Cypress Environmental Partners, L.P.
Q2 2016 Earnings Call Transcript

Published: 12 Aug 2016

[Operator:]

Welcome to the Cypress Energy Partners' Second Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. I would like to now turn the call over to Richard Carson. Sir, you may begin.

[Richard Carson:]

Thank you. Hello, and welcome to the Cypress Energy Partners' second quarter investor conference call. I am Richard Carson, the General Counsel. With me today is Pete Boylan, our Chairman and CEO; and Les Austin, our CFO. We released our second quarter 2016 financial results and posted the associated press release on our website, cypressenergy.com. In the press release, you will find an important disclaimer regarding forward-looking statements. This disclaimer is integral to our remarks and you should review it. Also included in the press release are various non-GAAP measures that we have reconciled to Generally Accepted Accounting Principles. Those reconciliations appear at the back of the press release. So, with that, I will turn the call over to Pete.

[Pete Boylan:]

Good morning. Thank you for joining us today and your interest in our company. As outlined in our press release, we maintained and paid our distribution consistent with the same distribution per unit in the last seven quarters, despite the continued challenging environment in the energy industry. It seems that the industry takes a few steps forward with oil prices surpassing $50 per barrel earlier in Q2, like in 2015, only to fall back again as we have recently seen. After over 18 months, since the start of the decline in commodity prices, our second quarter performance was essentially flat compared to our first quarter and all segments continue to grow at a weaker rate than we had previously expected. Several prominent energy service companies have recently called a bond in the market and I sure hope they are correct. Our operating results have certainly suffered during this downturn, but fortunately, Cypress business does not require substantial capital expenditures and we again finished the quarter with a solid balance sheet approximately $24 million of cash. As many are aware, approximately 50% of our limited partner units are owned by our GP sponsor and are subordinated to the common units. These units will remain in subordination until the payment of the distribution for the period ending December 31st, 2016. Subordination protects our common unitholders who have the right to receive available cash up to the minimum quarterly distribution first before the subordinated unitholders would receive any cash distribution. Our sponsor, Cypress Energy Holdings and its affiliates, own and control the GP and are aligned with our common unitholders with approximately 65% ownership in the LP. As a result of this alignment, CEH has again stepped forward in support of the unitholders with temporary relief of the administration fee paid to CEH pursuant to the Omnibus agreement which would have charged $1 million to CELP this quarter absent the relief as well as contributing $2 million in cash to the MLP to reimburse for certain expenditures to support coverage of the current distribution level. Consistent with the Omnibus agreement relief provided last quarter, this additional $2 million temporary relief from the sponsor did not require any additional consideration, equity or other from Cypress. Some form of temporary relief will likely continue until the end of 2016 or such earlier time that our business results improve as determined solely by CEH. CEH is not committing to support the LP beyond 2016 and if the industry does not improve leading to an improvement in Cypress' fundamental performance, the management team and the Board will, of course, reevaluate the current distribution policy. As discussed in our May Q1 investor conference call, we took steps in the second quarter to reduce our cost structure and protect liquidity, which totaled approximately $5 million in annual savings. These actions contributed to sequential improvement in the last month of the second quarter and should could -- and should continue to impact future periods. In July, based upon the continued evaluation of our water and environmental services segment, we temporarily changed one additional facility to by appointment-only status, made plans to do the same with another facility, and spent approximately $20,000 in enhancing our automation capabilities for the remaining facilities. This automation investment should drive an additional $500,000 of annualized cost out of this segment, primarily through labor and staffing reductions. Therefore, on an annualized basis, we have reduced our expenses by approximately $5.5 million. Pipeline inspection and integrity services remain federally mandated essential services to protect our nation's critical aging infrastructure. They now represent approximately 97% of our revenue. The new proposed DOT PHMSA and California rules should benefit our business if enacted. Our team continues to focus on organic growth opportunities with our customers as well as acquisitions. We continue to win new customers and business that will benefit us in future periods. We also continue to review acquisition opportunities while maintaining our disciplined approach to evaluating acquisition targets. We've passed upon a number of opportunities as a result of valuation and a material midstream opportunity we were considering was recently removed from the market. We have several opportunities we're currently evaluating in both inspection and water, as well as a traditional midstream investment that would add a third leg to our business and further diversify CELP. Our sponsor remains willing to finance attractive investments that could be offered to the MLP as opportunities for future dropdown that are larger than what CELP could afford at this time. Additionally, affiliates of our sponsor have expressed a willingness to finance acquisition opportunities in excess of $1 billion. As a result, we believe we're not only limited to small acquisitions. In fact, we continue to explore some transformational midstream opportunities that would diversify our company, allow us to materially grow the market capitalization and size, and re-rate our yield and evaluation. CELP is not currently evaluating any opportunities that would require material dilutive equity issuances. I would like to introduce Les, our CFO, so that he can walk you through the highlights on the financials.

