. We still see several projects for next year that exploit our technology, however overall we believe the activity level will be down.

Our production testing business revenues increased sequentially by 13%. Several factors contribute to this such as stronger activity levels in North America, reflected by higher rig count and completions, as well as the positive seasonal aspect in Canada. We continue to focus on improving market share in North America, with those customers increasing their production activities.

Our international business will continue to be subject to significant pricing pressures, but we believe we will see slow improved dynamics as we move into 2017. I also remind you that in all the areas from an operational point of view, we continue to recognize the synergy at the well site, both domestically and internationally, of having operational responsibility for both our fluids and production testing segments in one management group.

Our compression division reported third-quarter adjusted EBITDA of $23.1 million, resulting in a quarterly EBITDA margin of 32.7%. A key metric for us has been a flattening of our fleet utilization in the third-quarter, as indicated by the utilization rate of 75.2% compared to 75.8% in prior quarter. We continue to be encouraged by this flattening and see signs of progress as we move through the fourth quarter with particular emphasis in one of our areas of strength, the Permian Basin.

We continue to move forward with our ERP integration project, the first phase is expected to be completed in early 2017. This integrated system will allow us to run the business more efficiently in the field and in the back office and prepares us for growth in the future. This is also important when we look at the cost structure in maintaining that in an area we've been very aggressive in reducing that.

Offshore services adjusted EBITDA of $4.7 million, or 16% of revenue, a 58% sequential improvement over the second quarter and reflected the seasonal peak of decommissioning activity in the Gulf of Mexico. We expect the fourth quarter of this year and the first quarter of next year to continue to reflect the weakness in customer spend during this downturn in the seasonal low end of the cycle.

Overall, we continue to reduce costs, evaluate asset deployment and focus on being free cash positive in this segment. We continue to monitor the progress on the NTL related to bonding. In the short-term it has delayed spending and hopefully when the resolution happens that deferred spending will be reinstated. When this happens we are positioned very favorably to react quickly on a structurally low cost structure.

We continue to execute the necessary balance sheet and capital initiatives for both Tetra and CCLP. During the third quarter we completed an additional $30 million of Series A convertible preferred unit offering for CSI Compressco; this gives us a total of $80 million.

The offering has been structured to pay quarterly distributions in additional preferred units equal to an annual rate of 11% of the issue price, subject to adjustment. Commencing in March commencing in March 2017 a ratable portion of these units will begin converting into common units over the remaining 30 months. As stated on the CSI call last week, we executed an amendment to the existing secured credit facility, moving to leverage ratio of covenant to 5.95 through the second quarter of 2018.

Tetra-only free cash flow was use of $13.9 million in the third-quarter, excluding CCLP earnings but including the distribution that comes back to Tetra. Several contributors to that. First, the timing of some of our larger projects through the second half of the year has been delayed and led to a deferral of collections. In several cases, certain customers have pushed out their payment timing as a result.

As we move into the fourth quarter our expectations are that we will generate $5 million to $15 million in free cash flow for the full year. This assumes the completion of several projects in the fourth quarter that have been delayed with the associated expectations that a portion of these collections will be pushed into the first quarter of 2017. This also reflects the trend of deferred spending mentioned previously on our offshore services segment.

In summary, the second half of the year has shown most of trends we anticipated when we last spoke in August. First, the continued uptick in activity in North America which we have seen favorable impact, and expect to see a continued trend in fluids, production testing and compression businesses.

Second, the execution of several large projects in the Gulf of Mexico. Other than the slight timing delay, the overall size and impact of those projects remain consistent with our expectations.

Third, continued decline in demand for our offshore services, driven by deferral of our customers with an ongoing aggressive cost-cutting action plan. Fourth, a very positive result from CSI Compressco, as demonstrated by margins of 32.4%. Favorable trends in fleet utilization, giving us optimism that as we move into the new year, we will be moving in to a more positive direction for that business.

With that I will hand it over to Elijio.

