Earnings Call Transcript - TTI Q1 2020

Operator, Operator

Good morning and welcome to the TETRA Technologies First Quarter 2020 Results Conference Call. The speakers for today's call are Brady M. Murphy, Chief Executive Officer; Elijio Serrano, Chief Financial Officer; and Jacek Mucha, Vice President of Finance and Treasurer. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I will now turn the conference over to Mr. Mucha. Please go ahead.

Jacek Mucha, Vice President of Finance, Treasurer

Thank you, Brandon. Today's 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 beyond the control of the company. You are cautioned that such statements are not guarantees of future performance and that actual results may differ materially from those projected in the forward-looking statements. In addition, in the course of the call we may refer to net debt, free cash flow, adjusted EBITDA, adjusted EBITDA margin, adjusted profit before tax, or adjusted earnings per share, backlog liquidity, coverage ratio, or other non-GAAP financial measures. Please refer to this morning's press release or to our public website for reconciliation of non-GAAP financial measures to the nearest GAAP measures. These reconciliations are not a substitute for financial information prepared in accordance with GAAP and should be considered within the context of our complete financial results for the period. I will now turn this over to Brady.

Brady M. Murphy, Chief Executive Officer

Thank you, Jacek, and good morning everyone. Welcome to the TETRA Technologies, First Quarter 2020 Results Conference Call. I will summarize some highlights for the quarter and discuss how the current market conditions amid the COVID-19 pandemic and subsequent impact on oil prices are impacting our businesses. Then I will turn it over to Elijio for some balance sheet and liquidity details, which in turn will be followed by your questions. As it relates to the COVID-19 pandemic, I'm very pleased with the way our management team and employees have responded to this crisis. Every employee has taken this very seriously in implementing the safe practices that have been provided by the Centers for Disease Control and Prevention and the Occupational Safety and Health Administration. During this extraordinary time, we have implemented many actions to keep our employees and their families safe, all while delivering on our customers’ requirements at the highest levels of service quality. We continue to monitor the changes in the guidelines and will adjust our action plans accordingly. In the meantime, I want to thank all of the employees for their contribution to a safe working environment and delivering an excellent quarter during these unprecedented times. Turning to our results for the quarter, the first quarter of 2020 was a very strong quarter and start to the year for TETRA, achieving the highest first quarter adjusted EBITDA in five years. Despite U.S. land rig activity in the first quarter that was roughly 25% below the first quarter of last year, our adjusted EBITDA improved 32% on a year-over-year basis to nearly $48 million and a 9% lower revenue. This speaks to the successful strategies that we have been implementing, as well as the management team and great employee base that we have at TETRA. The year-on-year free cash flow improvement of nearly $40 million was also very important for us as we head into a very different and unprecedented market environment. I'm extremely proud of our results and what our employees have accomplished. In addition to the year-on-year cash flow and EBITDA improvements, the highlight of the quarter was our Completion Fluids & Products business performance, which was by all accounts a very strong quarter. With an adjusted EBITDA margin of 28.7%, we have achieved or exceeded our goal of adjusted EBITDA margins for our base completion fluids business of greater than 20% for the fourth consecutive quarter. In the past two quarters, we have announced major awards in many of the key deepwater markets, including Asia Pacific, Brazil, West Africa, and the Gulf of Mexico. In the first quarter, 35% of our completion fluids and products revenue came from customers’ deepwater completion projects, as we continue to build market share in high-value deepwater completion markets around the world. We also continue to grow the CS Neptune pipeline of projects in both the Eastern Hemisphere and Gulf of Mexico, and given what we know today, several of these projects should occur before year end. We are very pleased that TETRA's CS Neptune was awarded the prestigious E&P Special Meritorious Awards for Engineering Innovation in the Drilling Fluids and Stimulation Category for the year 2020. Another 40% of our completion fluids and products revenue for the year is expected to be from the industrial market, which is comprised of agricultural, food, manufacturing of flame retardant products, and seasonal weather products among others. This market is holding up very well in the current environment. In the first quarter, we renewed a four-year contract with one of our largest industrial products customers in the United States. Our Northern European industrial chemicals business is on track in the second quarter to contribute between $10 million and $15 million of incremental revenue and up $10 million in cash from operational activities above its normal quarterly run rate. As mentioned previously, we have negotiated a long-term, low-cost supply of raw materials for our chemical processing plants in Louisiana and West Virginia, and in the first quarter, we expanded that supply with additional agreements. This has increased our available capacity well into the future, but it also led us to the difficult decision to close our higher cost mechanical evaporation chemicals operations in El Dorado, Arkansas. The operations there are expected to