Tetra Technologies Inc (TTI) 2018 Q4 法說會逐字稿

Good morning and welcome to TETRA Technologies' Fourth Quarter Full Year 2018 Results Conference Call. The speakers for today are Stuart M. Brightman, Chief Executive Officer, and Elijio Serrano, Chief Financial Officer for TETRA Technologies, Incorporated. Also in attendance is Brady Murphy, President and Chief Operating Officer. (Operator Instructions.] Please note this event is being recorded.

I will now turn the conference over to Mr. Brightman. Please go ahead.

Thank you, Nancy. Welcome to the TETRA Technologies Fourth Quarter 2018 Earnings Conference Call. Elijio Serrano, our Chief Financial Officer, and Brady Murphy, our President and Chief Operating Officer, are also in attendance this morning and will be available to address any of your questions. I will highlight a few key items, 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, backlog, coverage ratio or other non-GAAP financial measures. Please refer to this morning's news 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.

On February 25 we issued a press release of my plans to retire at the May 2019 annual shareholders meeting as CEO of TETRA and as Chairman of the Board of CSI Compressco. I plan on standing for election to the Board of Directors of TETRA at the upcoming May 2019 shareholder meeting.

I would very much like to congratulate Brady as he moves into his new role as CEO of TETRA and Chairman of the Board of CSI Compressco beginning in May. This is a transition plan the board and I have been working on since we hired Brady, and he has clearly demonstrated he has the skills and capability and wherewithal to evolve the organization and further advance TETRA and CSI Compressco.

We have many opportunities ahead of us, and the board and I are very confident that he and the management team will help TETRA and CSI Compressco continue to evolve as we focus on creating shareholder value, generating cash and improving returns on capital. We have developed a very deep bench of talent within the management group that has been with us for a period of time in addition to other recent additions.

I would like to reach out and thank our shareholders, our sell side for their support, the management team and our board for 14 years that I've been at TETRA and CSI Compressco, which includes the 10 years that I've been CEO of TETRA. I have built great relationships in and outside the company that I cherish and expect to continue to evolve in the future.

With that, we'll talk about the fourth quarter. The fourth quarter was our third full quarter under new segmentation and reporting structure following the divestiture of the offshore decommissioning business and of Maritech. We continue to evolve TETRA's focus on fluids, water management, flowback testing and compression, as we believe these segments have competitive advantages, generate stronger returns on capital and have the greatest growth opportunities going forward.

I view 2018 as a very successful year for us. We have much to be proud of. TETRA's a much different company today than it was at the end of 2017, and I truly believe we are in a much better position to create shareholder value. We had a very strong fourth quarter, as all of our segments performed at or above our internal expectations and increased revenue sequentially despite some of the market challenges in North America, with the crude prices dropping to the low 40s during the quarter.

In a quarter of uncertainty on the onshore market well below peak levels and the offshore deepwater market, each of our 3 segments delivered 20% type-adjusted EBITDA margins, with fluids producing 20.2% adjusted EBITDA margins, water management and flowback services delivering 19.9% adjusted EBITDA margins and compression producing 21.1% margins.

In 2018 we completed 2 acquisitions in the Water & Flowback services segment. We've talked quite a bit about the acquisition of SwiftWater in early 2018 to expand our presence in the Permian and Delaware basins and to add incremental service offerings, mainly water treatment and recycling. That acquisition has been a great success, as SwiftWater provided a much bigger Permian footprint for our water business. It also has outperformed our financial expectations. Our focus and a big part of our overall strategy in the Water & Flowback services segment is to take advantage of our multiple service offerings by integrating them and combining with automation technology to be the lowest cost per barrel, safest and most efficient water management service provider.

Since the rollout of our integrated solutions product strategy that we noted at our investor conference in May, as of Q4 we were on 16 different integrated solution projects across multiple basins, up from 11 that we reported in the prior quarter. This is something to be extremely proud of, as we are adding value to our customers and creating better margins through these projects. These integrated projects allow us to differentiate ourselves from the competition, allow us to remain at the jobsite longer and allows us to be more efficient and generate higher margins. I believe this has contributed to the strong fourth quarter that we just reported.

