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Edited Transcript of CELP earnings conference call or presentation 14-Aug-18 2:00pm GMT

Q2 2018 Cypress Energy Partners LP Earnings Call

Tulsa Aug 30, 2018 (Thomson StreetEvents) -- Edited Transcript of Cypress Energy Partners LP earnings conference call or presentation Tuesday, August 14, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey A. Herbers

Cypress Energy Partners, L.P. - VP, CAO & Interim Principal Financial Officer of Cypress Energy Partners GP LLC

* Peter C. Boylan

Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC

* Richard M. Carson

Cypress Energy Partners, L.P. - Senior VP & General Counsel of Cypress Energy Partners GP LLC

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Conference Call Participants

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* Brian Joseph Butler

Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst

* Cheng Wang

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Michael Christopher Gyure

Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Cypress Energy Partners Second Quarter Earnings Release Conference Call. (Operator Instructions) I would like to advise all parties that this call is being recorded.

I'd now like to turn over to your host today, Richard Carson. Please go ahead.

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Richard M. Carson, Cypress Energy Partners, L.P. - Senior VP & General Counsel of Cypress Energy Partners GP LLC [2]

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Thank you. Hello, and welcome to the Cypress Energy Partners Second Quarter 2018 Investor Conference Call. I am Richard Carson, the Senior Vice President and General Counsel. With us today are Pete Boylan, our Chairman and CEO; and Jeff Herbers, our Vice President and Principal Financial and Accounting Officer.

We released our second quarter 2018 financial results and posted the press release on our website, cypressenergy.com, yesterday. In the press release, you will find an important disclaimer regarding forward-looking statements. This disclaimer is an essential component of our remarks, and it is important that you review it. Also included in the press release are various non-GAAP measures that we have reconciled to financial measures under generally accepted accounting principles. Those reconciliations appear toward the end of the press release.

With that, I will turn the call over to Pete.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [3]

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Thank you, Richard. Good morning. Thank you for joining us today and for your interest in our company. First of all, I would like to thank all of our dedicated employees for their hard work that, combined with the continued improvement in market conditions, led to solid Q2 results.

Commodity prices ultimately impact everyone in our industry, regardless of the type of assets you own, the services you offer or the contracts you have with your customers, and we are no exception. We continue to benefit from stronger crude oil prices that have risen approximately 40% from a year ago. The strength of our recovery can clearly be seen in our significant improvements in EBITDA and distributable cash flow compared with prior periods.

Our Pipeline Inspection business, TIR, Tulsa Inspection Resources, achieved an important milestone in June, celebrating its 15th anniversary. TIR is a remarkable success story that has been profitable every year of its history, has proven its resiliency during the financial crisis and the recent energy downturn, and has posted an impressive history of growing its business organically.

We've been quite active this quarter deleveraging the partnership with the refinancing of our credit facility, issuing preferred equity, selling our other Permian Basin saltwater disposal facility and reconstructing another saltwater disposal facility in North Dakota. I would like to highlight each of these transactions and how they have or are expected to impact our business.

During the second quarter, we refinanced our credit facility and have significantly reduced our debt from $136.9 million at the end of last year to $76.1 million at June 30, a decrease of 44%. By reducing our debt, we will enjoy much lower interest expense. In addition, we now have a much stronger balance sheet, with a net leverage ratio of approximately 3.09 trailing 12-month EBITDA.

To delever our company, we hired an adviser and shopped the market for the best available terms on preferred equity before issuing a $43.5 million convertible preferred private investment and public equity, otherwise known as a PIPE, from an affiliate of our sponsor. Although we explored other deleveraging options, we were not presented with any superior alternative to the PIPE, although we continue discussions on our potential strategic partnerships.

Our business will benefit from substantially low NII leverage, which in turn significantly reduce our interest expense, improve our distributable cash flow and position us to increase the size of our credit facility when we find a suitable acquisition opportunity.

