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Edited Transcript of TTI earnings conference call or presentation 9-May-19 2:30pm GMT

Q1 2019 Tetra Technologies Inc Earnings Call

THE WOODLANDS Jun 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Tetra Technologies Inc earnings conference call or presentation Thursday, May 9, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brady M. Murphy

TETRA Technologies, Inc. - President, CEO & Director

* Elijio V. Serrano

TETRA Technologies, Inc. - Senior VP & CFO

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Conference Call Participants

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* Coleman Wayne Sullivan

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* John H. Watson

Simmons & Company International, Research Division - VP & Senior Research Analyst of Oil Service

* Praveen Narra

Raymond James Ltd., Research Division - Research Analyst

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Stephen David Gengaro

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

* Thomas Patrick Curran

B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the TETRA Technologies' First Quarter 2019 Results Conference Call. The speakers for today's call are Brady M. Murphy, Chief Executive Officer; and Elijio Serrano, Chief Financial Officer for TETRA Technologies, Incorporated. (Operator Instructions) Please note this event is being recorded. I will now turn the conference over to Mr. Murphy. Please, go ahead.

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [2]

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Thank you, Nancy. Welcome to the TETRA Technologies' First Quarter 2019 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. 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 analysis made by TETRA and are based on a number of factors. These statements are subject to a number of risks and uncertainties, many of which, are not beyond the control of the company. You're cautioned that such statements are not guarantees of future performance and that actual results may differ materially for 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 and 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 this period.

This is my first conference call as CEO of TETRA and Chairman of the Board of CSI Compressco, following Stu Brightman's previously announced retirement effective May 3, at the May 2019 shareholder meeting. I'm excited and honored to take over from Stu and wish him the very best in his retirement. Stu will remain on the Board of Directors of TETRA through May 2020 and will remain available to support, consult and assist us as appropriate. Over his 10-year tenure as the CEO of TETRA, Stu, the board and the management team were instrumental in evolving the company and providing a foundation for a very bright future.

TETRA today is a company with great employees, an energized and talented management team and 3 great business segments that are very well positioned to take full advantage of the evolving energy services market in the coming years. Looking forward, there are several areas of priority that you'll see from us. First, I want to ensure a safe working environment for all of our employees, contractors and customers. No matter what part of the market cycle that we are in, this will always be a priority for us and all of our operations.

Second, we will be very focused on creating value for our shareholders, and this will be realized by generating high returns on capital. At the core of TETRA's capabilities is the ability to innovate and differentiate in each of our various business segments and service offerings. We will leverage that strength to gain market share, improve margins and generate returns above our cost of capital. From unique offerings in our Water & Flowback divisions, such as TETRA STEEL, treatment recycling solutions for any produced water composition and closed loop water and flowback automation services to nearly 40 years of innovative completion fluid offerings from our Fluid divisions; including zinc-free, high-density CS Neptune fluids, TETRA continues to bring high-value fluid innovations to the shale and deepwater markets.

Our Compression division is participating in a long-term North America gas production growth cycle, which is one of the best and consistent growth markets in our industry. We continue to participate in new compression opportunities with returns greater than 20% in our key markets and for key customers that rely on our service offering for both gas gathering and gas lift.

With that, I'll now provide some commentary on our first quarter results. In the first quarter, we experienced continued improvements in Compression services revenues and margins and are finalizing an agreement with a major operator for CS Neptune project in the Gulf of Mexico. We experienced lower margins in Water & Flowback services in a transition quarter, driven mostly by a significant shift in our customer concentration and profile. Comparing to the fourth quarter of last year in the Water & Flowback services segment, we have seen a major shift of revenue this quarter from smaller North America independent operators to large major operators. We believe this shift happened because the smaller independent operators were more negatively impacted by the drop in crude prices at the end of 2018. While we believe this transition is good for TETRA in the long run and will help us showcase our technology differentiation and integrated offerings to the operators with stronger balance sheets, this transition came with additional job demobilization and mobilization costs within the quarter and had a meaningful impact on our margins. The Completion Fluids & Products segment saw some sequential decrease in revenue and margins partially from seasonally weaker Gulf of Mexico demand, which was largely offset by strong international sales, which, we believe, is part of improved international market outlook for 2019.