wind down before the end of the second quarter. The Water & Flowback Services business held up relatively well in the first quarter, with flat sequential revenue, but with adjusted EBITDA margins improving by 200 basis points to 11.8% from the fourth quarter and adjusted EBITDA improving 21% to $6.8 million. As this business is heavily leveraged to the U.S. onshore completions activity, the market is expected to be impacted the most in today's environment, and we anticipate activity to drop dramatically in the second quarter as completion activity declines. We are taking all the necessary steps to align that business with expected activity levels. In addition, with the company-wide cost reduction actions which I will touch upon later, we expect to exit the second quarter with 35% fewer employees in our U.S. land operations for this segment versus where we were as of March 31 of this year. Despite the decline in the market, we have been successful in deploying our SandStorm sand separation technology, which finished at the end of March with the highest utilization rates since we introduced it in the second half of last year. While our capital expenditures will be reduced until market conditions improve, this is one of the areas we're willing to invest in given the rapid customer adoption and market share gains at good returns. We also continue to make great progress with our integrated projects strategy and ended the quarter with 30 integrated projects for 17 different customers, providing those services in all the major U.S. basins, including the Appalachian Basin, which is much less affected by the decline of current crude oil prices. While we know the next few quarters will be extremely challenging for this business, we believe the combination of aggressive cost-cutting, increased adoption of our automation products and services, and delivering on our new technologies should help us maneuver through this downturn. Moving on to our compression business, which performed relatively well in the first quarter despite much lower sequential improvement sales and aftermarket activity, first quarter adjusted EBITDA was $26 million. Despite lower sequential adjusted EBITDA, our profitability increased, as evidenced by our first quarter adjusted EBITDA margins that were 240 basis points higher at 28.8% versus 26.4% in the fourth quarter of last year. However, in March, especially near the end of the month, we started seeing weakness in the market as some customers returned equipment while cutting their drilling and production plans in response to the downturn in the industry. This has also accelerated into May and April. Our utilization at the end of March was 86.5%, down 350 basis points from the end of 2019. As we move on to the second quarter, we expect our compression business to be challenged by customers shutting in production to align with much lower product demand and a lack of available storage. The production shut-ins are a new development from prior downturns and are having a rapid impact on our business. Today we've heard from at least 10 publicly traded operators who have announced plans to shut-in production for their U.S. shale production. By the end of May, we expect up to 20% of our fleet to be impacted by shut-ins in some form or fashion. Furthermore, historically only 2% of our fleet has been on standby rates at any point, but we now expect over 10% of our domestic fleet will be on standby rates by the end of May. Given the lack of new equipment orders over the past several months and/or the near to mid-term outlook for demand for new compression equipment, we’ve decided to shut down our fabrication operations in Midland, Texas. The closure of that facility is anticipated to happen in the early third quarter of 2020 as we finalize fabrication of the remaining current backlog. As we exit the fabrication business, we will also look to sell our prime 38-acre Midland facility and real estate. Moving forward, things have changed dramatically in the energy markets and continue to change very rapidly. The U.S. land rig count is now below 400 or down 50% since the beginning of the year, and by all accounts, fracking completion activity is declining just as rapidly. Most of all, not all E&P operators have revised their 2020 budgets in the last six weeks, and we now project operators' capital spending for U.S. land to be down 40% to 50% from 2019 levels. We have responded accordingly with across-the-board company cost reductions which include salary reductions, headcount reductions across the organization, a 20% reduction in Board of Directors cash retainers, reduction of all discretionary expenditures and suspension of employer 401-K matching programs, as well as negotiated reductions with expenditures with many of our suppliers. In addition, we have reduced our TETRA capital expenditures to between $10 million and $15 million for the year, with a vast majority already committed in the first half. We'll continue to adjust the cost structure to match the current market conditions. So in summary, we had a very strong first quarter in a challenging environment, but with over $100 million of adjusted EBITDA in the past two quarters and a $40 million improvement in TETRA-only cash flow year-on-year in the first quarter, we have positioned the company very well to navigate this crisis. The diversity of our business with a large component of deepwater offshore and industrial markets and our vertical integration that provides us a cost advantage will help us move through what will be a very difficult period for the service industry in the U.S. land markets. When this market eventually rebounds, TETRA will be very well positioned to be even stronger. With that, I’ll turn it over to Elijio who will provide some financial comments on cash flow and balance sheet, and then we'll open it up for questions.

