Earnings Call Transcript - TTI Q2 2021

Operator, Operator

Good morning, and welcome to TETRA Technologies Second Quarter 2021 Results Conference Call. The speakers for today's call are Brady Murphy, Chief Executive Officer; and Elijio Serrano, Chief Financial Officer. 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. Serrano. Please go ahead.

Elijio Serrano, CFO

Thank you, Kate. Good morning. And thank you for joining TETRA's second quarter 2021 results call. I would like to remind you that this conference call may contain statements that are or may be deemed to be forward-looking. These statements are based on certain assumptions and analysis made by TETRA and 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 the actual results may differ materially from those projected in the forward-looking statements. In addition, and in the course of the call, we may refer to EBITDA, adjusted EBITDA, adjusted EBITDA gross margin, adjusted free cash flow, net debt, liquidity or other non-GAAP financial measures. Please refer to today's press release or to our public website for reconciliation of non-GAAP financial measures to the nearest GAAP measure. These reconciliations are not a substitute for financial information prepared in accordance with GAAP and should not be considered within the context of our complete financial results for the period. In addition to our press release announcement that went out earlier this morning and posted to our website, we also filed our 10-Q yesterday, that's available on our website. I'll now turn it over to Brady.

Brady Murphy, CEO

Thanks, Elijio. Good morning, everyone. Welcome to TETRA Technologies second quarter 2021 earnings call. As you may have seen from our recent press announcements, we've had a very busy few months. I will summarize some highlights for the quarter, as well as some additional color on our recent announcements before turning it back over to Elijio to provide some information on cash flow, the balance sheet, and liquidity. For the second quarter financials, we grew revenue by 32% sequentially, with an adjusted EBITDA of $13 million, up 44% sequentially. Year-on-year, Water & Flowback grew 53%, while Completion Fluids were down 9% year-on-year. We finished the quarter with the month of June being the highest revenue and EBITDA for our Completion Fluids since February of 2020, as we saw a material increase in new activity in the latter part of the quarter. Our strategic equity investments in CSI Compressco and Standard Lithium continued to contribute as their equity values continued to increase. Year-to-date, this has added $5.6 million of EBITDA, with $1.6 million coming in the second quarter. While inflation pressures, particularly labor, fuel, and materials, impacted our Water and Flowback business in the second quarter, we have line of sight to improved margins for the third quarter, supported by two new recycling projects and pricing agreements for key customers that started in July. The second quarter results were much improved over the first quarter. It is the recent uptick in our customer activity in June and July, as well as the significant positive news in our recent announcements that has us optimistic for our future outlook. Completion Fluids & Products adjusted EBITDA increased $6.8 million sequentially, inclusive of a $1.5 million favorable mark-to-market adjustment for our investment in Standard Lithium. Adjusted EBITDA margins for the quarter were 27.7%, marking the ninth straight quarter in a row above our 20% target, and in line with our previous guidance of EBITDA margins in the mid-20s. Revenue increased by 39% from the first quarter due to the seasonal increase of our northern European industrial chemicals business and stronger offshore completion fluids. We're very pleased to announce that during the month of July, we completed our first international CS Neptune fluids job in the North Sea, also our first high-density monovalent operation. While this project was considerably smaller than our typical Gulf of Mexico project, it was a significant milestone highlighting the acceptance of our proprietary technology into new markets. As we have discussed previously, most of the North Sea applications for Neptune will be smaller jobs with lower fluid volumes than our prior Gulf of Mexico jobs. But once accepted in the market, we believe there's potential for a higher frequency of jobs. Zinc is banned for use in the North Sea, leaving a zinc-free solution, such as CS Neptune, in a strong market position. During the second quarter, we secured two deepwater awards, one for the Gulf of Mexico and another for Brazil, which will increase our market share in both markets. Recall that in the third quarter of last year, an independent industry research firm concluded that TETRA “delivered the best overall value for Completion Fluids in the Gulf of Mexico.” We feel these recent awards helped validate this claim and will see the benefits starting in the third quarter. We received a major offshore award in Mexico that started in late June and will continue into the third quarter. This has been our first major Completion Fluids award in Mexico in over three years, and we believe that market will continue to open for our products and services. With these recent project awards and overall activity improvements, we expect our international and offshore completion fluid sales to increase materially in the second half