The Compression segment continues to perform well, and demand for services is outpacing supply. And although we experienced a slowdown in the equipment sales in aftermarket business due to timing of shipments and overhauls, this was expected as we mentioned on our last call. Overall, in a challenging quarter from the drop in crude prices at the end of 2018, which led many of the NP operators to revise downward their 2019 capital spending plans, we feel good about the quality of the customers and the quality of the revenue we added in the quarter and believe we will deliver improved quarterly sequential results for the rest of the year after a quarter of transition.

As we've previously mentioned, a key part of our overall strategy in the Water & Flowback services segment is to increase our integrated solution projects, which allows us to stay on jobs for extended periods of time, showcase our technology and more effectively utilize our equipment and personnel. We have the ability to integrate our multiple service offerings and utilize closed-loop automation technology to be the lowest cost per barrel, safest and most efficient water management service provider. We have made steady progress each quarter since we introduced this strategy almost a year ago at Analyst Day in New York. We were on 11 projects at the end of Q3 last year, 16 at the end of 2018 and 19 in Q1 of this year. 2 of these additions in the first quarter were large recycling projects. Our first recycling award started in the summer of last year, and we continue to work this project and expand operations with this operator.

We're pleased with the traction this strategy is delivering for us. It's important to note that our customer mix with the integrated projects reflected a similar customer mix change as our overall North America business. Projects for our large operators improved by 7, but were offset by a reduction of 4 from the smaller operators. The switching costs that I mentioned before also affected our margins on the integrated solutions projects for the quarter.

We completed 2 acquisitions in 2018, and we'll continue to look at strategic opportunities to add to our footprint and offering. We've already seen some opportunities this year and will evaluate them for strategic fit at the right values. We are highly focused on cash returns as we pursue any future acquisitions.

First quarter revenue was modestly down sequentially and adjusted EBITDA was down $5.8 million for Water & Flowback services, again reflecting the additional costs incurred from the aforementioned customer mix shift and some high repair costs on our flowback equipment after a 3-year revenue and activity high in the fourth quarter of 2018. Our segment adjusted EBITDA margins of 12.8% were below the 19.9% margins, which we achieved in the previous quarter. We expect adjusted EBITDA margins to improve during the second quarter, but not yet recover to the fourth quarter levels. We will continue to invest in our proprietary technology, such as TETRA STEEL, automation and produced water treatment recycling offerings. We expect to have more opportunities for the differentiated offerings as we build our relationship and market share with the major operators.

Also, as we move more into the post-frac flowback and treating produced water, we expect that we'll see projects of longer duration giving us a more consistent revenue stream and more predictability in our future operations. This segment is expected to continue to grow despite some of the short-term challenges, and we will continue to add capital organically as we look for inorganic opportunities to aid our growth. Completion Fluids & Products segment revenue decreased modestly from $64.7 million in the fourth quarter to $61.6 million in the first quarter, or 4.8%. We saw some weaker Gulf of Mexico demand, mostly offset by strong international fluid sales.

Our Chemicals business performed well and benefited from an early start of our Eastern -- our seasonal Eastern European -- our European industrial activity. Adjusted EBITDA margins of 16.8% were down 340 basis points sequentially, but were 520 basis points better than the first part of 2018. Excluding last quarter margins, we've previously seen adjusted EBITDA margins in this segment mostly in the low teens in quarters without the benefit of CS Neptune. The 16.8% in this market environment is something we're comfortable with. And given the benefit of our vertical integration and bromine supply cost advantage, we believe this segment can generate 20% type EBITDA margins in the low deepwater market activity and without the benefit of CS Neptune.

Most of our Completion Fluids sales are for the deepwater wells for which drilling and completion has been depressed for several years. However, we are seeing signs of deepwater activity coming back. As this segment strengthens and drilling activity improves, we should see some real benefit for our Completion Fluids sales, even excluding the benefit of CS Neptune.