Elijio Serrano, Chief Financial Officer

Thank you, Brady. In the first quarter, TETRA generated free cash flow from continued operations of $4.7 million, up from $1 million in the fourth quarter of 2019 and up nearly $40 million from the same period of 2019. While some of this cash generation was due to collections of receivables that slipped from the fourth quarter of 2019, a significant portion is from our strong first quarter operating results and our focus on working capital management. This cash generation was also above our most recent guidance. As a reminder, typically the first quarter of each year consumes cash due to the timing of large annual payments, yet despite this historical seasonality, we're able to achieve strong cash generation as we move into what we expect to be a challenging balance for the year. During the quarter, we also generated $22 million of consolidated cash provided by operations, a $17 million improvement sequentially. TETRA liquidity at the end of the first quarter improved approximately $13 million from the same period a year ago, positioning the company well to manage into this downturn. TETRA liquidity is defined as unrestricted cash-on-hand, plus availability under our revolving credit facility. Year one of a downturn is typically met with cash generation as we monetize working capital, particularly from collecting receivables and draining inventory. We don't expect this to be any different and believe that our liquidity could increase over the next one to two quarters. For TETRA, first quarter capital expenditures were $5.6 million. In 2020, we expect TETRA capital expenditures to be between $10 million and $15 million, down from our prior guidance of between $20 million and $30 million as we adjust our capital spending to the current market conditions. TETRA net debt at the end of March was $185 million, with cash-on-hand of $22 million. Our $220 million term loan is not due until August 2025 and our $100 million asset-based revolver, which has a current borrowing base of approximately $60 million, does not mature until September 2023. The only significant maintenance covenant we have to comply with is a one-time interest coverage ratio on the term loan. At the end of March, our interest coverage ratio was 3.9x versus the covenant of 1x. Annual interest expense on this term loan is approximately $16 million to $17 million for the coming year. We believe we have adequate liquidity to manage in this downturn. And as before, I’d like to remind everybody that TETRA and CSI Compressco debt are distinct and separate with no cross-defaults, no cross-collateral, and no cross-guarantees on the debt between TETRA and CSI Compressco. I’ll now make a few comments on CSI Compressco. On April 17, we commenced an offer to certain eligible holders to exchange any and all of their outstanding 7.25% senior unsecured notes due in 2020 to our newly issued 7.5% senior secured first lien notes due 2025, and 7.25% senior secured second lien notes due 2027. On May 1, we issued a press release extending this first deadline from April 30 to May 14. The second deadline originally communicated of May 14 remains unchanged. Any questions from our bondholders related to this process will be directed to our Bank of America contact that is managing this process for us. For CSI Compressco, in order to respond to this downturn and to a lower customer demand, we are lowering our capital expenditures to be between $20 million and $35 million for 2020, with maintenance capital expenditures reduced to between $20 million and $22 million and investments in technology to improve operating efficiencies reduced to between $3 million and $5 million. For CSI Compressco, growth capital will be between $5 million and $8 million as we wind down some customer commitments, and in the second half of the year, we expect total capital expenditures for CSI Compressco to be approximately $6 million per quarter. At the end of the first quarter, CSI Compressco’s leverage ratio was 5x. Given the outlook for our decline in earnings, we expect the net leverage ratio to increase in the upcoming quarters. At the end of March, CSI Compressco’s total gross debt outstanding was $649 million, of which $350 million are secured notes that mature in the year 2025 and $286 million are unsecured notes that mature in August of 2022. The indentures for the secured and the unsecured bonds do not contain any maintenance covenants. CSI Compressco also had a $50 million asset-based revolver with a current borrowing base of about $25 million, before letters of credit of which $3 million was outstanding at the end of the first quarter. Cash-on-hand at March 31, 2020, for CSI Compressco was $7.4 million. As CSI Compressco came out of the previous downturns from 2014 through 2017, we changed its capital structure to eliminate maintenance covenants in order to give us more flexibility to navigate through future downturns. Yesterday, CSI Compressco hosted its first quarter earnings conference call and provided a significant amount of detail on what the compression sector is expected to face with this downturn. I encourage you to listen to that earnings call if you haven't done so already. In the last downturn, TETRA remained free cash flow positive in each of the downturn years. While this downturn is historic, caused by a global pandemic and a steep drop in demand for oil in addition to oversupply with inventory capacity quickly filling up, we believe we've got the playbook to manage our business during difficult times and will again execute on the actions necessary to remain free cash flow positive during periods of reduced activity levels. We're off to a strong start with our cash generation in the first quarter of this year and are prepared to take the actions necessary to navigate through this downturn. Our diverse business model which includes industrial chemical sales, international onshore and offshore activity, vertical integration in chemicals, and proprietary CS Neptune technology position us well to tackle any market conditions and challenges. I encourage you to read our press release from this morning and the CSI Compressco news release from yesterday for all the supporting details and additional financial and operational metrics. Brandon, with that let’s go ahead and open it up for Q&A.