of the year compared to the first half. With the ongoing success of our northern European industrial chemicals business, we're moving forward with a relatively small capital investment in our Kokkola chemicals plant in Finland to increase capacity by over 25% by mid-2022. The decision to increase our capacity was based on strong returns in this business and growth opportunities that we see in the market. The Water & Flowback services second quarter revenue increased by 22% sequentially and adjusted EBITDA increased by 123%, driven by rebounded activity from the first quarter that was negatively impacted by the winter storms in February. As mentioned earlier, inflationary pressures impacted our profitability in the second quarter quicker than we were able to obtain price increases with our customers. We've been fortunate over the years to enjoy a strong, well-capitalized customer base comprised largely of the majors and super major publicly traded companies, which is pointed out by data showing that in the first half of 2021, 34% of our revenue was derived from large publicly traded operators that by the end of June made up only 12% of the US rig count. In this recovery, we're seeing privately held and independent operators leading this increase in activity. We responded well with this change, being awarded multiple integrated water management jobs, including two new produced water recycling projects for these operators. In fact, as we close out July, we're running at or near maximum asset utilization for our water recycling, water transfer, water treatment, and our sand management with Sandstorm. Our priority is pricing that will allow us to generate an acceptable rate of return before adding new assets. In the second quarter, we were actively deploying a fleet of Sandstorm units for our first international sand management contract in Argentina. We believe that by mid-July, all of our Argentina assets would be in full revenue, and our US fleet is now operating again at maximum utilization. We have a good line of sight of continued growth in the third quarter, but with much improved and expanding margins. Regarding our low carbon energy business initiatives, we've been very active with a lot of new developments, all of them we view as positive. Addressing the news release from yesterday first, we completed a preliminary technical assessment by an independent geological consulting firm to assess lithium and bromine exploration targets of the company's approximate 31,100 net acres of brine leases in the Smackover Formation in Southwest Arkansas. We view this report positively, supporting our expectations that our acreage is rich in bromine and lithium concentrations. With respect to approximately 27,500 acres of that total, TETRA previously entered into an option agreement with Standard Lithium, allowing them to acquire lithium rights with annual cash payments to TETRA to maintain that option. Pursuant to the agreement, after Standard Lithium initiates commercial production, a royalty payment will replace the annual cash payments. As previously announced, this acreage has 890,000 tons of LCE equivalent in the inferred resource category. The technical assessment has identified a brine exploration target estimated to contain between 2.54 and 8.58 million tons of bromine and for lithium, the target is estimated at 16,000 to 53,000 tons. The current market price of LCE is approximately $12,000 per ton, and the current price for bromine is around $3,174 per ton in the U.S. and $7,882 per ton in China. These exploratory target estimates and market prices represent significant potential source of future value to TETRA. With these developments, we plan to accelerate our evaluation of full economic feasibility now. Regarding bromine initiatives, we continue discussions with multiple energy storage companies that utilize zinc-bromide as a key part of their electrolyte chemistry. Our PureFlow high-purity zinc bromide has been qualified by three energy storage manufacturers, and we've received our first commercial purchase order ahead of our year-end expectations. With a multi-year recovering oil and gas market, with TETRA's bromine-based Completion Fluids continuing to grow in market share, combined with the forecast outlook for PureFlow based on customer projections, we believe we need plans for considerably more bromine to meet our future growth potential. Consequently, we announced that we executed a memorandum of understanding to work with Anson Resources, an Australian publicly traded minerals company, to explore a business relationship for lithium and bromine extraction from their Paradox Basin Brine Project in Southern Utah. Finally, after considerable due diligence and successful CO2 mineralization to the design specifications in a San Antonio SkyCycle pilot plant, we have agreed to make a $5 million investment in CarbonFree in the form of a convertible note. This allows us to participate in the equity upside as CarbonFree commercializes its technology. In closing, overall, we had a solid quarter, sequential improvements in our segments, and with increased activity in international markets, we expect continued pricing improvements. Our base business shows clear signs of improvement, and our multiple low carbon energy opportunities are developing faster than we had anticipated. With that, I'll turn it over to Elijio to provide additional details before we open it up for questions.