In December 2018 we completed a smaller tuck-in acquisition in the Water & Flowback services segment in the Appalachian region to significantly increase our water management offering in that region, further boosting our integrated project strategy. That acquisition is now nearly fully integrated, and in the first couple of months with TETRA has generated margins and returns above our initial expectations. We will continue to look at strategic opportunities to add to our footprint and offering at the right value on the right basins. We are highly focused on returns as we pursue any future acquisitions.

Fourth quarter revenue was modestly up, and adjusted EBITDA was unchanged for Water & Flowback services from the third quarter despite a challenging Lower 48 market, as crude prices dropped to the 40s around Christmas and with some customers shutting in early for the holidays. I think this segment performed well during the fourth quarter, given the volatility of the market.

Even though there's been some pullback in fracking activity in some areas, we continue to be bullish on this segment long term, as this is an area where water volumes are going to continue to increase, and the amount of produced water continues to become a bigger challenge to our customers. This is why our approach towards integrating and automating these services are becoming differentiators, especially when combined with some of our proprietary technologies such as TETRA STEEL 1200 and the automated blender. Additionally, we are investing funds and resources to automate our services to reduce the amount of required personnel around the well site, which will boost our margins. The combination of automation and a broader service offering is becoming a differentiator.

Our segment adjusted EBITDA margins at 19.9% were slightly below the 20.3% which we achieved in the previous quarter. We have now seen 3 consecutive quarters with some of the strongest margin in the segment over the last 3 years. This segment is expected to continue to grow despite some of the short-term challenges, and we will continue to add capital organically as well as look for inorganic opportunity to aid its growth. During the year we looked at several other acquisition opportunities, and we continue to have the discipline to go after those that fit the strategy only and give us the returns we're looking for.

Completion fluids and products segment revenue increased modestly from $63 million in the third quarter to $64.7 million in the fourth quarter, driven by increased offshore domestic and international sales. Adjusted EBITDA margins of 20.2% are the highest in a quarter since the last quarter of 2015 without the benefit of CS Neptune revenue and are up 40 basis points sequentially. This is the first time we've crossed the 20% EBITDA margins mark, as we previously have seen adjusted EBITDA margins in this segment mostly in the low teens in quarters without the benefit of CS Neptune.

The segment can generate 20% EBITDA margins in a weak deepwater market without the benefit of CS Neptune, which reflects our vertically integrated business model that provides us at cost a booming supply advantage. The industry is going through a period of rising bromine prices, but our supply agreement is allowing us to capitalize on our vertically integrated business model that provides a cost advantage in a period where our competitors are seeing a higher cost of bromine. We continue to see this segment strengthening, even when we exclude the benefits of TETRA's CS Neptune.

We previously reported that the CS Neptune projects anticipated for the fourth quarter 2018 were pushed into 2019. As we mentioned in our press release this morning, one of the anticipated projects was not completed by our customer, as the customer decided to cancel the completion phase of the well. The drilling phase of the second project continues, and timing for CS Neptune would be dependent on the formation pressures encountered and completion timing, but most likely in the second half of 2019.

We're also currently in advanced discussions for a Gulf of Mexico project scheduled for this year and believe that the downhole pressures will require CS Neptune as the solution. Beyond 2019, we're in discussions with 2 more major Gulf of Mexico deepwater operators for the lower Tertiary development projects. These lower Tertiary development projects will likely require a Generation 3 CS Neptune fluid capable of achieving density weights of 17 pounds per gallon. This technology is increasing the number of CS Neptune applications by significantly opening the downhole pressure window, and we continue to make strides in the development of this solution as well as in testing it with our customers, as can be evident by the aforementioned discussions. Our overall pipeline for CS Neptune completion fluid projects continues to build, and our relationship with Halliburton to identify additional CS Neptune completion fluid opportunities continues to gain traction.

For the compression segment, we reported significant sequential improvement in revenue and adjusted EBITDA. Compression EBITDA improved sequentially at every quarter in 2018, starting with the second quarter of 2018 coming out of the downturn. Compression fourth quarter revenue was the highest in the history of CSI Compressco since the acquisition of CSI in August of 2014. Throughout the year, compression made progress growing its revenue and adjusted EBITDA by deploying new large-horsepower equipment and high returns and recognizing the operational and financial benefits from the fully integrated ERP system deployed in 2017.

While some of the industry struggles with Permian Basin takeaway constraints, we continue to see compression as part of the solution. Demand for compression to address the issues impacting demand for some well site service companies remains strong, and all of the additions to the compression fleet are backed by customer commitments.