[Les Austin:]

Thanks Pete. I would like to take a moment to highlight some of our financial information. Adjusted EBIT, which we define as net income or loss plus interest expense, depreciation and amortization expense, income tax expenses, impairments, operating costs, non-cash allocated expenses, and equity-based compensation was $3.2 million, $5.5 million of which is attributable to our common and subordinated unitholders and adjusted EBITDA loss of $2 million, which is attributable to our general partner, and an adjusted EBITDA loss of $300,000 attributable to our non-controlling interest holders that owns 49% of our hydrostatic testing division. Distributable cash flow for the second quarter was $3.5 million and today, we paid a quarterly distribution of $4.8 million or $40.6413 per unit, which represents a 4.88% increase over our minimum quarterly distribution and is consistent with the prior seven quarterly distributions. Our common unit coverage ratio was 1.45 times since 50% of our units remain in subordination through payment of the distribution for the period ending December 31st, 2016 at the earliest, providing protection for our common unitholders during this period. I am providing this additional information to further help our investors understand our performance. On a GAAP basis, net loss in the second quarter was $11.6 million, which included an impairment charge of $10.5 million related to impairment charges on a facility in North Dakota and on the goodwill associated with our integrity services segment. Net loss was comprised of $4 million, attributable to our common and subordinated unitholders including $6.4 million of the impairment charge, $4.6 million attributable to our non-controlling interest holders including $4.1 million of the impairment charge and $3 million attributable to our general partner. In addition to the financial highlights on net loss, adjusted EBITDA, and distributable cash flow mentioned previously, I would note the following

[Pete Boylan:]

Thanks, Les. We look forward to a time when we can report an acquisition, improve results us inspector headcounts increase, DUC completions in our water divisions and our integrity services segment backlogs are executed. Commodity prices continue to be extremely volatile as we’ve seen with WTI pricing reach nearing $53 a barrel on June 8th only to fall below $40 on August 2nd. However, we believe that our inspection and integrity business can benefit materially from the proposed new PHMSA and California rules which have not yet been enacted. The number of DUCs continues to grow exceeding, as Les said, over 500 in the 15-mile radius of our facilities and when commodity prices improve, our SWD business should benefit from those completions and new long-term produced water from those wells. I wish to thank our dedicated and hard-working employees for completing another quarter with no meaningful safety issues. Our business is slowly, but steadily and -- improving each month and including this part of August. We have a strong sponsor that has material economic interest in the LP units that is interested in growing the value of the LP interest and assisting in the financing of acquisition opportunities that are larger than the MLP could handle independently. We truly appreciate your valuable time, investment, and continued support and we remain focused on execution. Our Board, management team, and employees remain committed to building a great company with a focus on long-term unitholder value through a disciplined approach to growth. Operator, we may begin to take some questions.

[Operator:]

[Operator Instructions] And our first question comes from Ethan Bellamy from Baird. Please state your question.

[Ethan Bellamy:]

Hey, good morning, guys. Pete, you mentioned potentially revaluating the distribution, is that a near-term event or a 2016 event or something you that can wait till 2017 to do?

[Les Austin:]

I think we'll wait till 2017 to do that. Obviously, we have to look at things on a regular recurring basis, but we're thinking about that as a 2017 event.

[Ethan Bellamy:]

Okay. You have some steps on drilled but uncompleted wells near your systems in the Permian and the Bakken. What rate do you estimate those are being chewed through by producers right now?