Elijio Serrano, CFO

Thank you, Brady. In the second quarter, we incurred $4.7 million of non-recurring charges, including $2.7 million of non-cash stock warrant fair value adjustment expense, $714,000 of non-cash stock appreciation rights expenses, $627,000 related to long-term compensation, and $688,000 of restructuring and other expenses. The second quarter also included a $1.6 million gain on mark-to-market adjustments for our equity in CSI Compressco and Standard Lithium. We will continue to see mark-to-market adjustments for these entities. As of yesterday, the market value of these investments was $17.8 million, which we can monetize at the appropriate time. From the beginning of the year to the end of June, this value increased by $5.6 million, or 51%. As you evaluate our balance sheet, liquidity, and cash position, we have almost $18 million of marketable securities available to us. In July, the value of these investments increased another $1.8 million. Second quarter adjusted free cash flow was a use of cash of $4.5 million compared to $5.4 million generated in the first quarter. Despite the rapid ramp-up in revenue this year, we remain free cash flow positive on a year-to-date basis. We saw a build-up in working capital in the second quarter, mainly in accounts receivable. To give you some perspective, revenue in June was 25% higher than in April. We have reduced our term loan by $36.3 million, from $220 million as of September 30, 2020, to $184 million as of June 30, 2021, and further reduced it by $8.2 million in July. This reduction will save us approximately $3.2 million in cash interest expenses annually. In July, we amended our ABL, extending the maturity by over two years to May 2025 and increasing availability by approximately $9.4 million. We expect to further increase availability as part of pending amendments. Total debt outstanding was $171.8 million at the end of June, while net debt was $121.4 million, excluding the value of our investments in CSI Compressco and Standard Lithium. Liquidity at the end of the second quarter was $82 million, defined as unrestricted cash available plus borrowing under the revolving credit facility. We had unrestricted cash of $50.3 million available at the end of June, plus $31.7 million under our credit facility. With the Kokkola facility expansion, we do not expect this CapEx to be significant, as our operations consistently produce predictable cash streams. Last week, we received a $547,000 payment from Spartan for the sale of our controlling interest in CSI Compressco earlier this year. We have an additional payment due in 2022 of $3.1 million upon achieving specific financial metrics. We also expect to make that $5 million investment in CarbonFree before the end of the third quarter, allowing us to participate in their carbon capture commercialization. Lastly, consistent with what we communicated on June 25, we were added to the Russell 3000, positively impacting our stock price. I encourage you to read the press release and our 10-Q for further details.

Operator, Operator

The first question is from Stephen Gengaro of Stifel. Please go ahead.

Stephen Gengaro, Analyst

Thanks, and good morning, gentlemen. I have a few things if you don't mind. I would like to start with you. You talked about the expectations on both Fluids and Water & Flowback for the second half of the year. Can you give us a sense on the kinds of revenue and margin expansion you expect in the third and fourth quarters? I know you don't want to give precise guidance, but it seems there's a lot of moving pieces here.

Brady Murphy, CEO

Sure, Stephen. We have good line of sight for the third quarter. We expect double-digit growth for our Water & Flowback business and potentially close to doubling the EBITDA margins from where we ended Q2. As for the Completion Fluid side, the Gulf of Mexico award will definitely see a positive impact in Q3 and Q4. The Brazil award will most likely not see an impact until Q1 next year, but the combined impact of awards will help our margins substantially. If that helps.

Stephen Gengaro, Analyst

That does help. Was the second quarter a normal sort of European chemicals quarter? Or was there anything, because the margins look pretty good?

Brady Murphy, CEO

It was a normal quarter for our Q2 European business. We've made a lot of improvements to our profitability and margins there.