Our compression segment continues to be robust and growing. We've increased revenues for 5 consecutive quarters and expect 2019 to grow on a year-over-year basis, though we don't expect Q1 to be as high as Q4 was due to seasonal slowdown and lower equipment and aftermarket sales within the segment. CSI Compressco announced in its press release yesterday that capital expenditures are expected to be between $60 million and $65 million. It includes the $18 million to $20 million for maintenance capital expenditures, and they are expected to be self-funded.

In addition, as Elijio will elaborate, TETRA will buy and lease CSI Compressco an additional $15 million of high-horsepower equipment. Inclusive of TETRA capital investment, CSI Compressco is expected to deploy approximately 99,000 of new horsepower into its fleet in 2019, all with customer commitments. This compares to the 92,000 horsepower deployed in 2018, mainly in the Permian Basin, South Texas and SCOOP/STACK in almost exclusively high-horsepower units focused on gathering systems in centralized gas lift. The new units CSI is deploying are priced higher than other similar units in CSI's fleet, and the incremental margins achieved on those units are materially higher than those on the existing deployed units. As a result, the new units are generating returns of capital of approximately 20%.

Pricing for the CSI Compressco fleet also increased throughout 2018 as contracts rolled over or new contracts were put in place. Utilization for 1,000 and higher horsepower equipment focused on gathering systems and centralized gas lift was 95% at year-end, which is essentially at full utilization for the large-horsepower equipment. Overall, utilization for the fleet increased to 86.6%.

CSI Compressco's equipment sales activity was extremely strong in the fourth quarter. It was the highest since the August 2014 CSI acquisition, benefiting from extremely strong bookings at the beginning of 2018. CSI Compressco ended the year with a backlog of $105 million, all of which is expected to be delivered in 2019. CSI Compressco ended 2018 with orders of almost $190 million, a record for the company. Its 2019 delivery book is nearly filled with a year-end backlog and orders received to date and due to lead times of certain components.

With that, I will turn it over to Elijio to provide some financial details on the quarter. Then we'll open it up for questions.

Thank you, Stu. Consolidated fourth quarter revenue from continuing operations was $282 million compared to $257 million in the third quarter of 2018 and compares to $200 million from the fourth quarter of last year. Consolidated and adjusted EBITDA from continuing operations for the fourth quarter was $46.6 million and compares to $41.8 million in the third quarter and $29.6 million in the fourth quarter of 2017.

Revenue for completion services and products was at $65 million and compares to $63 million in the third quarter of 2018. The modest sequential increase was driven primarily by strong year-end offshore fluid sales in the Gulf of Mexico and international markets. Completion fluids and products adjusted EBITDA was $13 million or 20.2% of revenue. We had no CS Neptune sales in the fourth quarter, as all of our opportunities moved to 2019 and beyond, consistent with the guidance on our prior earnings call.

Water & Flowback services revenue was $80 million in the fourth quarter, an increase of $1 million from the third quarter. Water & Flowback services fourth quarter adjusted EBITDA was $15.9 million or 19.9% of revenue. U.S. onshore Water & Flowback services revenue increased modestly despite concerns in the market about takeaway capacity in the Permian and the Delaware basins.

As mentioned in our press release this morning and some of Stu's comments, we are making strides in our integrated management offerings and we are in the midst of being on 16 different projects at year end, up from the 11 we reported during the last earnings conference call. We have now fully integrated SwiftWater into our Permian Basin operations and are continuing to see cross-selling benefits from this acquisition.

In the fourth quarter, we also completed a small water management acquisition in the Appalachian Basin and are excited to broaden our customer base and offering in that region. The integration of that business should be completed in the first quarter of 2019. We expect a 2- to 2.5-year payback on this investment.

Compression services fourth quarter revenue increased sequentially by 20%, primarily due to continued strong activity from aftermarket services and a record high in new unit sales. Compared to a year ago, revenue is up 66%. Compression segment adjusted EBITDA in the fourth quarter was $29.2 million, a $4.6 million improvement from the previous quarter.