During the second quarter, we sold our Orla, Texas facility on attractive terms for $8.25 million, $250,000 of which was escrowed while we completed the reconstruction of the facility, and we recorded a gain in our financial statements of $1.6 million on this transaction. The proceeds from the sale provided additional capital that we used to reduce the outstanding balance on our revolving credit facility prior to our refinancing.

With this divestiture, we are now able to focus all of our saltwater disposal efforts on our North Dakota operations where we have substantially more scales of economy with our 9 saltwater disposal well facilities in the Williston Basin. In 2017, our sponsor provided $4.1 million of support at no charge to our unitholders, reconfirming the fact that its interests are fully aligned with our unitholders because of our 64% common unit ownership interest in CELP.

During the first half of 2018, given the material improvements in our business, we did not require sponsor support and do not anticipate requiring additional support from our sponsor in the future. As a result of the seasonality of our business, we believe that we will continue to improve our operations through the third quarter and into the fourth quarter before we experience typical lower activities due to colder weather, holidays and our customers' annual budget cycles. Our business metrics at the end of the second quarter, and those projected going forward, have also improved.

We provide essential midstream services, with approximately 96% of our revenue and approximately 78% of our EBITDA in the second quarter generated from our required mission-critical pipeline inspection and integrity services. Our focus continues to be on growing and diversifying our inspection and integrity services, increasing our customer base and pursuing additional piped water midstream projects.

During the second quarter, we continued to make progress with service lines begun in 2017 and planned further expansions in our inspection and mechanical integrity service businesses.

Our Pipeline Inspection segment revenue from our U.S. operations were appreciably higher during the second quarter of '18 compared to the same period in '17. Our gross margin also improved 15% over the prior year on flat revenues, reflecting our conscious decision to discontinue some low-margin work in Canada and focus on higher-margin integrity service opportunities. These improvements have also improved our working capital efficiency.

We remain very focused on growing maintenance and integrity projects, margin improvement, capital efficiency and managing and increasing our distributable cash flow. As previously discussed, we continue to be most focused on our mix of customers' lines of business and the inherent margins that go with them, not gross headcount.

We continue to believe that our Pipeline Inspection and Integrity Services segments will have many additional opportunities over the next several years due to continued aging of North America's existing pipeline infrastructure, increasing regulatory requirements and the continued energy sector economic rebound. We will continue to invest in organic growth while also looking at acquisition opportunities that will broaden the lines of service we can offer our clients.

Our 51%-owned Integrity Services segment that provides hydrotesting services also showed significant improvements compared with the same period in '17. Revenues increased 28%, but more importantly, gross margin increased over 130%. We have strengthened our management team, built our backlog and continue to bid on a substantial number of upcoming opportunities. We have high expectations for this business segment given maintenance work that was deferred by our pipeline customers during the industry downturn, as well as new construction projects coming online.

With respect to our Water Services segment. Activity in North Dakota has materially improved from the same period a year ago and we currently benefit from a combination of higher oil prices and rig counts, the completion of the DAPL pipeline, which improved differentials, and the substantial new investment for private equity-backed E&P companies who have plans to invest in drilling and completing new wells.

The rig count has more than doubled from the bottom of the downturn and permit growth has been solid. We continue to benefit from the January 2018 completion of 2 new pipelines in one of our facilities as demonstrated by the increased volumes and the average saltwater disposal rates per barrel. We also continue to explore additional pipeline opportunities that would expand the volumes we process with limited additional costs since our saltwater disposal well facilities are currently operating at about 40% of their true capacity.

Our Grassy Butte saltwater disposal well facility was damaged last year in a lightning strike and fire resumed operations in the quarter as well. Our second quarter 2018 volumes on the remaining SWD facilities, when you pro forma for the divestiture of our Texas facilities, were actually up an impressive 60% from the same quarter last year and our revenues increased over 100%.

Total revenues of our Water Services segment were 50% higher in the second quarter compared to the second quarter of 2017, despite having sold 2 of our Permian Basin saltwater facilities. During the second quarter of 2018, approximately 43% of our water volumes were received via 9 pipelines, and we continue to pursue other pipeline opportunities, as I mentioned earlier. And over 90% of our total water is produced water.

