Cypress Environmental Partners, L.P.
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good day ladies and gentlemen and welcome to the Cypress Energy Partners L.P. Third Quarter Earnings Release Conference Call. All lines have been placed on a listen-only mode and the floor will be opened for questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Richard Carson. Sir, the floor is yours.

[Richard Carson:]

Thank you. Good afternoon and welcome to the Cypress Energy Partners L.P. third 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. This afternoon we released our 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 reconciliation schedules appear at the back of the press release. So with that, I will turn the call over to Pete.

[Pete Boylan:]

Thanks Richard. Good afternoon everybody. Thank you very much for your interest and investment in our company. We continue to make some progress in Q3 with sequential topline organic revenue and gross margin growth during the quarter that generated 7% quarter-over-quarter adjusted EBITDA growth. Our third quarter results included a 16% increase in our Water & Environmental Services segment volumes, coupled with a 15% increase in our inspector headcounts in our Pipeline Inspection and Integrity Services segment over the prior quarter. We incurred some higher repair and maintenance costs in our Water & Environmental Services segment during the quarter that we believe were non-recurring in nature. And our mix of business in the Pipeline Inspection & Integrity segment led to slightly lower gross margins in the quarter. We are not satisfied with our performance but our management team remains very focused on pursuing long term growth or continuing to focus on the ever-changing regulatory requirements. And now lower commodity prices that primarily impact our customers and the Water & Environmental Services segment but also impact some of our inspection clients. We obviously can't control energy prices, nor investor sentiment toward the industry, but we can certainly continually improve our operating results and grow thoughtfully. We secured several new inspection clients during the quarter that should represent some promising new growth prospects in future periods, offset by some projects that didn’t start as originally planned but simply split a little. The segment also continued to organically grow revenue sequentially in October. Our focus on produced water that occurs for the life of completed oil and gas wells versus flowback in our Water & Environmental Services segment will help reduce some of the inevitable pressure everyone in the industry faces from lower crude oil prices. During the quarter, we continued to evaluate a number of acquisition opportunities that look very interesting and I hope to complete at least one of them in the next 90-days. We remain very disciplined about our due-diligence and are passed on several opportunities as a result of items uncovered during this important process. Several transactions occurred during the quarter in the Water & Environment segment that quite frankly did not make sense to us. We were pleased to announce our second consecutive increase in distributions, consistent with our long-term stated objective of thoughtfully growing cash flow distributions per unit. During the quarter, we increased our credit facility to $200 million and currently have approximately $125 million of availability. We continue to evaluate the timing associated with the dropdown of the remaining 49.9% interest of TIR not currently owned by CELP. We also continue to operate with a strong balance sheet and capital structure that allows us to pursue opportunities and we have a significant pipeline of opportunities we are currently evaluating. In fact, our cash position continues to exceed our original S1 forecast and we have less debt than originally forecasted. Demand for our inspection and integrity services remains solid, although as I mentioned earlier some projects have slipped from a start based on timing and then pushed in the future periods as a result of promoting issues that the pipeline owner experienced. We also continue to work very hard on pursuing strategic opportunities to grow our volumes in the Water & Environmental segment including pipeline opportunities with E&P producers. Additionally, we continue to hire additional talent to build the organization's capabilities to pursue organic growth impacting our EBITDA margins in the short-term. 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 released today. Net income for the third quarter was $5.1 million, $3.6 million of which is attributable to our common and subordinated unitholders and $1.5 million of which is attributable to our non-controlling interest holders. Adjusted EBITDA which we define as net income plus interest expense, depreciation and amortization expense, income tax expenses, and offering costs, less gain on reversal of contingent consideration was $7.9 million, $5.3 million of which is attributable to our common and subordinated unitholders and $2.6 million of which is attributable to our non-controlling interest holders. Distributable cash flow for the third quarter was $5.2 million and we will pay a quarterly distribution of $4.8 million or $0.406413 per unit which represents a 4.88% increase over our minimum quarterly distribution and a 2.41% increase from the prior quarter. The financial statements had been presented as if the contribution of the SWD business and TIR occurred at the later of the beginning of the period presented or the date Cypress Holdings obtained control. Accordingly, the prior year income statement and cash flow only reflects the third quarter 2013 plus four days of TIR activity because holdings did not obtain control until June 26, 2013. The prior year columns are labeled as recast for this reason. In addition to the financial highlights on net income, adjusted EBITDA, and distributable cash flow mentioned previously, I would also note the following; we averaged 1,648 inspectors per week for the third quarter of 2014. We disposed a 5.5 million barrels of saltwater for the third quarter of 2014, compared to disposing 5.1 million barrels of saltwater for the third quarter of 2013, despite increased competition in several locations. Average revenue per barrel declined from a $1.19 for the third quarter of 2013 to a $1.09 for the third quarter of 2014 primarily due to the decline in oil prices of approximately 24% over the last four months. Our leverage ratio as calculated under the credit facility is 0.82x and our interest coverage ratio is 6.32x, reflecting a strong balance sheet-with ample availability of cash and substantial availability there. We finished the quarter with $24.7 million of cash which is over 100% more than planned and our debt outstanding is slightly less than originally planned, as a result of our management of working capital and a capital expenditure like business mode. Maintenance capital expenditures for the three months ended September 30, 2014 were $80,000 reflecting the limited maintenance capital expenditures required to operate our business. And with that, I will turn the call back over to Pete.