CSI Compressco's coverage ratio was 28x, up from 1.07x in the third quarter due to the stronger earnings and the distribution reductions we announced in the December 20, 2018, press release. As a reminder, on December 20, CSI Compressco announced plans to reduce a quarterly common unit distribution for the fourth quarter from $0.1875 per unit or $0.75 per year to $0.01 per quarter, or $0.04 per unit per year.

With respect to the CSI Compressco balance sheet, the goal was communicated at the May 31 investor conference that we held in 2018 to improve our EBITDA leverage ratio from the current levels to 4.5x or below. Based on the 2019 adjusted EBITDA guidance that CSI Compressco provided yesterday and in its press release, the net leverage ratio will be in the 4.5x at the high end of the adjusted EBITDA to 5x at the low range of the adjusted EBITDA, a material improvement from the current levels, reflecting the strong rebound in adjusted EBITDA that we are seeing.

TETRA's balance sheet remains strong. As a reminder, in the third quarter, we refinanced TETRA's outstanding debt by replacing the secured bank revolver with a $200 million term loan B. We also have a delay draw option available to us for $75 million that can be used for acquisitions. We also put in place an asset-based credit facility. This refinancing provides TETRA with better flexibility, friendlier covenants and allows us to have the financial capacity to address opportunities as they arise. As of December 31, 2018, TETRA-only net debt was $158 million, inclusive of $24 million of cash on hand.

For CSI Compressco at the end of December, we had $15.9 million of unrestricted cash. The CSI Compressco new debt structure that we implemented earlier in 2018 is without maintenance covenants and no near-term maturities. CSI's net debt at the end of December was $617 million, inclusive of $15.9 million of cash on hand.

And as before, I'd also like to again remind everybody that TETRA and CSI Compressco's debt are distinct and separate. There are no cross defaults, no cross collateral, and no cross guarantees on the debt between TETRA and CSI Compressco.

TETRA's objective in 2019 is to generate free cash flow at levels higher than we did in 2018. In 2018, TETRA-only free cash flow excluding discontinued operations was $3 million for the full year. In the fourth quarter, we generated $15.6 million of TETRA-only free cash flow. Our objective in 2019 is to improve on this $3 million that we generated for the full year of '18, including the impact of lower distributions coming from CSI Compressco to TETRA and after funding a $15 million compression investment of equipment that we'll make for CSI Compressco. That equipment will be owned by TETRA and will be leased to CSI Compressco, where TETRA will make the returns normally associated with compression equipment. CSI Compressco has the option to buy this equipment at any time over the next 5 years from TETRA at agreed-upon prices.

Our guidance for 2019 is going to be limited, given the volatility of the market in the fourth quarter and the uncertainty in the short term. We continue to monitor our customers' 2019 capital expenditures budgets and expect the Lower 48 overall E&P budgets to be down between 5% and 10% year-over-year, while international and offshore spending should be up modestly. However, we believe that most of our customers will not slow down as much, and the decline in spending in the Lower 48 is mainly due to smaller private E&Ps for whom our work is limited.

Despite the challenges we are experiencing and the more subdued outlook recently, we feel 2019 will be a stronger year. We expect our first quarter revenues to be down sequentially, driven by typical beginning-of-the-year slowdown, as some of our customers are still trying to finalize their 2019 capital budgets, and lower equipment sales and aftermarket services for CSI Compressco following their record fourth quarter levels. We expect consolidated first quarter adjusted EBITDA to be down sequentially on timing issues but to increase as the year progresses. I encourage you to read our news release from this morning and CSI Compressco's press release from yesterday for all the supporting details.

All in all, we believe we had a strong quarter in all our segments and a good end to the year. With that, I'll turn it back to Stu.

Thank you, Elijio, and we will now open the call to questions, and Brady will also help us with some of the Q&A. Thanks.

[Operator Instructions.] The first question comes from Praveen Narra from Raymond James.

Praveen, we might have you on mute.

Praveen, your line is now open.

Nancy, maybe circulate and we'll come back to Praveen and see if he gets a better connection.

Okay, thank you. Our next question comes from Kurt Hallead from RBC.

Stu, congratulations on your retirement. Brady, welcome aboard. So appreciate the fogginess that presents here in 2019. Maybe I can kind of go along with the dynamics of this. So you've mentioned you expect free cash flow -- I'm assuming that's on a TETRA standalone basis -- to be better in 2019 relative to 2018. What kind of order of magnitude improvement would you expect on a year-on-year basis?