We continue, as a team, to examine and evaluate accretive acquisition opportunities consistent with our previously stated goals of diversification. Our sponsor and their affiliates remain willing to deploy capital to assist us in acquiring attractive assets that may be larger than what we can currently acquire independently. We plan to offer those assets as potential drop-down opportunities.

With that, I'd like to turn it over to Jeff Herbers who will now walk you through some of the additional financial highlights for the quarter.

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Jeffrey A. Herbers, Cypress Energy Partners, L.P. - VP, CAO & Interim Principal Financial Officer of Cypress Energy Partners GP LLC [4]

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Thank you, Pete. Non-GAAP financial information that we will discuss on this call includes adjusted EBITDA and distributable cash flow. These metrics are reconciled to GAAP measures in our 10-Q.

Adjusted EBITDA for the second quarter was $5.9 million, $5.6 million of which was attributable to our common unitholders and $0.3 million of which was attributable to the noncontrolling interest owners that owned 49% of our hydrostatic testing subsidiary.

Adjusted EBITDA during the second quarter of 2017 benefited from $0.8 million of sponsor support. Exclusive of this support, operational adjusted EBITDA increased by 47% in the second quarter of 2018 compared to the second quarter of 2017.

Distributable cash flow for the second quarter of 2018 was $3.1 million. Distributable cash flow during the second quarter of 2017 benefited from $0.8 million of sponsor support. Exclusive of this support, operational distributable cash flow increased by 146% in the second quarter of 2018 compared to the second quarter of 2017.

During the quarter, we paid $1.7 million of cash for interest and incurred $0.1 million of maintenance capital expenditures. As you can see, we have a very attractive CapEx-light business.

Our net income in the second quarter of 2018 was $3.6 million. Of this net income, $3 million was attributable to our common unitholders, $0.4 million was attributable to our preferred unitholders and the remainder was attributable to noncontrolling interest. The net income attributable to our common unitholders of $3 million increased 108% over the second quarter of 2017. As Pete mentioned earlier, the preferred units were issued in the second quarter of 2018.

In addition to these financial highlights, I would also note that our leverage ratio, as calculated under our credit facility, was 3.6x and our interest coverage ratio was 5x. These ratios improved compared to the ratios in previous quarters as a result of the refinancing of our credit facility in the second quarter. Cash outstanding at the June 30 was $10.5 million.

The headcount of our U.S. operations was 9.8% higher in the second quarter of 2018 than in the second quarter of 2017. We sent an average of 1,188 inspectors per week to the field for the second quarter of 2018 compared to 1,186 in the second quarter of 2017, a slight decrease -- a slight increase despite the decrease in our active inspector work

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per week due to our decision to not continue with some low-margin work in Canada in the second half of 2017.

I'm especially pleased with our improvements in working capital efficiency in that we achieved a new record gross margin in this segment of 11.2% for the quarter, an increase of 15% over the prior year.

We disposed of 3.6 million barrels of saltwater during the second quarter of 2018 at an average revenue of $0.85 per barrel compared to 3 million barrels during the second quarter of 2017 at an average revenue of $0.68 per barrel. The 21% increase in volume is partially attributable to the 2 new pipelines that we connected to one of our saltwater facilities in January of 2018. And this increase in volumes occurred despite the sales in 2018 of our 2 Texas saltwater disposal facilities and the reconstruction of one of our North Dakota facilities that was inoperable for most of the second quarter as a result of the lightning strike that occurred in 2017.

As Pete mentioned, our North Dakota revenues increased 100% from a year ago. The increase in revenue per barrel is primarily due to a new gathering system, some price increases, higher oil prices and to management fees generated from a transition services agreement related to the sale of one of our Texas facilities. Confirming the attractiveness of the saltwater disposal business, the Water Services segment generated a gross margin percentage of 68% and an EBITDA margin of 45% in the second quarter of 2018 with nominal maintenance capital expenditures.