[Pete Boylan:]

Thanks Les. We greatly appreciate your valuable time, investment and continued support despite of volatile environment for the energy sector, the last few months. Our Board, our management team, all remain committed to building a great company and long-term unit holder value through a disciplined approach to grow both organically and through acquisitions. We look forward to reporting our Q4 results next year. Given the continued uncertainty of our Q4 and 2015 commodity prices, and the result in capital expenditure budgets of our customers, we are not going to provide 2015 guidance other than to reiterate our stated goal of growing distributable cash flow over the long term at a 10% annual rate. We remain confident that this is very achievable especially with our ability to graph down the remaining 49% of TIR in 2015, plus other opportunities that we are looking at. And as you know, we have now increased our distribution twice which wasn't initially contemplated in the S1. Operator, we may begin taking some questions.

[Operator:]

[Operator Instructions] Our first question is going to come from Michael Hoffman. Please state your question.

[Michael Hoffman:]

Thank you very much, Pete and Les for taking my call. On the third quarter, could you share with us the scope of what those maintenance expenses were, so we can understand what the underlying operating performance of the business is in the Water & Environmental?

[Pete Boylan:]

Yeah. We're not going to get into the specifics because we have many locations as you can appreciate. But effectively they revolve around some repair and maintenance items on some pumps, and they also revolve around some tank-cleanout issues. And we think we've got a good handle on those, and they were just some unanticipated issues.

[Michael Hoffman:]

And, I should have been clear about the way I was asking - I mean, sort of a dollar impact, so I understood, the current sort of profitability. So for instance, your cost of goods sold was up by almost 10 points sequentially. Is all of that the maintenance or some of that seasonal? How do I think about that?

[Les Austin:]

I think you can think about that mostly driven by the maintenance. We've give you the target margins that we anticipate and should be in excess of 65% gross margin in that business. So, you can kind of back-in to that numbers that the impact was for the repair and maintenance item.

[Pete Boylan:]

Keep in mind there's always going to be a gross margin impact associated with the oil prices. And as Les mentioned in his comments, oil prices are down 24% Q3 2014, versus Q3 2013. So you've got a combination of things going on that impact.

[Michael Hoffman:]

And since you got in, and I get that – but, you're taking the exposure in your price per unit that you would recover in oil and sell it, so with oil down, are you seeking to charge - raise your pricing to capture that margin, is there that opportunity?

[Pete Boylan:]

I don't think that's realistic. All of these locations have competitive dynamics, and producers are more sensitized to price now than they were a month ago or six months ago. So, I do not think that's a viable option of simply raising prices.

[Michael Hoffman:]

Okay. And just if I am clear on the 65% - that's the full year expectation including the negative impact on 3Q of your extra maintenance?

[Les Austin:]

That's the targeted margin that we had for the Water & Environmental Services segment.

[Michael Hoffman:]

Okay. That would be a very healthy improvement sequentially.

[Pete Boylan:]

I don't think, Les, is suggesting that we are forecasting huge Q4, that's going to somehow get us to that average and looked at the particular math. I think he was saying generally speaking, we'd be looking for 60 plus percent type of margins in this business.

[Michael Hoffman:]

Okay. All right, that's helpful. And then on the Pipeline Inspection - Integrity Inspection business, when you look at opportunities given all of a sort of discussion about safety and risk, how do you feel about the rate of that inspector growth on an average basis annually at this juncture? How would you scope that out in your mind?

[Pete Boylan:]

We feel like all the macros are excellent. As I mentioned, there's significant demand for the services. We have great customers. We picked up some new customers that are going to represent some great new work for us in 2015. We think we've got a sizeable stable inspectors available to us to staff these and other projects. As I mentioned in the call, I've been investing in building our business development talents, and you're seeing some of that impact in our EBITDA margins. But quite interested in building a long term company, not obsessing quarter-to-quarter, we want to make the right personal decisions. And so we believe there are tailwinds out there. We believe that these are the last budgets that ever get cut, no matter what happens to commodity prices because we have an environment where exactly those are being pursued for [indiscernible] as a result of the PG&E, and [indiscernible] incident, there's just a lot of visibility and a custom to being a prudent operator and safely and legally, properly operating their pipelines, and we don't see that going away at all.