Operator, Operator

Thank you. Our first question comes from Stephen Gengaro with Stifel. Please go ahead.

Stephen Gengaro, Analyst

Thank you. Good morning, gentlemen.

Brady Murphy, Chief Executive Officer

Good morning.

Stephen Gengaro, Analyst

I guess two things. One, I'll start with the fluids which is obviously a very strong performance in the first quarter. You gave some details on 35% being sort of deep water leverage and 40% non-oil and gas industrials, and you've also talked about some contract awards recently; they are secured for deep work. When we think about the fluids revenue line going forward and if we think about this in an environment where U.S. CapEx, land CapEx is probably down and we could let’s say 50% for the year and the second quarter looks to be really weak, how should fluids perform relative to that backdrop?

Elijio Serrano, Chief Financial Officer

So, remember Stephen that the second quarter has the seasonality peak in Northern Europe that historically has increased somewhere between $10 million and $15 million. We expect that the second quarter will drop off a bit, but that it'll hold up because of that seasonality. Then from Q3 and Q4 it really then will depend whether our operators react and start pulling back activity on the offshore side of it, but given some of the wins that Brady mentioned, some of the market share that we're gaining, I think that that drop-off will be significantly less than what everybody else is expecting on the onshore business.

Brady Murphy, Chief Executive Officer

Yes, typically Stephen these cycles, you know the offshore and international markets hold up much better than the very rapid U.S. activity, and we fully expect that to play out in this downturn. There have been some shifting around of some activity in the second half of the year, but so far nothing significant that would materially impact our forecast for our fluids business for the rest of this year.

Stephen Gengaro, Analyst

Okay, great, thank you. And then my second question, when you look at – and I know you talk about the debt structure and how it stands right now, and I know you walked through a lot of parameters around what's going on with the CCLP business and you had a lot of detail in yesterday’s conference call. If there is a problem at CCLP from a query perspective, what mechanically happened? Like what's the impact? I understand that you’re not on the hook for the debt levels, etc., but what would it look like if something like that were to take place from the Tetra's perspective?

Elijio Serrano, Chief Financial Officer

A couple of data points Stephen, and that's a good question. So yesterday we announced that CSI Compressco reported Q1 EBITDA of $28 million, and that’s still annualizing to over $100 million, but we clearly have lower quarters coming ahead. In the last downturn, CSI Compressco bottomed out at $86 million of EBITDA, and if you look at our interest expense on the bonds for CSI Compressco, about $48 million, and then maintenance capital expenditures of around $20 million, and then a couple of million dollars for cash taxes and so on. You're going to see a cash minimum requirement on an annual basis somewhere in the $65 million to $70 million range for CSI Compressco, or call it $17 million a quarter. Our objective is to keep the profitability above the EBITDA, above $17 million, and right now, we've got a cushion of $11 million between the Q1 EBITDA and those minimum cash requirements. And recognize that we have demonstrated that when necessary and if appropriate, we are not shy about taking costs out of the system. We also mentioned that we are shutting down our Midland fabrication facility and putting up our real estate for sale. It’s a 30-acre facility, prime real estate in Midland, and if we're successful with that, we should generate some cash. So while I think CSI Compressco has some challenges ahead of them with all the shut-ins that are occurring, I think that we've got this under control in terms of aggressively managing the cost to keep it cash flow positive.

Stephen Gengaro, Analyst

Great! Thank you for…

Elijio Serrano, Chief Financial Officer

And just to add to your impact to TETRA, so if things go very difficult and they get into a liquidity crunch, TETRA’s exposure is essentially around 34%, 35% ownership of the LP units of CSI Compressco and the GP ownership; that's the extent of our exposure to CSI Compressco and TETRA.

Stephen Gengaro, Analyst

Great! Thank you.

Operator, Operator

Our next question comes from Praveen Narra with Raymond James. Please go ahead.

Praveen Narra, Analyst

Great! Good morning, guys.

Brady Murphy, Chief Executive Officer

Good morning.

Praveen Narra, Analyst

I guess on the – I want to follow-up on the completion fluids revenue breakdown, the information you provided for 1Q that Stephen was referencing. Would there be a way you guys could provide that information for the whole of 2019, just to give us a sense of what a full year might look like, knowing the U.S. land portions begin to decline faster?