With respect to CS Neptune, on the last earnings call, we reported that we were in advanced discussions for Gulf of Mexico projects scheduled for this year. I'm pleased to announce that we've reached an agreement on the technical and commercial terms for a project and are in the process of finalizing the contract details. This is a Gulf of Mexico lower tertiary development project in the field with existing production, and where other wells in this field have pressures that require fluid density in the CS Neptune Generation 1 range. Drilling has started and the need for the Completion Fluids is expected to be in the second half of this year.

As with prior projects, these are deepwater complex wells with the exact timing on completion being a challenge to accurately predict. We expect this project to be of similar size as our previous Gulf of Mexico CS Neptune wells. As we have done previously, we will not disclose the specific customer revenue and profitability of these projects. We'll continue to have other advanced discussions for additional CS Neptune projects across the globe. Some of those discussions are directly with operators and some are through our relationship with Halliburton. As the list of opportunities for such projects increase, we see the potential for additional projects this year and in 2020, although timing of these complex projects are always difficult to predict as mentioned earlier.

As the offshore drilling sector increases activity, particularly deepwater, we'll have more opportunities for this proprietary fluid. We also continue to work on the next generation of CS Neptune that will have broader applications with higher densities as well as reservoir drilling, fluid designs and applications.

For Compression Segment, while our revenue decreased sequentially 25% to $103.5 million, this was entirely a function of the previous quarter's record high in equipment sales and aftermarket services, which we had previously communicated with the client in the first quarter before rebounding in the second quarter. Compression adjusted EBITDA was sequentially down $3.3 million to $25.9 million, but was up $7.1 million from this time last year. Our Compression services line continues to strengthen and improve in revenue and profitability. The demand for high-horsepower equipment to be added to our fleet continues to outpace supply, which gives us the ability to increase prices as contracts roll over and we put new units into service at what we believe to be the high end of market pricing.

On average, we're getting high single-digit price increases on large horsepower equipment as contracts roll over. On the new larger horsepower equipment, our fall-through margins are in the 65% to 70% range that are driving 20% returns on capital. All the new equipment we put in the service is attached to customer contracts as we do not build anything on speculation or anticipation of client demands.

We expect equipment sales and aftermarket to pick up starting with the second quarter and expect revenues to be significantly higher over the fourth quarter levels. In the first quarter, and for the first time in CSI history, operating horsepower surpassed the million mark. The utilization for 1,000 and higher horsepower equipment focused on gathering systems and centralized gas lift was 95.6% as of March 31, 2019, which is essentially a full utilization for the large horsepower equipment. Overall, utilization for the entire fleet is 87.2%, up 60 basis points sequentially. CSI ended the quarter with a backlog of $94 million. In April and May, they have added another $14.5 million of additional backlog, all of which is expected to be delivered in 2019. We remain bullish on the overall compression space as the industry is one of the strongest in the oil and gas spectrum.

With that, I'll turn it over to Elijio to provide some financial comments on cash flow and the balance sheet, and then we'll open it up for questions.

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [3]

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Thank you, Brady. Good morning, everybody. Consolidated first quarter revenue from continuing operations was $244 million compared to $282 million in the fourth quarter of 2018, and this compares to $200 million in -- from the first quarter of last year. Consolidated and adjusted EBITDA from continuing operations for the first quarter were $36.3 million and compares to $46.6 million in the fourth quarter and to $29.9 million in the first quarter of 2018.

I'm going to spend a few minutes on TETRA's free cash flow and the balance sheet, then on CSI Compressco's allocation strategy that was communicated to the market yesterday. In the first quarter, TETRA Only consumed free cash flow from continuing operations of $34.9 million. This compares to $29.9 million in the first quarter of a year ago. For the full year of 2018, TETRA Only free cash flow was $3 million positive. And as a reminder, during the entire 3.5-year downturn, TETRA generated positive free cash flow and was adjusted-EBITDA-positive for every one of those years. In the first half of the year, we have historically consumed cash, but have generated cash in the second half of the year. This is driven primarily from changes in working capital. There are 4 items that drive the timing on free cash flow. The first being the timing of payables that benefit the full year. This type of payment includes items such as insurance premiums, [infinite] bonuses for the prior year, property taxes, income and other taxes and other such items that are paid in the first quarter for either the prior year or our prepayments for the coming year.