During the second quarter, 90% of our total water volume came from produced water and piped water represented 43% of our total water volume. As commodity prices continue to improve and drilling and completion activities increase, we expect to have significant operating leverage with our current cost structure, and we anticipate minimal maintenance capital expenditures as volumes increase.

We estimate that each incremental barrel of water we dispose has an incremental contribution margin in excess of 80% on average. Our saltwater disposal facilities were utilized at approximately 40% of their capacity in the second quarter of 2018. As activity continues to pick up in the Williston Basin, we should see some additional activity and financial benefits.

Our Integrity Services segment, which refers to Brown Integrity, which provides hydrostatic testing services, generated revenues of $3.1 million during the second quarter of 2018 compared to $2.4 million during the second quarter of 2017, an increase of 28%. Gross margin was $1 million during the second quarter of 2018 compared to $0.4 million during the second quarter of 2017, an increase of 130%. Our gross margin percentages increased from 17.9% in the second quarter of 2017 to 32% in the second quarter of 2018, specifically related to our increased activity and the resulting increase in utilization of our field personnel.

On a consolidated basis, maintenance capital expenditures for the second quarter were less than $150,000 reflecting the attractive business model we have in our portfolio of businesses that all had limited maintenance capital expenditure requirements. This remains a key differentiator for us versus virtually all other MLPs. Our growth capital expenditures were primarily related to our pipeline expansion; the rebuilding of the surface equipment at 2 of our water facilities, one of which we subsequently sold; and equipment purchases to support our growing non-destructive examination business.

With that, I'll turn the call back over to Pete.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [5]

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Thanks, Jeff. As you can see, we're very pleased to report the significant improvement on our operations relative to the second quarter last year, continuing a steady improvement in our business and operating results that began several years ago. And we certainly remain optimistic about the future.

Higher crude oil prices and rig counts should continue to benefit our industry, our customers and, ultimately, our partnership. As mentioned earlier, we continue to look at potential complementary acquisition opportunities and other strategic alternatives, and our management team continues to focus on pursuing the hundreds of other potential clients in need of our inspection services.

Once again, we truly appreciate your investment, valuable time and your continued support of our partnership. Our board, management team and employees remain committed to growing our company, while maintaining a disciplined focus on long-term unitholder value. I continue to be proud of our solid safety record and everyone's continued focus on safety.

Operator, we may now begin taking questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a question on the audio, it comes from the line of Mike Gyure from Janney.

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Michael Christopher Gyure, Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs [2]

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Can you talk a little bit, Pete, maybe about the pipeline inspector headcounts, the availability that's out there and maybe kind of the regions where, I guess, you're seeing the most strength in that business?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [3]

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Sure. So we have, in our proprietary database, over 21,000 qualified inspectors. As you might imagine, there's tons of different specialties, qualifications, credentialing, et cetera. So not, of course, all of those people have this skill or that skill. But we have no shortage of available inspectors to put to work on projects. I think it is true that there's a tremendous amount of new activity taking place in the Permian to deal with the differential problem and a bunch of projects that have been announced, and we expect to do well with that. You are seeing in some of those regional pockets, like the Permian, some increasing rates that inspectors can command, which of course benefits us and our business model given how the economics work of this particular business. Once you get out of West Texas, there really isn't a supply and demand imbalance anywhere. And of course, the companies like us that have the safety record, the insurance, the working capital, the reputation, the relationship with the customers are very well positioned to recruit and retain the best inspectors in the business. But I don't know if that addresses your question, but at a high level, that's what I'd say. There also was a movement afoot to upgrade the training of all inspectors, and it's a process called API 1169 certifications, and we have been a leader in that. It started several years ago. And yes, I believe eventually all clients are going to require 1169 certifications. But that is also another issue impacting supply and demand in a local particular geography.