So Kurt, we're going to refrain from giving specific guidance, but 2018, as we mentioned, was $3 million. We believe that the impact of the Neptune wells and working capital initiatives will allow us to beat that one and put us in double digits for the year.

Okay. And can you remind us on the Neptune front, with the cancellation of this 1 project, what sort of order of magnitude revenue would we have been looking, or would you have been expecting for that project if it were to come through?

Yes, again, as you know, we don't typically talk about specific well revenue, margin, et cetera. I would give you a few comments and then hand it over to Brady to expand. But I think overall, the pipeline we have, the advanced testing we have, the specificity of jobs, we feel very, very comfortable. So despite the frustration of that 1 project not getting completed that we believe would have been a very successful well for us, we think we have more than other capable replacements during 2019. Brady, you might want to give a little bit more color, just the overall Neptune landscape because I know that's a big element of the strategy for everybody.

Yes, sure. So yes, Kurt, so obviously the 1 project that we were planning for was drilled, but the completion phase was not executed, was canceled. But as we mentioned previously, those 2 projects that we've been tracking, 1 of those projects will continue into 2019 is in the drilling phase. At some point in time we believe they will drill and complete a well that hits the Neptune pressure regime, and so that project is still active and alive.

Since then, we've added another project that we mentioned in our press release in the Gulf of Mexico. So typically, at least in terms of revenues, the volumes of the Gulf of Mexico wells and projects are higher than the international projects that we've mentioned previously. So again, that adds to our outlook and optimism for 2019 and beyond.

Okay, great, appreciate that color. And maybe if I just sneak one more in on the context of that water acquisition you acquired during the course of the fourth quarter, what kind of annualized kind of revenue and profitability will that bring to the table?

So Praveen, we file our 10-K tomorrow -- I'm sorry, Kurt -- you'll see when we file our 10-K tomorrow that we paid $8.6 million with a $1.5 million earn-out. And I mentioned earlier in the transcript that we expect a 2- to 2.5-year payback on an adjusted EBITDA basis. So that will give you a sense of the profitability.

Our next question comes from Stephen Gengaro, who is with Stifel.

Thank you, and I'll echo the congrats to you, Stu. So a couple of questions. I think the first one, when you look at the margins in the back half of the year for the fluids business, and quite honestly, even the water business, the EBITDA margin's right about 20%. And if we think about that going forward without a Neptune job and, obviously, on the fluids side, how do those margins evolve in '19? Are they stagnant? Can they trend up in a flattish activity environment? Like how should we think about that margin progression?

Yes, I think qualitatively at a flattish margin on the Water & Flowback side, we would expect to see continued improvement on margins. Because of the integrated projects, the automation, those will typically allow us to pull through more services, get better margins, so I think that will be a positive to us.

The other thing that we've seen in the 12 months we've owned SwiftWater, and even in the 2 months with our Appalachian acquisition, is when you bring guys in that know the business really well, you'll start to get some revenue pull-through probably higher than you modeled. And I've been really impressed over the last 12 months in the integrated projects expansion, the use of TETRA STEEL on -- produced water has increased.

Even in the first 2 months in Appalachia, the guys up there are finding new opportunities with their existing customers to pull through some other services. So I think that kind of portfolio broadening, the recycling of produced water, all that's going to continue to be positive.

On the fluid side, as we mentioned, we do feel like when we go through a period of high bromine inflation, which we're clearly in today, our supply chain strategy will enhance our margins. So I think Brady and the team have been very, very focused on making sure we're allocating to the right customers in the right regions. And then when the Neptune business comes on top of that, you've seen over the last several years what the expansion on margins is with those projects. We feel really good about all 3 of the businesses.

Thank you, and then as -- my second question, it's a little bit detailed. But so when you -- so it's kind of 2 parts. So one is, when you think about TETRA-only free cash flow, I wanted to, A, confirm. I think, Elijio, you said that you'll beat the $3 million mark and that includes the $15 million investment in equipment for Compressco? Is that right?

Right, so in 2018, Stephen, we generated $3 million of TETRA-only free cash flow, which included the benefit of the distributions from CSI Compressco to TETRA. And as you know, on December 20 we announced that we're cutting the distribution essentially to $0.01 per unit per quarter. We believe that our profitability in 2019 will absorb the lower distributions coming from CSI Compressco to TETRA and also will absorb a $15 million capital expenditure that TETRA will make and fund for equipment that will be leased to CSI Compressco.