[Pete Boylan:]

Great question Ethan. I'd love to give you in a simple soundbite answer. But as you know each and every producer has got kind of a different strategy of going about addressing the DUCs. And in some cases, producers have their own SWDs that are under-utilized. So, they may complete a DUC and no water from that DUC will be made available to any third-party provider. And in other cases, people have reprioritized their capital budgets to some other basin or some other area within a basin that's got superior economics and therefore, that DUC may be in the back of the line as oppose to the front of the line. And then -- yes, in other cases, we have people that are well-capitalized. These are in great areas and particularly, those down in Reeves County and the Delaware Basin where there are to and froing and completing them. So, it just varies with all 500 plus of them depending on who the operator is.

[Ethan Bellamy:]

Got it. And last question kind of big picture. I mean you've cycled through opportunities, it sounds like you've -- you're looking at extending the existing businesses, potentially adding another leg, some transformational items as well. I know all that comes up against your history both in these business and others been over disciplined deployer of capital. Can you handicap for us the probability of something happening and if so, what sort of will most likely channel for something to occur in say 2016?

[Pete Boylan:]

Yes. I hesitate to handicap anything because the environment has not created -- this downturn has not created some of the opportunities I would have expected to deploy capital. And there continues to be a tremendous amount of dry powder sitting on the sidelines with private equity and infrastructure funds and others that never ceases to amaze me. The lack of discipline some of them utilize and evaluating a particular investment opportunity. And so with that caveat, we have no problem paying up for a high quality asset. And as I mentioned in my prepared remarks, there was one that we really liked that would have been in excess of a $1 billion that would put a third leg under our stool that would have been super stable investment-grade long-term contract traditional midstream cash flows, that would've re-rated our company and done a whole bunch of things for us in addition to providing multiple years of dropdown inventory with those kind of quality cash flows. Unfortunately, that asset got pulled from the market and so we never got to see it through the finish of the process. There are others that are interesting that we continue to spend time on, but it's just hard to handicap what somebody else may be prepared to do relative to what we're prepared to do. So, if I had to guess today, I would say, I can't guarantee I will be able to consummate a deal yet this year, but we're certainly looking at seriously some transactions that will close this year and whether we will be the prevailing party, I can't tell you.

[Ethan Bellamy:]

Okay. I appreciate that Pete. Thanks and keeping plowing.

[Pete Boylan:]

Thanks.

[Operator:]

Thank you. And our next question comes from Brian Butler from Stifel. You may now state your question.

[Brian Butler:]

Good morning. Thank you for taking my questions.

[Pete Boylan:]

Sure. Good morning.

[Brian Butler:]

Just first on pipeline inspection piece of this, it looks like it's kind of leveled off over the last two quarters kind of that $67 million revenue range, do you have any visibility on what part of that is truly regulatory driven versus company's kind of project-based business?

[Pete Boylan:]

We have 30, 40 plus clients were working for at any given time. We've got over 100 MSAs and each and every client is a little different story. So, we would have to give some thought to that particular question. I don't really have any stats right now that I could rattle up. I would you know provide the following color is new construction activity has obviously changed a lot over the last 18 months as projects that were not funded got canceled as projects that did not have entitlements. I've got snarled and hung up in this administration's approval process of permitting new projects. And those projects are pretty well followed by the industry and the media of which ones have not been able to get their entitlements. So, you've got that issue going on. Then you've also got just plain old maintenance and integrity and I think everybody understands on this call that the pressure the industry has faced over the last 18 months to manage cost and cash flows is people have deferred to the extent they could or can any non-mission-critical spending. Now, we all know that you can kick the can down the road for a quarter or two, but at some point in time, you have to do certain things as it relates to maintenance and integrity to be a prudent operator, to protect the integrity of your system, and to comply with PHMSA and so forth. So, you got some of that going on and some excellent companies that were spending at a level of X a year ago are spending now at X minus 30% or 40% right now. And we expect that spending to pick-up again because again you can't defer indefinitely that. So, our headcount is steadily growing which is encouraging. Each week is getting better. Unfortunately, some big projects that we thought were going to go, have slid to the right in terms of their start dates, sometimes it's because of entitlements and approvals from regulators, sometimes it's because of customer demand and capital funding obligations. The integrity business continues to have high velocity of bids and projects were bidding on for hydro testing work. We're continuing to improve our win rate. We've got a nice backlog, as Les talked about in that area, and we're pleased with the progress we made over the last 60 days in that area.