[Michael Hoffman:]

Okay. And as you think about that, is that a middle single digit inspector growth? Or is that a high single digit? How do you think about that characterizing the growth rate relative to what you just talked about?

[Pete Boylan:]

Excluding any acquisitions, just looking at organic growth, I think it could be a double digit, but as I said on my call, because many companies haven't yet released the CapEx budgets and haven't yet commented on what may or may not change in 2015, we haven't completed our work and therefore we just want to be conservative.

[Michael Hoffman:]

Okay. And then on that capital spending, on the water side, most of them have actually reported and talked about it. So as you think about, who your customers are, have any of them in fact been in the group that's cut versus those who've reaffirmed?

[Pete Boylan:]

Not that we're aware of, but you have different knowledge than I do, doing what you do for a living, but I am involved in some other boards. And I think a lot of companies haven't yet made definitive statements about what their CapEx plans are for 2015, from what I am seeing.

[Michael Hoffman:]

Okay. Thank you very much.

[Operator:]

Okay. We have another question, this one comes from Abhi Sinha. Please state your question.

[Abhi Sinha:]

Hi, good afternoon everybody. So, quick one basically, in the last dialogs, you alluded that the pipeline inspection business, you're trying to go in southern regions of Georgia and Carolina. Do you have any update on that? I mean - where do we stand in that?

[Pete Boylan:]

Yes, we have made some progress on those fronts, Southern California gas has a new client, we picked up another PUC. As you may or may not know because some of these PUC's are rate payer, funded, they have some minority spending mandates. And we have recently formed a joint-venture with one of our shareholders that allows us to offer a minority solution for that, that we think could provide some incremental opportunities for us, for those clients that do have that mandate to have some diversity and minority spend. But it remains an area that we're focused on. And at the moment, we have a little bit of economic weaker in that area because as we've disclosed, we have a sequel of blocker and we need to pay tax on that PUC income while we were waiting for some clarity from the IRS before it went into the pause on some of the specifics of where the start and finish lines are with PUC pipeline work.

[Abhi Sinha:]

Sure. And then, I think you already mentioned little bit on this, but just want to make sure that the current commodity environment, does it have any impact on your Pipeline Inspection business, or it is just a seasonality, I mean you can model?

[Pete Boylan:]

We think it's largely immune from it. We had a lengthy discussion at our Board about this. Most of these companies are making multi-year investments that take substantial amounts of not only capital but time, planning, and permitting and going through the environmental impacts, stays, regulatory environment et cetera. And so buy-in-large, as we sit here today, our best judgment is, it doesn’t have a huge impact. There are some MLPs as you know, that have more exposure to commodity prices. But I don't think that anybody is going to take shortcuts on their integrity and maintenance work because of the personal liability and the desire to deal with regulatory compliance. And we're starting to see increased inspection for gathering lines due to regulatory drivers. So, there's a lot of macros going on, both at the State and Federal level that again we think are good. But I can't say it’s completely immune or it doesn’t have some impact if they were to be a significant decline for some extended period of time with commodity prices.

[Abhi Sinha:]

Sure. That's helpful. And the last one, I just want to check in, if you're chasing the water cut formations here, what regions come to your mind as a must cover that you think you really need to, obviously you should really expand in that region?

[Pete Boylan:]

Great question. We started the company with a focus on pursuing the regions, A; most importantly have long life production, B; have a substantial amount of water and the rock is associated with that long life production, and as you probably know, the water cuts vary all over the country. And some places like the Eagle Ford have very little water cut. And some places like the Mississippi Lime have huge amounts of water. The Mississippi Lime, we haven’t done anything there despite of being in our backyard because of a variety of issues including all of the seismic activity, and getting comfortable with what's going on with the OCC and all the debates surrounding that. So, our plan on strategy is to enter all of the key basins, and be diversified across oil and natural gas. But as we shared on our roadshow and so forth, we really focus on produced water, and other folks chase skim oil and flowback. We do not do that by design because we like the produced water economics and it helps insulate you from the downturn of commodity prices. But we have systematically thought about where we'd like to be. The Permian and the Bakken are great places where tiny and the Permian were - of suitable size, but there are number of opportunities we're looking at in both of those locations. And there is quite frankly a number of opportunities we're looking at in other locations as we speak. So, I think you’ll see us continue to grow. We do really try to focus on opportunities to have pipe water, and whenever we can partner with a producer, and ultimately either build the pipeline and our disposal, or alternatively pipe water from their fields into one of our existing SWDs, we’d rather pursue those opportunities than simply take the speculative risk of building a new facility solely dependent upon trucked water.

[Abhi Sinha:]

Sure. Appreciate the color. Thank you very much. That's all I have.

[Pete Boylan:]

Thank you.

[Operator:]

Okay. And there don't appear to be any other questions in the queue.

[Pete Boylan:]

Okay. Thank you everybody.