The second is the timing of capital expenditures and how we sequence them during the year. The third is the seasonality of our Northern Europe industrial chemicals business. For the Northern Europe industrial chemical business, we built a significant amount of inventory in the first quarter, convert that inventory to receivables in the second quarter, then monetize those receivables in the third quarter.

The fourth driver is the timing on any major projects. Brady mentioned that we have reached agreement for a CS Neptune project that we expect to be completed in the second half of the year. The sum of these 4 items impact the timing of when we consume and when we generate free cash flow. It is still our expectation that free cash flow in 2019 will be above the $3 million of free cash flow that we generated in 2018. The confirmation of the CS Neptune project adds to our confidence of achieving this target.

For TETRA Only, we expect full year capital expenditures to be approximately $25 million in addition to $15 million of equipment that we have agreed to buy and to lease to CSI Compressco supporting their high-return opportunities. While the equipment is on lease to CSI Compressco, TETRA will be making the vast majority of the returns on the $15 million investment. This $15 million investment will be made throughout the year. TETRA Only capital expenditures in the first quarter were $8.9 million.

TETRA's balance sheet remains strong. We have an outstanding $200 million term loan with a delayed draw option available to us that can be used to finance acquisitions. We also have in place an asset-base revolver, which we will use primarily for working capital needs. At the end of March, we had net debt outstanding of $192 million, inclusive of $20 million of cash on hand. We have a debt structure with no significant maintenance covenants. And as always, I would like to remind, again, everyone that TETRA's 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.

I'll now spend a couple of minutes on CSI Compressco. For CSI Compressco at the end of March, we had $16.9 million of unrestricted cash. The CSI Compressco new debt structure that we implemented last year is without maintenance covenants and no near-term maturities. CSI Compressco's net debt at the end of December was $617 million, inclusive of the cash on hand that I mentioned earlier. The net debt balance was essentially unchanged from the prior quarter. CSI Compressco yesterday reaffirmed its guidance of generating between $125 million and $140 million of adjusted EBITDA. At the end of that guidance and after allowing for approximately $49 million of interest expense, $19 million of maintenance capital and $4 million of cash taxes, they are expecting to generate over $60 million of free cash flow in 2019.

As equipment continues to be deployed and price increases continue to be attained, given the very strong operating environment, that free cash flow should increase in 2020 and beyond. In 2019, over $30 million of the free cash flow was returned to equity holders in the form of a Series A cash redemption or in reduced -- or in distributions. The Series A preferred units are down to a balance of $13.3 million as of today. The free cash flow for 2019 was spent on cash redeeming the Series A preferred units and on growth capital expenditure opportunities that are generating 20% returns on capital.

On the Series A preferred units that are being fully redeemed through the end of August of this year, CSI Compressco will finalize plans once this redemption is complete for the deployment of the free cash flow that will create the most value to their unitholders. TETRA is a general partner and owns approximately 35% of the outstanding common units of CSI Compressco. To make the determination of how the fourth quarter of 2019 and all of the 2020 CSI Compressco free cash will be deployed, they will carefully assess how the CCLP unit price is trading, the price of the CCLP unsecured bonds are trading and CSI Compressco's continued ability to generate higher returns and push price increases on the equipment being deployed. Once those are determined, we will make a determination as to how we will deploy the cash.

However, what CSI Compressco will commit to is that we will not invest all of its free cash flow into growth capital. CSI Compressco is moving towards a 50-50 split of free cash flow going to high-return growth capital opportunities and towards returning cash to their stakeholders, being both bondholders and equity holders. CSI Compressco are committed to improving their leverage ratio to 4.5x or better. If CCLP's unsecured bonds stayed at a material discount, CSI Compressco are likely to take the opportunity and move some of the available free cash flow toward retiring unsecured bonds, accelerating their path towards the 4.5x leverage ratio.

As part of the 50-50 growth versus stakeholder returns, CSI Compressco will also evaluate the amount of the distribution. The focus for CSI Compressco is to improve their leverage metrics to enhance unitholder value, while taking advantage of the high-return opportunities with our major customers, those customers that have strong balance sheets and will continue to drill through periods of oil price volatility.