Elijio Serrano, Chief Financial Officer

So historically, Stephen, when you take into – Praveen sorry, when you take into account the spike in Q2 earnings, it'll be right around 40% of the segment as industrial sales and it'll vary up or down depending on whether we pick up some big Neptune projects that increase the denominator. But the numerator comes out to about 40%, give or take a couple of percentage points on an annual basis for all industrial chemicals across the globe.

Praveen Narra, Analyst

Okay, and how about the deepwater completion side?

Brady Murphy, Chief Executive Officer

The deepwater can be a little lumpier, Praveen. You know certainly we have a well-established business in the Gulf of Mexico and key deepwater markets, but as you can imagine, the deepwater wells when we deliver a high-end completion fluid can be a bit lumpy and we did have some good sales in the first quarter that we're still expecting through those awards that we talked about, you know deliver a solid rest of the year performance on our fluids business.

Elijio Serrano, Chief Financial Officer

And Praveen, remember that we've got two significant competitive advantages on the deepwater fluids. One of them is a long term bromine supply agreement that we've got out of West Memphis and that has helped us for many years now. And then in the recent years with the introduction of CS Neptune, that also has represented a significant advantage that we've been able to leverage, both in the downturn and in the stronger recovery markets.

Praveen Narra, Analyst

Yes, this is certainly helping in 1Q. So when we think about the go-forward, I guess the difficult part is determining what the trajectory is based off of 1Q. So can you help us with the deepwater completions trajectory, even if it's just to say how strong 1Q was and what we should expect for the go-forward?

Elijio Serrano, Chief Financial Officer

In the fourth quarter, we had the Neptune project that boosted our margins and revenue. The international segment performed the best in the first quarter compared to all of last year, with significant contributions from projects in Asia, the Middle East, and the Gulf of Mexico, along with a major sale in Latin America. On the domestic front, excluding the revenue from the Gulf of Mexico for Neptune, we still experienced one of our strongest quarters in that region compared to last year. Looking ahead, while it's difficult to make predictions, we have some new wins that could potentially replicate our Gulf of Mexico and international performance in the first quarter, if not by the third or fourth quarter. The offshore performance in the first quarter was exceptionally strong.

Praveen Narra, Analyst

Right. Thank you very much, guys.

Brady Murphy, Chief Executive Officer

Thanks, Praveen.

Operator, Operator

Our next question is a follow-up from Stephen Gengaro from Stifel. Please go ahead.

Stephen Gengaro, Analyst

Thanks. I guess two more if you don't mind gentlemen. The first is, if we look at your historical sort of detrimental margins or incremental margins in the water and flowback business and obviously understanding that you're in for a very tough second quarter, and I know you're doing a lot on the cost cutting side. Am I – is it reasonable to assume that second quarter detrimentals could be pretty severe and then they normalize a bit as sort of cost cutting catches up with the revenue stream-wise? Is that a reasonable way to think about it?

Elijio Serrano, Chief Financial Officer

Good assumption, Stephen, and historically that's what has happened. The cuts and the flow down by customers are very rapid, and then we implement cost reduction actions, bringing equipment back to the shop and we see that first quarter get hit harder and then cost reduction actions kick in. So if it follows historical patterns, your statement is correct. However, let me interject that we have implemented a lot of technologies. We've implemented the blue link system that has brought automation and reduced staffing at many of our water treatment and water handling operations. We've introduced the SandStorm technology that is less dependent on people. We've also implemented quite a few fluids treatment operations and facilities that are less dependent on people. So this go round, we've got a lot more technology that has less dependence on people that I think will help us in this cycle.

Stephen Gengaro, Analyst

Thank you. And then on the adjusted EBITDA line, the corporate and eliminations line dropped off from kind of a $10 million to $11 million run rate to like $6.5 million in the first quarter. Is that a good run rate going forward given what you've done across that?

Brady Murphy, Chief Executive Officer

So, we mentioned when we announced that the NYSE had issued a notice too as they were taking cost actions, but we're still targeting our corporate G&A to come down to the $6 million to $7 million range in the coming quarters. That'll benefit us. In Q1 we did – we reversed out some items such as accruals for long-term incentives or annual incentive plans, but for TETRA-only expect that the corporate G&A will drop down into the $6 million to $7 million range as we continue taking cost out of the system.

Stephen Gengaro, Analyst

Okay, thank you.

Operator, Operator

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

Brady Murphy, Chief Executive Officer

Well, thank you, Brandon. I thank all of you for your interest in TETRA Technologies and thank you for taking the time to join us this morning. This concludes our call.

Operator, Operator

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