[Brian Butler:]

Okay. And thanks for the color. When thinking about the inspection in the second half of 2016, it sounds like you're still optimistic of a stronger second half than a first half, how does that compared to where we were after the first quarter on those expectations of a stronger second half? Is it not quite as strong or is it really the pipeline of bids and things have improved enough that you're now more optimistic about the strength in the second half?

[Pete Boylan:]

Yes, I think -- and Les can add any color, but I don't think the second half will be as strong as we had originally hoped. Having said that there's a couple major bids RFPs that are out there, that appear to be situations where the client is going to make a decision imminently in Q3 and if we were to prevail on some of those new opportunities, that can have a pretty significant impact on the second half of the year. Absent winning a new piece of business that we don't have, I think the growth is going to be a little slower than we had originally hoped for because projects sliding the right on start dates, projects not getting the entitlements et cetera. Les, would you add anything?

[Les Austin:]

Yes, from a historical perspective, in 2013 and 2014, we used to see about 55% of our revenues on an annualized basis in the second half of the year, 45% ballpark on the first half. Last year in 2015, it was closer to 50-50 and we think that while the second half should be stronger as these projects, that Pete has talked about, should start to be performed on, it’s not going to be at that same camel hump level that we saw in 2013 and 2014.

[Brian Butler:]

So, somewhere between 50% and 55% in the second half is just kind of what you are saying?

[Les Austin:]

That be accurate, yes.

[Brian Butler:]

Okay. And a lot of this coming on the integrity part of the business, it seems like you had a big jump -- step down in revenues on integrity and how much volatility can there be quarter-to-quarter, $2.5 million in revenues, can that be $1.5 million or is that really kind of quarterly low and it's really more upside from here?

[Les Austin:]

Yes, I think part of the volatility you saw in the second quarter related to the integrity services segment was what we talked about in the last conference call. Shutting down our Houston operation and pulling in our horns if you will to get our business cost structure realigned based on what we saw the work coming. But based on the backlog that we've talked about both Pete and I, you should see sequentially some improvements from that low point here we saw in the second quarter.

[Brian Butler:]

Okay, that’s helpful. And then on deepwater water piece of the business, can you talk a little bit about the consolidation that appears to then very slower has not occurred, have you seen any incremental volumes from competitors being bought going out of business? And what do you think that looks like over the next couple quarters, is there really opportunity there or is the volumes just kind where they’re at until activity improves, there's really no change.

[Pete Boylan:]

Yes, so obviously, the Permian is different than the Bakken, so yes, let me talk about the Permian, it’s a bigger market. You have some producers that have tremendous amount of activity going on, but they are vertically integrated and they are building their own SWDs, they have their own pipelines to transport the water, and they are outsourcing virtually nothing. You have on the other hand, a couple E&P companies that have just made a conceptual decision as a company that they don't want to be in that business and they will outsource that. And all the markets are still overbuilt for the level of activity, although, we've seen a nice recovery in rig count, in particular, in the Permian. There's still tremendous amount of capacity not only with producers own SWDs, but with third-party competitors. And depending upon where that rigs working in the decline curve, as you know; that exist in a shale well; that water is typically going to the closest facility. So, we have -- we talk to people all the time, we look at acquisitions all the time, and we do not believe, we are losing a disproportionate share of volumes to anybody and we've seen some people with a huge number of SWDs multiples of ours that have seen as big or bigger decline in their volumes and economic activity. So, the other thing that I think is macro backdrop is the incredible success that EQT and Antero andRice have had including their water infrastructure and their midstream entity that follows the C Corp [Indiscernible]. That has caused a lot of producers that might have otherwise considered divesting their water assets to say, no, let me keep them because I'd like that option Alati to include them in my own MLP or do something strategic down the road. And, yes, it's pretty well understood who some of those C Corps are have sizable water infrastructure. So, we just have not seen many opportunities to buy good water infrastructure from E&P companies looking to delever and divest. We've looked at a couple handful of deals, one-offs, here and there, and we -- in one case up in North Dakota, somebody was willing to pay a price that was completely uneconomic in our judgment and we're going to be disciplined and not in a go-deploy capital just because it happens to be accretive for a quarter, or two quarters, but is a lousy deal long-term in our view.