Returning to comment on TETRA consolidated, we expect second quarter profitability to be up sequentially across all of our segments, with the main driver being the transition towards major operators for Water & Flowback services, the timing of equipment and sale from deployed equipment for CSI Compressco and the seasonality of our Northern Europe chemicals business among other drivers. We further expect EBITDA to increase each quarter for the rest of the year with the major contributor being the CS Neptune project, Brady mentioned earlier. I encourage you to read our news release from this morning and CSI Compressco's news release from yesterday for all the supporting details.

With that, I'll turn it back to Brady.

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [4]

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Operator, we will open it up for questions now.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

The first question comes from Praveen Narra with Raymond James.

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Praveen Narra, Raymond James Ltd., Research Division - Research Analyst [2]

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I guess we could start on the integrated project. It's nice to see a number of customers using multiple. I guess my -- I'd be curious to hear how long it took for operators to go from a single trial of integrated project -- integrated service to adopting multiple? How many either pads or how much time it took? And how you think about that?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [3]

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Yes. Good morning, Praveen. I think it varies. Some of these operators -- we started early on in, say, Q3 of last year, and so we service those through the end of the year. We were basically on 16 projects at the end of the year, all of them were unique customers. As you move into Q1, we had 5 different operators adopt a second multiple or integrated offering. So that gives you a feel for the timing of transitioning from 16 unique clients to now a customer base of 5 with multiple in the first quarter.

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Praveen Narra, Raymond James Ltd., Research Division - Research Analyst [4]

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Okay. That's helpful. And then I guess now that you have several projects going, could you give us a sense as to, for the segment, what percentage of revenues are these integrated projects?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [5]

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Yes. I mean it's continuing to grow. It's becoming a meaningful part. I don't -- I don't know maybe Elijio can comment on the overall percentage of our North America revenue, but it's the fastest-growing portion of our revenue. And particularly the recycling projects, which we've mentioned, have been added. But I don't know the overall for tracking, actually, the overall percentage of our revenue at this point.

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [6]

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Praveen, I would suggest that it's still a small percentage of the overall revenue from this segment, but the key part of it is that it's now a sustainable month-to-month continuous opportunity with less mob and demob as we typically see with water transfer jobs.

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Praveen Narra, Raymond James Ltd., Research Division - Research Analyst [7]

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Right. And then I guess just one more, if I could. You mentioned some competitive pricing dynamics. I guess could you talk about how pricing is looking? Whether it's stabilizing across all segments? Or how you guys look at it?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [8]

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Yes. So our TETRA STEEL and our Flowback business has really been pretty resilient to any degradation in pricing. We're still getting a premium we think to what's in the market. We did see in the first quarter some pricing pressures on our single-jacket transfer lines. So that area in particular has seen some pricing pressures close to the double-digit range.

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [9]

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And Praveen, I will add that on the Compression side, when we saw a rebound early next year, we started ordering equipment and we had some customer commitments with pricing that we could attain early last year. That equipment started getting delivered in Q4 and Q1. And the equipment is being delivered in Q2 and beyond our equipment that we priced in Q2 and Q3 of last year. And now those are starting to come in at rates higher than what we've been deploying. So we're just now getting the benefit of that premium pricing for orders that were placed in Q2 and Q3 of last year on the Compression side.

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Operator [10]

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And next question comes from Sean Meakim from JPMorgan.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [11]

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So obviously it's good to see that you're into another Neptune deal, but just given the uncertainty that's still inherent in the project, could you maybe just give us some more parameters around how we should think about the timing between when the project begins? When you think you would get a go, no go on the need for Neptune? And then how long until you would be able to recognize revenue? And it's meant more to be not to be so specific to this project, but for this type of project -- again, I know there's a lot of -- a lot of things can change for a project like this in the deepwater, but I think it would be helpful for us to understand what that cadence looks like.