Stephen Gengaro, Analyst

The other thing I was curious about is the timing of some of the low carbon initiatives. Can you give us guidance on how we should think about the three main components of the low carbon niches?

Brady Murphy, CEO

Sure, we cannot provide specific guidance at this moment. However, with the Standard Lithium agreement, we are seeing meaningful benefits today. We’ve accumulated a significant value in our shares and the potential to acquire more shares over the next few years. On the PureFlow side, we expect meaningful orders to start coming in Q1 of 2022, which will be material for our business. Regarding CarbonFree, they are expected to sign their first plant construction project soon, with operations starting by the end of next year or early 2023. As we move into that period, our calcium chloride production and sales could potentially double.

Elijio Serrano, CFO

Stephen, I wanted to add some data points. We produce about $100 million of revenue from calcium chloride. With these initiatives, there's a significant opportunity ahead. We believe the market potential is not fully understood yet.

Stephen Gengaro, Analyst

That's great. Thank you.

Samantha Hoh, Analyst

Hey, guys. Thanks for the guidance on the EBITDA margins. I was wondering about the impact from moving assets for Sandstorm to Argentina in Q2. Do you have the impact on revenue and EBITDA margin?

Brady Murphy, CEO

Samantha, due to logistics and customs, we probably lost about two months of revenue from a significant number of units. However, we believe that for the third quarter, we’ll have all units back in full production.

Samantha Hoh, Analyst

Great. What about your first order for bromine? What are the mechanics for fulfilling that?

Brady Murphy, CEO

That first order is significant as it confirms the technical qualification of our PureFlow. It also establishes commercial terms for future deliveries. This is a smaller order as we start ramping up, but it sets the benchmark for larger quantities expected next year.

Elijio Serrano, CFO

Today, we produce and sell significant volumes of zinc bromide into the oil and gas sector. We apply our patented process to convert that into PureFlow for immediate opportunities.

Samantha Hoh, Analyst

Do you have to change the chemistry for different customers?

Brady Murphy, CEO

No, the chemistry remains consistent, though energy storage specifications for purity are significantly higher than those required for oil and gas.

Samantha Hoh, Analyst

For the CarbonFree investment, how does that change the discussion about the MLU?

Brady Murphy, CEO

We expect to finalize terms by the end of the year, as the collaboration progresses excellently. Both sides are working toward a definitive agreement.

Samantha Hoh, Analyst

What about your Arkansas reserves and their development?

Brady Murphy, CEO

We will proceed with an inferred resource effort, sampling fluids in our wells. This work will not take much time, and a report will follow for both bromine and lithium in our leases. We’re excited about the potential here.

Samantha Hoh, Analyst

The calcium chloride plant expansion in Finland, can we assume your CapEx will stay around the same run rate?

Elijio Serrano, CFO

The CapEx will be spread between this year and next year, and we expect it to be fully operational by this time next year. It won’t significantly affect our CapEx.

Stephen Gengaro, Analyst

How should we think about free cash generation in the back half of the year?

Elijio Serrano, CFO

With the awards in the offshore side and opportunities in pricing for onshore, we expect EBITDA to ramp up. The speed of year-end activity will determine how much of our accounts receivable we can monetize.

Stephen Gengaro, Analyst

So we could see significant benefits from deepwater contracts?

Brady Murphy, CEO

Yes, we expect mid-20s EBITDA margins but won't see the spikes we’ve seen in the past with Neptune jobs until next year.

Stephen Gengaro, Analyst

If we consider a $50 million plus in EBITDA this year, could these new carbon initiatives match that?

Elijio Serrano, CFO

Correct. If we double profitability from calcium chloride and see advantages from Standard Lithium, plus growth from PureFlow, there is a significant upside.

Brady Murphy, CEO

Yes, we believe that if successful, CarbonFree and PureFlow will provide significant contributions by 2024.

Stephen Gengaro, Analyst

Thank you for all the color. It's very helpful.

Operator, Operator

There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Murphy for closing remarks.

Brady Murphy, CEO

Thank you, Kate. We appreciate everyone's attention and interest in TETRA. For now, we will close the call. Thank you.

Operator, Operator

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