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Michael Christopher Gyure, Janney Montgomery Scott LLC, Research Division - MD of Forensic Accounting and MLPs [4]

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Great. That's very helpful. And then maybe, again, staying in that business with the pipeline inspection. Can you talk a little bit about the headcount, up significantly in the inspector year-over-year, I think you said 9.8%. How should we think about the customers, the additions to your customer base, is that sort of along that same size increase? Or is it sort of spread across, I guess, your existing customer base?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [5]

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Yes, good question. And unfortunately, I wish there were simple answers to some of these. But the -- last year, as you may recall, we added I think over 40 new customers. And I think of our available or addressable market is over 1,100. And they fall into 3 general buckets, there's really 4, but the first one would be super majors that are owned upstream, midstream, downstream, they are Royal Dutch Shell and ExxonMobil, et cetera, they have all kinds of assets, pipelines, storage facilities, gas plants, compression stations, et cetera, that need inspection. The next -- and they don't have to be publicly traded but all the super majors are. There's -- although there's also some large E&P companies that have upstream and midstream assets that are private, PE-backed that need inspection. Your next bucket is your traditional midstream companies, most of which are public, the Enbridges, the DCPs, the Plains, the Enterprises. But there's also dozens of private equity-backed midstream companies that need inspection and have all those assets. The third major bucket is local distribution companies, we call them PUCs, public utility companies. There's over 130 of those that have small diameters, some have larger-diameter trunk lines, natural gas pipelines that bring gas to businesses and homes, et cetera, that are regulated typically by their state and they spend whatever they need to spend on inspection and integrity and get to pass it through to the rate payer, you and I. Then you've got some other folks that have assets that need inspection and downstream and pet chem and LNG facilities and so forth. So we believe we've only scratched the surface on what's possible. And sometimes it can take years of calling on a client before they're ready to make a change with their incumbent vendor. Sometimes, you get lucky in that a new sheriff's in town, central procurement gets involved, they want to shake things up and they go out to market, and you hit the timing right, you get invited and you have a chance to go show your capabilities, and you are awarded the work. And then other times, sadly, there are situations where an incident occurs, a spill or some high-profile crisis, you're familiar with some of them, and there's a scramble and they oftentimes end up considering new vendors and removing any vendor that they felt like didn't provide adequate services. So those are kind of the 3 different areas. But it oftentimes starts with 1 or 2 or 5 inspectors. And if we get in there and do good job, maybe it starts with staking, maybe it starts with non-destructive examination, maybe it starts with basic inspection and then it can mushroom from there very quickly. So our focus has not been on gross headcount, but has been on quality work with good clients where we can sell a multiple suite of services. And we really let other players in our industry pursue what I call the low-margin basic body shop type of inspection services. And so when you really look at what occurred year-over-year, we lost it -- our peak over 200 of those low-margin basic inspection services in Canada, and more than replaced it with other higher-quality, a lot of integrity, higher-margin headcount. So we're pretty proud of what we accomplished despite, at the time, people were concerned that somehow that was going to be a problem for us.

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Operator [6]

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Your next question comes from the line of Brian Butler.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [7]

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The first one, can you just give a little color kind of maybe on the deal environment and what you're seeing out there? And I know you continue to look at acquisitions, but maybe just put in perspective of how that's kind of transitioned from '17 into the first half of '18 and kind of how it's moving forward now.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [8]

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Sure. Well it is a very competitive environment, there's a tremendous amount of capital out there. We have finally seen fund flows turn positive in the MLP space after negative fund flows for several years. If you look at some of the prices being paid for traditional midstream assets, they're quite expensive. We are spending most of our time focused on the things we previously described that are covered under our private letter ruling that we believe are attractive businesses that have very nice free cash flow dynamics that can leverage some of the strengths we've got and we can acquire them on accretive terms that make sense. And I'm hopeful that we'll be able to get something done in the near future. We're pretty close, but you never know, anything can happen in the deal business. But I have been surprised at what some people have paid for saltwater disposal well assets. We have looked at a number of acquisitions and what others were willing to pay, I don't think makes any economic sense. And we have passed on a number of those, instead choosing to pursue organic growth opportunities, like what we did up in North Dakota that have substantially better economics for all parties. The inspection business has a number of opportunities out there that we continue to look at, but I'd say there's no shortage of capital and plenty of competition looking for assets right now.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [9]