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [12]

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Right. So as I'd mentioned, Sean, drilling has commenced. We're familiar with this particular field. There is existing production there. So we have a fairly high confidence level that the well will be productive. And we're pretty familiar with what the pressure regimes are projected to be. So from that standpoint, I think our confidence level is fairly high. But as you know, it is a deep water well. The pressure regimes could be different than anticipated. So we won't really know until they have drilled through the reservoir, taken the pressures, make sure they have got the zones that they want to complete, and we'll be ready to mobilize our Neptune. So hope that gives you a little bit of color, but that's probably about as much as I can give at this point.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [13]

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Is there any -- can you give a generic timing that's going from commencement of drilling towards completion? And how long that takes to make it into revenue for TETRA?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [14]

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The completion phase at this point is projected probably latter part of Q3, if they stay on the drilling plan, as we understand it. But again, as we've seen before, some of these projects can move to the right a little bit, but we would recognize revenue when that completion fluid is deployed for the well.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [15]

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Got it. Okay. That's very helpful. And then just -- so on Water & Flowback, can you maybe just give us a sense of, on a run-rate basis excluding some of the transitional issues that you had in the quarter, does the change in customer mix on it don't have an impact on margin? Are the project-based -- is the project-based activity more what can drive differential in the margin? And if you go to the back half of '19 and driving EMPs do begin to ramp up activity, is it fair to say that you'll try to pursue some type of all of the above strategies, in other words trying to maintain these new relationships that you've been developing while also trying to win back some of the other work and maybe a bit more transitory?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [16]

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Right. Yes. Absolutely. I mean, let me answer the second part of that first because we really value the relationship we had with some of the smaller independents who had to reduce their activity, and we obviously plan to stay in contact with them with their plans and as they go back to work, we feel we'll be ready to support them. But clearly, we like the fact that we were able to transition so quickly in Q1 through the larger EMPs, demonstrate the value to them, and obviously, they are going to be a more important part of our business going forward.

From the margin standpoint, I think in terms of the highest impact, clearly, the shift in revenue was very unusual for us to see that type of shift in the same quarter. So I think the mob and demob costs -- when you're mobilizing, you have higher -- in demobilizing, you have higher manpower cost, and you're not getting the full services revenue for your equipment and offering. That impacts your margins pretty significantly, and we saw that in Q1. I think the flowback gear that we had a record quarter in Q4, the repair cost was the second part of the largest contributor. And then as I said, the single-jacket transfer line pricing was down somewhat from previously, but in terms of sequencing that's the lowest impact, we think, in the overall margin progressions from Q4 to Q1.

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Operator [17]

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The next question comes from Stephen Gengaro from Stifel.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [18]

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I guess 2 questions. The first just from a bigger picture perspective. I mean you talked a little bit on the -- in your prepared remarks about this. But when you think about the products within the TETRA family and you think about returns on capital going forward, can you help us, sort of, with a road map to returns on capital that meet you across the capital? What needs to happen? Whether it's market-driven? Whether it's TETRA-specific? Which products are [I guess the] largest contributors, et cetera? Just so we sort of understand that sort of outlook there over the next, say, 1 to 2 years.

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [19]

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So Stephen, let me start that and then I'll let Brady add to that. So 3 distinct segments. And as you know, we've got a separate capital structure for CSI Compressco, and other than this, [$15] million support that we are temporarily providing for them. We kept them pretty much distinct and separate and that everybody lives within their cash flow.

On the TETRA side, starting first with the Fluids business. You know that we've got a vertical integration. We've built up manufacturing facilities. We've got a very good network of distribution points, barges to move equipment back and forth on the opportunities across the globe. And we've got that network fully built out. If the deepwater market rebounds, we don't have to add more manufacturing capacity. We don't have to add more barges to move product around. We don't have to add more tank farms to hold the product out there. It's really going to be cost of goods sold that move through the system. And you've seen that during the downturn, we can run this business with maintenance capital under $5 million a year. So if the deepwater starts to benefit us -- the rebound in the deepwater starts to benefit us, there's very little incremental capital required on the Fluids business.