Tetra revenue of $176 million increased sequentially by 1%, but the quality of the revenue we meaningfully better. A $900,000 sequential improved in revenue generated a $0.10 improvement in adjusted EPS and a $4 million improvement in adjusted EBITDA.

Stuart mentioned earlier that fluids adjusted EBITDA was up materially from second quarter. Offshore services peaked with a significant increase from then second quarter while compression and production testing services adjusted EBITDA was down only slightly.

On a consolidated basis adjusted EBITDA margins of 20.9% increased 210 basis points from 18.8% in the second quarter. We continue to generate EBITDA margins in the 18% to 21% range over the last two quarters, despite the significant decline in activity, due to the stability of our compression business and from the technology office and lower cost structure of our fluid position.

We continue the aggressively manage our costs. Cash costs as defined as the difference between revenue and adjusted EBITDA declined an initial $3.1 million in the second quarter to the third quarter from $142.7 million to $139.6 million. If you evaluate over the past eight quarters what we have achieved in our cost structure, you will note that from the time we completed the acquisition of CSI in August of 2014, we reduced SG&A costs by over $45 million on an annualized basis when comparing the fourth-quarter 2014 to this recently completed third quarter of 2016.

The costs associated with our field organization referencing in field offices personnel and all related field expenses have been reduced for the same time period from $491 million on an annualized basis to approximately $308 million, also on an annualized basis this past quarter, a reduction of over $182 million or 37%. When combined with the SG&A cost reduction I previously mentioned, we've been able to take out approximately $228 million of field-related and SG&A costs without compromising our footprint, service offering or exiting any key area. These aggressive cost actions have allowed us to remain EBITDA-positive while many in our industry continue to struggle.

The diversity of our revenue stream from onshore and offshore, domestic and international, oil field services and industrial, product and services, well pad and infrastructure, have been a differentiator here in this downturn. As part of this cost reduction, we've eliminated layers of management, consolidated the core functions, combined service centers and shifted manufacturing to optimal locations to take advantage of lower input costs.

The next major initiative underway in the implementation of our new ERP system for CSI Compressco that will allow us to use technology and change the way we do business and permanently further reduce base costs. This new initiative will save us over $4 million per year beginning in the second half of next year. When activity levels rebound we intend to use this technology to keep costs from increasing commensurate with stronger activity levels.

It is clear to us that deepwater Gulf of Mexico will take longer to rebound compared to our onshore markets. With this in mind, we will continue to attack our cost structure and keep shifting our cost basis to extract as much margin as possible and reduced revenue levels.

With respect to free cash flow, we have historically generated the majority of our free cash flow in the third and fourth quarters due to the seasonality and timing of our revenue. Offshore services, for example, peaks in the third quarter and we collect those receivables in the third and fourth quarter. Historically for all of Tetra, revenue peaks in the second quarter and declines gradually in the third quarter then declines minimally in the fourth quarter.

This year we're seeing third-quarter revenue be slightly above the second quarter and are expecting fourth-quarter revenue to be stronger than the third quarter. As a result, we are not in a position to convert receivables into cash and bring working capital in the same pattern as we have historically. This will result in working capital built into the fourth quarter and being modified in the first quarter of next year. Other than offshore services, that seasonal decline in the fourth quarter, we are expecting the sequential revenue improvement in the fourth quarter for fluid, production testing and compression.

With respect to the balance sheet, we have taken a series of steps over the past two quarters to strengthen our balance sheet. We have completed equity offerings or Tetra and CSI Compressco levels and have amended our debt covenants to give us more cushion to manage during this extended downturn. When combined with the cost reductions previously mentioned and the diversity of our revenue stream, we believe we remain uniquely positioned to remain EBITDA- and cash flow-positive in this challenging market.

From a housekeeping perspective, I'll address the unusual charges incurred in the third quarter. The third quarter included $10.5 million of special charges with the vast majority concentrated in CSI Compressco. These $3 million of cash costs associated with our equity offering and bank amendments are reflected primarily in SG&A. And $6.3 million of non-cash charges related to a mark-to-market adjustment to the recently issued convertible preferred notes are reflected in other expenses.