Okay, that's $15 million, right?

One-five.

Yes, yes, okay, okay. And then just as a follow-on to that, and this may be -- it may be a question for Stu or Brady or whoever wants to take it -- but when we think about the long-term investment in Compressco and how that evolves and whether it does evolve, this transaction would seem to suggest it won't evolve, and not that that's a good or bad thing, but can I read into that, that you're even more excited and focused about the opportunities in compression? Or was the investment made for other reasons?

Yes, I'll take the first pass at it, and if Brady wants to add, that's great. Again, clearly, how we continue to evolve CSI Compressco is a very strategic question and a very good question. And we've done great with that business. The cash flow it's brought to the parent company has been very beneficial.

When I look at the $15 million backstop, I think I'd put it in the context, Stephen, of we know -- we've looked at the cash flows of the business this year, given the guidance that's out there. We made a decision to pay down this Series A with cash instead of equity due to the stock price, which I think everybody has universally applauded. We look at next year and we see in the range of $60 million of free cash flow available to that business. So we're very focused on how we use that cash to continue to delever, which we want to get down below 4.5x, judiciously put it to growth CapEx on high-return projects with busy customers that we want to continue to build out and think through the distribution policy.

So the $15 million is just, as we looked at the capital allocation this year, we thought that was an investment we wanted to make as a company, and we thought the best source of that in the short term would be TETRA. And as Elijio referenced, over the next 5 years CSI Compressco has the ability to take that equipment back, buy it and keep it under its asset base. So I look at that as kind of a temporary, onetime-ish type of investment that makes sense, given all the other variables that are intersecting. I would not view that as a strategic statement of intent, one way or the other.

[Operator Instructions.] Our next question comes from Praveen Narra with Raymond James.

Stu, congratulations on the upcoming retirement. I guess I was just getting too choked up to talk about it before. I guess if we can talk a little bit about the integrated water uptake -- obviously, a lot of projects coming up -- can you talk about both the customer profiles of those who are seeing the uptake? And if you could, could you talk about how the profitability compares to how you guys had talked about it at the analyst day?

Yes, we'll let Brady handle that one because he's kind of the leader on that initiative.

Yes, these are very important projects to us. As far as the customer base, it really goes across all of the operators, from the major IOCs to the smaller independents. So we're seeing uptake and support really across the board. In addition, we've expanded where we started in the Permian to now the other regions. I think we mentioned in our press release in the Appalachian region, in the Mid-Con and we're now in one in the Rockies as well. So the uptake across the customer base goes across the board.

The margins on these projects, we believe, will be and demonstrate better margins than our typical discrete services, primarily because of the efficiencies that we can bring in utilization of people. We're on the jobsites longer. The actual pricing for us is sometimes better. So yes, overall, it's been a real -- its uptake has been stronger than we anticipated and continuing to gather momentum.

Right, okay, perfect. And then I guess following up on the prior question just in terms of prioritization of capital, so you mentioned how the TETRA-CSI agreement kind of falls in. But how do you see future capital expenditures going forward? Is it largely the build-out of these advancements or are there just some areas where you're getting sub-1-year paybacks? How do you think of it?

Yes, when we look at it, I'd say if you look at the profile of the 2 TETRA businesses, fluids is -- we've made those major investments over the years. When I look back over all the changes we've made, which I think all great changes for the future, the one consistent theme is we've always continued to grow the fluids business and build that infrastructure. And I think we've seen in the last several years, it's a great free cash flow vehicle.

So I don't see a lot of new investment going into fluids. I think the Water & Flowback, we have a distant #2 market share in that business -- growing, but there's still a big gap. I think the strategy we have on integrated solutions, the coverage in all the basins, some of the proprietary technology on recycling -- that's the area where you'll see most of that CapEx. And we expect at the middle of the cycle, those are going to be 18-month paybacks. So those are the type of things.

You don't have to -- you can do it within free cash flow. It makes sense. And we're very, very sensitive to the focus on returns and capital allocation, and the thing nobody ever sees except management is the projects that get turned down, the decisions we decide not to go forward on. So I would give credit to Brady's operating team, Elijio's team. We're being very disciplined on capital, but I do think, going forward, water will be the place where most of that organic growth is going to come from.