Now on the Water & Flowback testing side, we've been investing in recycling, in water treatment and in the value-added coming from the TETRA STEEL technology. And we have previously mentioned that we're getting returns of 18 to 24 months on this investment. And we've got hurdle rates that we negotiate aggressively with all the requirements coming in from the various operating units in terms of who's getting the capital. Those that are getting the best pricing, that are getting consistent utilization, and as we move now into some integrated projects, we're being out there on projects multiple months at a time instead of demobilizing and remobilizing every couple of months. So our return expectations for this segment remain in the 18- to 24-month period.

Then with CSI Compressco, we've been mentioning that we are attaining 20% return on capital. We're getting 5-year payback on 20-year equipment. It is our position that we're pricing at the top of the market when we compare and hear what others are doing out there. Those returns are holding. We're starting to concentrate our business toward those large operators that have the balance sheet to be more consistent in their spending patterns. And I think that we're starting to see that on the CSI Compressco site, especially when you look at fall-through rates in the 70% range on the Compression Services side. So that's how we think of it. We look at CSI Compressco as a standalone, 20% returns on capital, focus on core customers. Water & Flowback, 18 to 24 months, and the Fluids networks already fully built out. We don't expect to add more capital to that business.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [20]

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Okay. But when you talk about those portions of those businesses, will that be enough to drag the entire segment's cost of capital?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [21]

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We believe so.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [22]

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Okay. And then just as a follow-up or a nonrelated follow-up. When I think about the second quarter incentives, it's like $47 million, $48 million of EBITDA and we sort of think about the moving pieces on the 3 segments, any comments on the current incentives? And also, as you sort of think about that, which segments do you think we see the biggest sequential improvements in?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [23]

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So we've -- we ended the third quarter with our 3 segments performing at a better run rate than we started in the first quarter. We got our first pass of our April numbers, and we're encouraged with what we see. We think that the biggest impact is going to be first from the compression side of it, as more equipment gets deployed, and then we also mentioned yesterday that equipment sales is almost going to double from Q1 to Q2, and that we're expecting second quarter equipment sales to be in the $50 million range compared to somewhere around the $25 million range in the first quarter. So we think that those will translate into a very nice ramp up in EBITDA, Q1 to Q2.

The second area that we expect to see a benefit is, as we've now completed or we have seen a significant transition on the -- towards majors versus a smaller independent, that's gaining traction, that's converting to incremental profitability. We think that will be the second segment that can benefit. Then if we get timing in our favor on some of the Completion Fluids offshore, that will be the third opportunity on upside.

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Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [24]

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And then you also get the seasonal impact, right, on the Fluids side?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [25]

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Yes. And we have historically seen revenue improve from Q1 to Q2 anywhere between $10 million and $15 million of revenue with a very nice fall-through of EBITDA after that.

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Operator [26]

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The next question comes from John Watson from Simmons Energy.

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John H. Watson, Simmons & Company International, Research Division - VP & Senior Research Analyst of Oil Service [27]

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On the mob and demob costs in Q1, should we think about that as being about $5 million on the EBITDA line?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [28]

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We're not going to go into that level of granularity. I wouldn't suggest it was as much as $5 million. But focus more on it that it was demobilizing and before we start generating revenue on the new opportunities we've got downtime of people transitioning our equipment from one project to the other. But the actual out-of-pocket costs were not that high.

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John H. Watson, Simmons & Company International, Research Division - VP & Senior Research Analyst of Oil Service [29]

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Okay. Got it. And then the repair costs and Flowback, can you talk us through what that means? I think for some of your Flowback equipment you charge back the repair to your customer? Can you give some more color regarding the higher repair costs in the first quarter?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [30]

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Brady mentioned that in the fourth quarter, the volumes on the flowback testing site were incredibly high. It was one of the peak quarters that we've seen in recent history. If we complete one job and move to another, we have to pressure test all the equipment. We have to go through and clean up equipment and any repairs that have to be done if we believe it was caused specifically on a customer project due to either the debris coming through or pressure that was different than what we modeled in, then we will charge it to the customer. But you have to come in and pressure-test everything once it comes off and go through a cycle of doing that periodically. And that's really the process that we went through.

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John H. Watson, Simmons & Company International, Research Division - VP & Senior Research Analyst of Oil Service [31]

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Okay. That's helpful. And just one more within Water & Flowback. Are there any facility sales that we should be anticipating in the second quarter?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [32]

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None at this time.