Given that these notes will be settled in CSI Compressco equity, we are required each quarter to estimate the future value of the equity we will be issuing as these notes convert into common units. When the unit price of CSI Compressco increases, the estimated value of the security increases and we increase the value of the liability. If the unit price decreases, we reduce the value of this liability with a corresponding impact on the income statement. All of these are non-cash charges.

It is also important to reiterate what we mentioned in the press release. US GAAP requires us to classify the convertible preferred units as debt. When given that they will most likely be filled in equity or covenant competition purposes, the convertible preferred units are considered equity.

And before I turn this back to Stuart, I would like to make some comments on CSI Compressco. We announced early this past Friday after the equity offering and the bank covenant amendment, they include the leverage ratio from 5.04 times at the end of June to 4.83 times at the end of September. The new leverage covenant is 5.95 times beginning at the end of the year through June of 2018. We believe we have the balance sheet where we want it for this environment.

CSI Compressco also reported a coverage ratio of 0.99 times, essentially at 1. After the earnings call, we had questions arise on the consequences of running a coverage ratio below one time. I would like to put this in perspective. If CSI Compressco runs with a coverage ratio of 0.90 times, this equates to only $1.3 million of cash being distributed per quarter above distributable cash flow.

In the unlikely event that they ran a 0.90 times for four quarters, this would only add $5.2 million of incremental debt, or about 1% of total outstanding debt, and makes no meaningful impact on their leverage ratio. Therefore, we will be comfortable for a few quarters running with a coverage ratio below 1 time if we needed to.

With that, let me turn it back to Stu.

Thank you. And with that, let's open up the lines for questions.

(Operator Instructions)

Marshall Adkins, Raymond James.

Good morning guys. Let's focus on fluids, if we could. Awesome margins there. What drove those and are they sustainable going in and through 2017?

As I said Marshall, the two major contributors to that was the progression of increase in activity on our water management business. We had referenced in prior quarters some of the projects we're starting in West Texas, that's going well. We've had some strength in MidCon as well.

We're seeing increased utilization and great customer mix focused on our produced water capabilities. That's something that's started, it's going the way we expected and we expect to see positive trends on that through next year. Big focus on how to differentiate that service line at the well site. So that was one key element.

Another element is -- and again just to go back to that, as we see that trend in activity onshore, it's not just the water management. We sell a lot of product into those shale applications. We've seen the demand for our product sales go up as well onshore. So that would be a second element with the onshore increase.

Offshore, as we said before, we had pretty good visibility into a couple of projects in the second half of the year. We have one of those come through in the third quarter, we expect another one on the fourth quarter. And those are always positive. Gulf of Mexico business is always fairly good margin for us, particularly when it involves some of the new technology.

Those would be the two biggest elements overall. Our industrial fluids business continues to hold up solid, no change in that. Normal pattern second quarter is the bigger quarter, third quarter in the year, it comes down from the seasonal high. Those would be the main elements.

And again, if you extend it to next year, offshore I think anybody that's operating in the deepwater is going have a more challenging next year. You've seen all the commentary on prior calls the last several weeks. We still have line of sight on some projects next year, the overall activity should be down. So again, hard to think that would be an improve scenario next year, but we still should have some decent projects offshore.

That's what I was trying to get to. If the margins were driven by a mix shift to the Gulf, then I would question the sustainability. But it sounds like there's a big chunk of the improvement due to the US, which should be sustainable in most of our outlooks. Am I reading that correctly?

Yes. And I would add a little bit more color that we have several projects in the Gulf of Mexico. We had some in the third-quarter, we had visibility in the fourth quarter and we expect less of those big projects next year but we still have visibility. I think if you go sequentially year on year, we would expect our Gulf of Mexico fluids to be down, we would expect our onshore fluids to be up.