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Okay, that's helpful. And I guess, also, on then the regulation front. A little color on kind of what's going on there. Are we still moving towards inspections, I guess, increasing? And is there a backlog that's still out there from the downturn that may have been put off that is being worked through? Or are we really now just working on new stuff as growth and kind of rig count increases?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [10]

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Yes, we think there's a very significant backlog of stuff out there that got deferred. It was a generational type of downturn that pressured every energy company. And as you might imagine, every energy company had to make difficult choices with their cost structure and deferred whatever they could defer. The beauty is you can't kick the can down the road forever in this business, and you ultimately need to invest the appropriate amount of resources in inspection and integrity. So we see a really nice backlog of work. It remains to be seen, but if I had to guess, I believe hydrotesting has a higher probability of becoming mandatory. As you've had more incidents occur in these PUC LDC natural gas line explosions that are smaller diameter OD pipe that isn't piggable. And so really hydrotesting is the only way to look at it. The other thing that I think is occurring is a lot of GNP assets, gathering and processing, smaller diameter pipe that heretofore had never been required to be inspected at the state level and was exempt at the federal level. Some high-profile incidents and spills are causing a lot of customers to begin doing ILI rounds in dig projects and hydrotesting of those lines. California probably has the most stringent new rules as a result of the San Bruno incident and the Santa Barbara incident. There's a PSAP program that the California Public Utilities Commission that oversees the 2 big players out there, PG&E and SoCalGas. You can go read about it on their websites, but basically it's a massive mandatory hydrotesting of all of California's infrastructure. And so we do a lot of work out there for PG&E, and we're not currently doing any hydrotesting work, but we think that's a good opportunity and we've got great capability there. So my sense is not only are you going to have new construction that you continue to read about with takeaway capacity issues in the Permian, but I think we're going to continue to see more and more spending on maintenance and integrity work because of the aging infrastructure and the state regulatory overlay that we're starting to see on top of the DOT-PHMSA requirements.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [11]

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Was any of that backlog conversion present in second quarter results here? Or is that still kind of waiting to be converted?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [12]

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Oh, I think we're getting some of the benefit. It's kind of hard to say. Nobody is ever going to really tell you, "Gee, this was a project I was going to do in X and I deferred it to Y." So -- but I would assume some -- we're benefiting from some of that.

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Brian Joseph Butler, Stifel, Nicolaus & Company, Incorporated, Research Division - Research Analyst [13]

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Okay. And then just one on modeling. The -- what tax rate should we be using in the second half of '18 and looking at '19? It was a low in the books anyways, the tax rate was low in the second quarter and I'm just trying to get that straight.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [14]

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Jeff, do you want to get back to him on that or do you have a point of view?

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Jeffrey A. Herbers, Cypress Energy Partners, L.P. - VP, CAO & Interim Principal Financial Officer of Cypress Energy Partners GP LLC [15]

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Yes, we'd be happy to get back to you on that. It's hard to model on a consolidated basis because it's really only the public utility subsidiary that's subject to income taxes.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [16]

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Yes, it's a little more complicated than that. So all our PUC business, as Jeff was saying, we, out of abundance of caution, run that business through a C corporation, block it and pay tax on it. As you probably know, MLPs are allowed a 10% to gross revenue exemption for nonqualifying activity, and the IRS considers our PUC to be nonqualifying. We haven't taken advantage of that exemption, instead we paid the full tax on it. As our revenues grow, if we do an acquisition that leads to material revenue, we'll have incremental flexibility there. Of course, federal rates went down, so we're a beneficiary of federal rates going down because we have to block and pay tax at both the state level and the federal level. And then we have diversified our client mix in the PUCs, so we work for a number of PUCs in a number of different states. And then lastly, you have what Texas calls a franchise tax, other states call other things that really aren't income taxes, but they show up in the tax line under GAAP, and those are tied to revenue and mix, if I'm understanding that correctly, Jeff.

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Jeffrey A. Herbers, Cypress Energy Partners, L.P. - VP, CAO & Interim Principal Financial Officer of Cypress Energy Partners GP LLC [17]

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Correct, correct.