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Operator [33]

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(Operator Instructions)

Our next question comes from Thomas Curran from B. Riley FBR.

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Thomas Patrick Curran, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [34]

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Elijio, for the Water & Flowback services division, could you just share with us what the revenue split was last quarter and this quarter between your 2 segments, water services and then flowback and treatment?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [35]

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We stopped providing that granularity, but I would suggest that water flowback is the greatest revenue stream within that segment. And that is inclusive of water treatment also.

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Thomas Patrick Curran, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [36]

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In both quarters?

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [37]

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Correct.

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Thomas Patrick Curran, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [38]

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Okay. And then Brady, could you give us an update on specifically for the water side where you're at with your automation plan? And at what point you would expect to have that concluded?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [39]

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Yes. Sure. I mean, you may be aware we have a lot of components of our current offering automated, whether it's the pumps, whether it's our distribution manifolds, whether it's our recycling units. The next phase really is taking the entire system that's on location, providing a holistic closed-loop automated software to be able to run that program -- even run that operation even remotely. And we're in the final stages of testing that software as we speak. And we are deploying it to a couple of trial clients in this quarter. And again, we believe that will be another step change in the overall automation capabilities of TETRA.

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Thomas Patrick Curran, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [40]

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Great. And just in terms of the percentage of your pumps and manifolds that are automated at this point, where do you stand currently for each?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [41]

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Yes. So we have nearly 100% of the pumps that we own. We always have a portion of our pumps that are on rental. Those we are working on a solution to be able to automate those as well, but that portion of the fleet remains on -- not automated, but again, we're working on a solution for that. Really, the rest of our manifolds are recycling equipment that's deployed with automation capabilities. So that's -- that would be 100%.

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Elijio V. Serrano, TETRA Technologies, Inc. - Senior VP & CFO [42]

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Thomas, I'm going to add one more data point to the question that you raised. Remember that in the fourth quarter, we did an acquisition of a water treatment in -- water transport company in the northeast. So now we've got the full 3 months benefit in the first quarter. Therefore, the water management business increased sequentially and the production testing was down modestly. And we attribute a lot of it toward the integrated projects plus the acquisition now with 3 months in the first quarter versus 1 month in the fourth quarter. Just a little bit more color to the question you asked.

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Operator [43]

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The next question comes from Cole Sullivan from Wells Fargo.

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Coleman Wayne Sullivan, Wells Fargo Securities, LLC, Research Division - Senior Analyst [44]

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On the last call, there was an international Neptune project that was -- looked like it could be in the wings for the second half of the year. Is that something that's still in the pipeline at this point?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [45]

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Yes. We actually have a fairly significant list of international pipeline projects. Now whether that falls into this year or 2020, a little bit difficult for us to predict at this point. And we don't like to comment until we actually have a secured order, but we're still tracking quite a few and a growing list of projects again through -- some of those through the Halliburton relationship that one could come into this year, but multiple projects, hopefully, in the coming years as well.

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Coleman Wayne Sullivan, Wells Fargo Securities, LLC, Research Division - Senior Analyst [46]

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Okay. And then just quickly on offshore and Completion Fluids. It looks like the 2Q is kind of ticking up, in the commentary you guys made on the second quarter expectations. How do you see that activity overall in '19 versus '18? Is there any way to kind of frame that?

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [47]

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Yes. On the offshore side, our Fluids business, we believe, internationally will continue to outpace 2018. We're clearly seeing some increased activity and opportunities for us. We also feel the Gulf of Mexico will be potentially up from 2018, certainly with the CS Neptune project that we have in our plans that would clearly be the case. But even with our base bromine business, demand looks fairly strong. So we would say, yes, year-over-year we should be seeing increased activity.

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Operator [48]

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

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Brady M. Murphy, TETRA Technologies, Inc. - President, CEO & Director [49]

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We appreciate your interest in TETRA Technologies, and thank you for taking the time to join us this morning. This concludes our call.

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Operator [50]

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The conference is now concluded, and you may disconnect your lines. Have a good day.