Okay, perfect, that's helpful. It seems like you all lost a lot of share in the US in both the fluids areas, but that's coming back. Is that fair to say that the share we lost -- or you lost earlier, you're starting to recapture at this stage?

I don't think that's totally accurate. I view that we've maintained our share both onshore and offshore. In fact, I think in 2015 and 2016 we've increased our share in the Gulf of Mexico, a lot of that being driven by new technology.

I think the revenue and associated margins onshore has been all activity-driven and associated pricing. But we don't feel we've lost any share. In fact, in certain areas customers have taken share onshore and that's embedded in the results for the third quarter.

Perfect. So model the US component's rig-count driven from here, then?

Yes, what's the understanding, we think we will take some share on the water management as we go through based on the new technology.

Perfect. Thanks guys.

Thank you, Marshall.

Jacob Lundberg, Credit Suisse.

Good morning guys.

Good morning.

I wanted to follow-up on the Permian water project, just looking for an update on it. On the last call you said you had hoped to start the third pad towards end of the third quarter moving into the fourth quarter. Has that played out as expected?

And then should we expect some incremental contribution in the 4Q over 3Q to the degree that you didn't get a full quarter contribution of that third pad in the third-quarter?

I'll let Joseph answer that. He's been out there the last several weeks and has a really good handle on that.

Yes, we have started the third pad as expected and as communicated in the previous-quarter earnings call. Just to give you more color on land, we continue to focus like Stu said, on gaining share in water management with our differentiated solutions for reduced water re-piping and treatment technology as well. We see those margins improving into Q4.

We've managed to get from our preferred customers a couple of price increases, so the margins from that segment of our fluids will continue to include moving into 2017 as well. At the same time, we have expanded our distribution in the Permian and hope to start distributing fluids to most of the Delaware customers in Q4 and that will also contribute margin in Q4 versus Q3.

With regards to chemical products, we have to get some price concessions to continue to replace some of the oil and gas customers with industrial customers. And as the oil and gas activity rebounds slowly but surely in North America land, we're starting to see signs of those products coming back into our revenue stream. That gives you an idea about how land, fluid, inclusive of water, is going.

At the same time, with regards to the water management solutions we've introduced, we see a good pipeline replicating some of the technology with high-end customers in the Permian Basin. We don't expect to see an improvement in Q4 from those additional customers we are after. But come Q1 2017, we hope to see a significant rebound in addition to the margins from that particular segment of the business.

Great, thanks, guys. And then a follow-up on the CS Neptune in the Gulf of Mexico. I'm trying to understand potentially a sequential decline in revenues in the fourth quarter. In the press release you note that you have a project starting in the fourth quarter. Is it fair to assume that you will have -- in terms of just CS Neptune in the Gulf of Mexico, a sequential decline in revenues in the fourth quarter from the third quarter? And if that's the case, could we get any sense for the magnitude of the decline?

In the fourth quarter the next projects start on time, we should not see any revenue our margin deterioration. The only issue with that, that is also affecting our free cash flow guidance, is that it is pushing towards the end of the year.

We had expected to start this project early in December. There are some operation-related issues with the well that are pushing the timing of the project towards the mid to end of December. That is the only thing that, to be honest with you, we do not control.

And if that starts on time then there will not be any margin deterioration or any revenue deterioration. But if it pushes toward the end of December, then that project will be partially invoiced in Q4 and the rest of it will be invoiced in Q1. It's not a matter completing the well, it's a matter of 12/31/2016, to be honest.

All right, very helpful. Thanks, guys.

Stephen Gengaro, Loop Capital.

Thanks, good morning, gentlemen. Two things. One, back to fluids, if you don't mind. When we think about the sequential improvement in operating income, or pretax income, can you help provide us a little more color on how much of that was driven by the Gulf versus the land side?

Yes, I think directionally both were a component. Typically the lumpiness of some of the offshore is larger, so that's a bigger component. But both contributed to third quarter.

If you look at the land side of the business alone, are the incrementals north of $30 million or no?