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [18]

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So those are all the variables. So I would expect rates to be lower than they've been in the past, primarily driven by the cut in the federal income tax rate. But again, our mix of business, if we were to pick up some big work in a state with a higher franchise tax on gross revenues, you have that dynamic going on. So the mix is always changing.

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Operator [19]

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Your next question comes from the line of Patrick Wang.

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Cheng Wang, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [20]

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Sticking with the M&A theme. When you talk about potential exclusive activity behind radar, could you discuss the types of funding you'd expect to use here? It's such an attractive opportunity merge. And should we expect something similar to the preferred offering? And can we expect sponsors will support here?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [21]

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Sure, good morning. Yes, so we've got a couple of things that were pretty far down the road, and we would likely do those up at the GP. Fund them, clean them up and, eventually, bring them into the MLP for a combination of cash and equity to be determined. We also have the ability to do a transaction directly in the L.P., especially when there is a seller that's interested in a tax-efficient transaction with a security that pays a nice dividend. And so you have some of those. But as I mentioned in my prepared remarks, we have sponsor and affiliates that are willing to provide capital for good opportunities if we determine it's not appropriate to bring them initially directly into the L.P.

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Cheng Wang, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [22]

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Okay, great. That makes sense. And then shifting over to the water business. With those 80% contributions you mentioned earlier, can you talk about your near-term appetite for additional pipeline infrastructure into your facilities? And then how would you force rank this type of organic growth versus acquisitions?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [23]

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So we always look at acquisitions, and if we think something is accretive, fairly valued, doesn't have a whole bunch of problems -- and we look at a lot of deals that have a lot of problems that people not in our business don't really understand what they're getting into. Because there are issues that can make a trailing 12-month EBITDA or DCF look really good that are going to be really expensive down the road and they're going to underperform. So when we can get comfortable with an acquisition opportunity, that there isn't a whole bunch of problems in deferred maintenance, if there's not lousy leases with surface owners that have residual liability down the road, we're happy to pay a good price if it's accretive to the company. And in particular, if we think we can add incremental value to our customer relationships, pipeline opportunities, scales of economy, et cetera. But having said that, the acquisitions are generally less lucrative than building additional pipelines or making piped water deals with producers to come into our existing assets that have the capacity. And so we have a number of opportunities we're currently working at any given time that fall under that category. And within that category of a new pipeline into one of our existing facilities, there's really 2 business models. There is the business model we prefer, which is the producer builds the pipeline on their balance sheet into our facility, we negotiate a multi-year contract, we give them attractive economics because they risk the capital building that pipeline into our facility. And those tend to have better net economics. But we're also happy to invest capital, our own capital, as we did in the 2 pipelines we built and completed in January of this year, where a producer wants to spend their capital on other things, finding new hydrocarbons, drilling new wells, et cetera, they prefer not to build the water infrastructure, we're happy to go build the pipeline, build new SWDs if need be. And in that case, we're going to end up with a stronger contract with economics that assure us an attractive return on that capital. Typically, you end up with your traditional midstream business model of X dollars a barrel for transportation that helps you amortize and earn a return on the cost of building that pipeline and the capital required to do it, plus obviously you get your disposal economics per barrel. So we're open to both. We have done both, and we have plans to complete some more of them.

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Cheng Wang, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [24]

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Got it. That's very helpful. And then the last one from me. At your Grassy Butte facility, was the utilization there approximately in line with the 40% for you -- for the rest of your business?

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Peter C. Boylan, Cypress Energy Partners, L.P. - Chairman, CEO & President of Cypress Energy Partners GP LLC [25]

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No, it would have been much lower because it just -- it almost probably didn't contribute anything in the second quarter. I think we got it opened late in June. So practically, it probably had negative cash flow in the quarter.

Well, operator, it doesn't appear we have any further questions. So thank you again, everybody, for your interest and have a great week. So long.

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Operator [26]

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Thank you to all presenters. Ladies and gentlemen, that concludes your conference call for today. You may now disconnect. Thank you for joining and enjoy the rest of your day.