Yes, and if I could just add to that, Stu, certainly the TETRA STEEL, even with the activity declines that we've seen since the end of Q4, we're sold out on TETRA STEEL. We'll continue to make investments in that technology. The recycling, as Stu mentioned, we're still seeing uptake in that, even with a little bit lower activity on the completion side. And the automation component of that, that we -- that's a key enabler for all of our integrated projects -- would be priority areas for us for capital allocation.

The next question comes from Thomas Curran with B. Riley FBR.

Stu, smooth sailing in your next chapter, and Brady, congratulations and best of luck. For Water & Flowback, could you update us, just how does the pipeline of potential M&A prospects look as we sit today? And what have you seen in your regional markets in terms of new entrants? How has the competitive landscape evolved since the last call?

I'll cover the first part on the M&A and then I'll ask Brady to take the second part on the evolution of the competitive landscape over the last few months. I'd say the Water & Flowback is an incredibly fragmented market, always has been, will continue to be. Lots of opportunities for consolidation.

We looked at many opportunities last year. And again, when you look at some of the adjustments in the numbers, you'll see that we had some fees associated with transactions we did. We also had some fees associated with transactions we didn't do. And we think there's a lot of other water-related companies that either have specific technology or certain geography within a basin, that it augments what we have.

The most recent acquisition up at Appalachia's a great example. We've been in this company up in Appalachia forever in our water business, predominantly up on the northeast area in our testing businesses, predominantly down in the southwest area, and we now add a really great water company to that. So I would expect to see those bundled projects in the southwest continue.

So I think there's going to be a strong pipeline, and we have a very strong internal definition of what our balance sheet's going to look like. I'd say the last several years, Elijio has taken a lot of time with his team to remove the covenants to give us flexibility. I think we learned some lessons in the downturn of not wanting to be in a position to issue equity when we don't want to. So I think that oversight gives us the flexibility. But we're going to do it in the context of maintaining the pristine balance sheet at TETRA, and we're certainly not looking to issue equity at this price point.

So when the world gets better, when we, hopefully, see improvement to the valuation of the company, as the activity gets more predictable, I think the space we've invested in, we'll do organic and inorganic. So I'm very optimistic about the ability to grow both organic and inorganic in North America.

Brady, do you want to talk about the competitive landscape?

Yes, no, just to add a little bit of color to your comments, it is a very fragmented market. We believe there's a lot of room for consolidation and that we are in a great position to be part of that consolidation activity.

If you look at our strategy with the integrated projects, where we have a strong water business but perhaps not a strong PT or vice versa, when we add that other component to a local market like the acquisition at Appalachia, we immediately see the benefits of an integrated business, which we've already taken advantage of in Appalachia, as we've mentioned. So that will continue to be something we're focused on and looking at opportunities on a go-forward basis. I actually see more consolidation because of the efficiencies that can be brought than we're seeing in terms of significant new entrants, from my perspective.

Thank you for all that color. As a follow-up, Brady, I know you just mentioned that you're sold out of the TETRA STEEL, not surprising. And I'm sorry if I missed this earlier, but could you update us on where you ended 2018 in terms of total temporary transfer miles of hose, both TETRA STEEL and then just standard industry lay-flat? And based on the fact that water will be commanding such a large share of the CapEx budget this year, where you would expect to exit this year in terms of inventory?

Yes, Thomas, I don't believe we actually communicate the mileage of hose externally for single-jacket and TETRA STEEL, so I'm afraid I'm not -- I may not be able to answer that. I'm sorry, Stu?

Yes, so we haven't, so I just want to jump in. Yes, I'd give some color but historically, we haven't quantified miles of single- or double-jacketed.

Would it be fair to say, though, that you expect to meaningfully increase it over the course of this year?

Yes, I would expect that to be the case, Thomas, yes.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Brightman for any closing remarks.

Yes, thank you. Again, in summary, I think it was a great quarter, great year. I think we're incredibly well positioned in this volatile market to perform very well in '19. I'd say most importantly, as this is my last call, and Brady and Elijio will handle it in May, the company's in great shape. I'm incredibly proud of what we've accomplished, and I leave the company in awesome hands with these guys as well as all the other folks that are back around the world. So thank you all for your support over the years.

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