Yes, they are definitely north of $30 million. We doubled our revenues quarter on quarter from land fluid-related activity.

Okay, that's very helpful. Thank you. And then when we look at the production testing side, and we think about 2017 or 4Q and into 2017, how correlated would you expect to be with this North American rig count?

In the short-term I would say that the pricing is the largest factor in that particular division. We don't have exactly the same differentiation we've been able to introduce successfully on the fluid side. So we continue to suffer from pricing pressure due to oversupply in the land market. Everybody's trying to offer frac flow-back services.

So in order for us to maintain the same and grow our market share, we've had to give extreme pricing concessions. You can see it in some of the margins in Q3 over Q2. But we hope to continue to gain quality customers as we move into the fourth-quarter, but we don't see any price improvements until mid to late 2017 for that particular division. That's the metric.

Okay, great. And then one final, if you don't mind. Just to clarify when you talk about the cash flow and the delays that were encountered in collections, is that because of project delays and timing of the work being done that just got delayed for -- because the customer wanted it to? Or was that because the customers actually delayed payment on completed work?

You got a little bit of both. The biggest part is the customer operational delays, unplanned things happen. And then when you get that, given some of the lumpiness, some of those delays as the work is completed during the quarter.

In the third quarter as well as most likely the fourth quarter, you see that timing of the receipt move into the subsequent quarter. And in general, as you see in the press release, our collection period increased during the third quarter, like you've seen in many other companies, where we just have some customers that have chosen to push the payment into the beginning of the following quarter.

Okay, very good. Thank you.

Marc Bianchi, Cowen.

Thank you. Focusing back on the fluids business, you mentioned that this additional Neptune project in the fourth quarter, is that the fifth Neptune well? Do I have that right?

Remember that in early in the year we mentioned that we missed some of our guidance due to having one dry well in the Gulf of Mexico. So if you count that as a well, then the next one will be well number five, correct.

Okay, thank you, Joseph. Still on fluids but unrelated to that, if I look at the outlook for 2017 for fluids, it sounds like it's going to be down for the year compared to 2016 on a revenue basis.

Is it reasonable that EBITDA could be flat or perhaps up with 2016 in fluids. Is there anything underlying there? I'm thinking if North America land is improving and there's $30 million-plus incrementals on that, perhaps there's a chance that EBITDA could actually be better while revenue is going down.

I wouldn't go that far at this stage. It depends on the size of the rebound. It depends on the commodity price and the willingness of our customers to spend budget. A few of our customers have increased their budget moving into 2017, and we see it as a good sign this year. I wouldn't bet on improving margins year on year at this stage.

Now, we have modeled how much of the weakness in the Gulf of Mexico and related margins we would be able to offset in land activities. We feel comfortable with our plans for 2017, but it assumes many things like increased rig count activity, increased completions activity, particularly in the Permian Basin and the MidCon areas, the Rockies and Appalachia, and a soft recovery in Canada as well.

If you take all that, we hope to be able to offset some of these gaps in the offshore activity. But at this stage I would not be able to confirm or state that we will be able to compensate for all of that weakness in the deepwater.

Sure. I understand there's a lot of variables. Maybe thinking about it on a sequential basis, if you hold flat here in the fourth quarter in fluids EBITDA, can you help us understand the step-down if Neptune goes away because of there's a little bit of a gap in some projects?

Is it something perhaps that wouldn't be below second-quarter 2016? Or is there any way you can give us some kind of a guidepost to there to the step-down?

I think, Marc, it's awful early to try to be that precise for next year. We'll have a much better handle on that when we reconvene early in the year.

I think at this stage, the way I would think about it as Joseph summarized, positive trends on offshore. The overall activity offshore down and we do have some visibility on Neptune projects next year that hopefully will come in, and exact timing of it is still unclear.

We still need to get through the end of this year, see budget, see what happens in the meetings the next few weeks. Then we will come back and get a little bit more granular on that.