[Brian Butler:]

Okay. And then just one last one on the -- thinking about the distribution post-2016, if the sponsors is going to stop kind of providing some of that temporary relief, where does that coverage ratio need to be and what's the willingness of management to use the balance sheet to kind of support the distribution at current levels if the business stays kind of at these or marginally improves?

[Pete Boylan:]

Well, as we said back in the IPO Roadshow and everything we're not going to target a single coverage ratio, because there's a lot of factors that go into what is an appropriate coverage ratio. And it's been our believe that this downturn will end at some point in time and depending upon who you talk to you, some people are quite bullish about where we are in the cycle, and where prices are moving and if that DUC inventory builds, as companies start to stabilize, which is, as you know, has certainly occurred in the last 90, 100 days, in the MLP industry, people will start spending again and we got this cost structure in pretty good shape right now. We've taken $5.5 million out of it. Our water business has gone from something that was close to $15 million-ish in Q3 2014 to something closer to the $3 million or $4 million-ish. So, when you look that kind of decline in cash flow, it doesn't take a lot when things turn for us to have some significant improvement in our earnings power. And so we have opted to support the MLP, the general partner with the hope that things will indeed improve and we will be able to either find acquisitions that we like and whether they need to be done up with the GP and subsequently dropped on friendly terms, or whether they can be done directly in the MLP, varies depending upon the particular opportunity. But that's kind of the thinking that's gone on behind things. So, we're just going to have to continue to evaluate things on a quarter-by-quarter basis and see where the business is at as we enter 2017 and what kind of recovery has occurred in the water business, with commodity prices, what kind of growth has been there in the inspection business, what kind of acquisition opportunities we've been able to consummate.

[Brian Butler:]

Okay. Thank you very much for taking my questions.

[Operator:]

And our next question comes from Mike Gyure from Janney Capital.

[Michael Gyure:]

Hey good morning. Can you guys talk a little bit about your thinking for I guess the remainder of Brown Integrity if you would -- if you're thinking about exercising that option next year for the other 49%? And if so, kind of, what capital you would be thinking about associated with that?

[Pete Boylan:]

Good morning. We really haven't had any discussions with our partners that on the other 49% with regard to that. Obviously, Q1, Q2 were a big disappointment for all of us and we had to really focus on getting that cost structure right-sized for the downturn. And as I mentioned in May, we kind of had a perfect storm where they had acquired this company called PSI in Houston in August of 2014 and the Founder of that company had a health crisis and was kind of taken out of commission and we were an earn out period with them. So, as you know, during an earn out, you have to tread gently as it relates to exercising your influences as a 51% holder, but we all stacked hands and agreed that we needed to address the realities of the market as this downturn continued. And trophy [ph] actions we took in May to close the Houston office and to materially change the cost structure of the organization. So, I think you both of us are pleased with the progress we're making. As Les mentioned, we're having some of the best weeks that we've had in a long, long time. The backlog looks good, the bidding looks good, but I think it's too early for us to speculate as to timing and valuation and how we go about acquiring the balance of it.

[Michael Gyure:]

Great. And then maybe one last one on the availability and market for inspectors, I guess can you talk a little bit about sort of what you're seeing out there, let's say maybe the third quarter versus the third quarter last year?

[Pete Boylan:]

Yes, it's been a dramatic change that benefits our company. During the great building boom, I call it a 2010 to 2014, there was an imbalance between supply and demand for inspectors and there was a shortage of inspectors. With the tremendous change in the industry, there is now a ton of inspectors looking for work and obviously, those companies like ourselves that have 100 plus MSAs and work for a wonderful prestigious clients, they covet -- and regularly pursue job opportunities with us. So, we have a huge database of qualified inspectors. We have hundreds of calls coming in every month with inspectors looking to work and so we like the dynamic that we have now much better than what we were facing in the peak of the bubble with $100 oil where it was hard to find inspectors even though you had the work to deploy them.

[Michael Gyure:]

Great. Thanks.

[Pete Boylan:]

Thank you.

[Operator:]

And thank you. I will now be turning the floor back over to Pete for concluding remarks.

[Pete Boylan:]

Well, that concludes our call. Thank you again for your interest and time today and hope everybody has a great weekend. So long, bye.

[Operator:]

This concludes today's conference call. Thank you for attending [abrupt end]