But I wouldn't model anything that is worse than Q2 or Q1 for the fluids division with regards to expected margins.

Okay, thanks, Joseph. One more for Elijio. Looking at a fourth quarter here where you're going to continue to do well in fluids, but you're going to roll off a pretty good EBITDA quarter from fourth quarter 2015. If the free cash flow does not come in at the range of guidance, it seems to me like you might be close to that four times covenant if that's the case in your own modeling. Can you help us think through the contingencies there for dealing with that if it becomes something you need to do?

Marc, we've got a couple of items working in our favor as we move toward the end of this year and early next year. We had a challenging start to Q1 of this year that had an EBITDA loss. We don't expect that we will have the same kind of EBITDA loss in Q1 that we had in 2016, so that will work in our favor.

Then you've seen AR build up as revenue has pushed out into Q4. They will start monetizing that Q4 in Q1. We think that the combination of better free cash flow and then rolling into better Q1 margins, that we're okay on covenants for this year.

Okay, thanks for that. I'll turn it back.

Martin Malloy, Johnson Rice.

Good morning. On the Neptune product, are there any opportunities where you could see this used in other basins outside the Gulf of Mexico?

Like we mentioned earlier in the year in the previous earnings call, we had a very credible opportunity in the middle of 2016 that didn't happen because our customer elected to assume operational risk when we were bottoming out on commodity prices under $30 and focus on -- from that particular customer, on cash flow for dividend purposes.

Moving into 2017 we believe that we have more than a couple of credible opportunities to expand beyond where we are today with a single customer. We expect Q1 to continue and go back to complete what we, in Q3, partially addressed with our customer. So there's been more work on well number three that we addressed in Q3.

And our two credible opportunities, one, again in the Gulf of Mexico in particular. One in the Middle East that we feel confident that it's going to happen somewhere in the middle of the third-quarter of 2017. And another one that we're working on, provided we can have, logistically, the solution for a North Sea delivery process if the customer elects to use that particular product for their [run].

So that gives you an idea of our sum credibles. Of course we are trying to expand the envelope of the application as well. We're not putting that in any 2017 plan or budget due to the weakness in the overall spend from a deepwater activity perspective.

If the commodity prices were to rebound towards November 30 and our customers see that deepwater activity may be accretive for them, and they go back to starting operation or more development projects, there is definitely a wider application for that product when the activity recovers in deepwater.

Okay. And then on water recycling and the customers you've talked about there, some new high-quality customers for that product line, are these existing customers of Tetra that you're bringing in this additional service to provide?

Yes. We focused on -- in the last two years, let me take you back to the last two years. In the last two years, we have diversified our customer base towards high-quality names. Names that are working in premium basins like the Permian Basin and STACK in the Mid-Continent area. We have tried to focus on customers that will also pay us on time and have very low risk of getting out of business or not being able to meet their demand.

So for us, we continue to retain those quality customers. We promise and deliver on incidence-free service, both on service delivery and HSE quality and safety. The quality names that I mentioned are customers that are today our customers where we may not have a holistic solution to water recycling, but they are considering replicating some of the stuff that we have sold to others when it comes to the produced water recycling and water treatment solution.

Great. Thank you.

Kurt Hallead, RBC Capital Markets.

Good morning.

Good morning.

I was wondering if we can get some additional color on the Tetra standalone leverage ratio in the third-quarter.

Kurt, the Q4 leverage ratio will be slightly above 3.6. I'm sorry -- Q3.

3.6 in Q3?

Yes, slightly above it.

Okay, great. And then with respect to the revised free cash flow, you guys have given some additional color around elements of it going forward. Would you expect to be able to get back that free cash flow level over the next couple of quarters? Or is that really not -- is that going to be impossible to happen at this point?

The big opportunity we have is that as revenue starts to peak in Q4, when historically it has started to drop off in Q4, we will have an ability to monetize that AR. We believe that we'll start collecting some of the Q3 revenue that peaked in Q4, and then we will have the opportunity to collect that also in Q1 as it peaks in Q4. I would say that we've seen a shift as cost revenues continue to increase, all those collections into Q4 and Q1.

And like we said actually before with regards to the backlog from operations perspective, so cash from operations is supposed to be better than the first half of 2016 moving into the year end and moving into the first part of Q1 and early Q2 of 2017 as well.

Okay, thanks for that. You provided some very good color on the outlook for fluids going out into 2017. I was hoping that you can walk us through your view points on production, testing and offshore. Maybe high-level like you did with fluids, so revenues up or down 2017 versus 2016.

I think if you look at offshore services, it's hard to expect a worse year next year activity. But we haven't seen any catalyst for our customer spending yet. I think there's a lot of that tied to where the industry comes out on the bonding NTL.

So we've cut costs, retrenched a little bit, made certain that we will be around breakeven free cash flow at that even further reduced activity, and being able to respond very quickly if we see an uplift there. I would say that it looks probably similar to this year.

On the testing, as Joseph said, activity picking up, a lot of available capacity out there, pricing still very sticky and the opportunity to try to differentiate, go to some of the larger customers. It's probably a little bit tougher challenge than where we have differentiation on the water and fluids side. But that the focus is leverage those common customers.

Internationally, as we've said previously, some of the international markets, particularly Saudi, there's been a lot of challenges in the pricing level in the market. We think our activity will pick up in testing internationally. And the challenge will be to pick our spots where we have an opportunity to get some price.

We would expect to see overall positive trends next year. Maybe not as much as we see in North America water, though, in fluids.

Okay, great. Appreciate that color.

John Watson, Simmons & Company.

Good morning. Joseph touched on this briefly, but could you elaborate on the pricing pressure within frac flow-back? And when you foresee improving activity leading to more favorable pricing?

Sure, we'll let Joseph continue that dialog.

Similar to modeling for overall fracking, what is happening is the capacity has not completely been removed from the market. So for services companies to really retain some of the market share for, what I would call, not very much differentiated service, you still have to give price concessions.

Now, our EBITDA margins in no way compare to the fairly negative EBITDA market margins on frac, so we've been able to retain quality customers. In some cases, some of our customers have quizzed us on what would it take for you to be EBITDA-neutral? We are working some customers domestically to make sure that we run EBITDA-neutral.

In that whole mechanism, what we're also trying to do is make sure that in every 30-day period we are running the volume-price model, if you will, so that we can dictate how much price concessions we can give. In some particular basins domestically we have elected not to do or conduct any business and relocated some of our equipment to stay in the Permian to go after quality names and volumes of completions activity.

That's really been the trouble. We do not want to make for achieve or go after more revenue and lose more money. That's not the objective. The objective is to compensate for the price concession by loading our [eco-sense] and utility base in a 30-day period rather than over the quarter. That's how we plan to continue to drive towards the EBITDA-neutral in the short-term and try to use the volume to start seeing EBITDA-positive margins for that frac go back domestically.

Internationally we have seen signs of pricing stabilizing a little bit. But we continue to go after quality projects where we're not just doing frac flow-back, but we're doing production testing and wet testing in some particular cases. We have a couple of big large opportunities and if they were to happen, it still depends on the award, but if they were to happen we would see visible improvement in 2017 over 2016 from an international production testing margins perspective.

Okay, that's helpful. So within frac flow-back it's still a spot market at the moment, do you see a shift to a term contract with a concrete price in the near term?

We have some customers where we have longer-term contracts like six months, one year, where they are starting to lock pricing so that they control pricing erosion, moving into a higher commodity price, maybe higher volume where they may think that capacity would be coming to equilibrium. But most of it, I would say 80% to 85% is the spot market pricing, yes.

Great. Thanks, guys, I'll turn it back.

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference over to Mr. Brightman for any final remarks.

Thank you very much, great questions as always. We'll look forward in February to updating everyone on the year-end conclusions and our views on 2017. So thanks again.

Thank you, sir. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.