TETRA Technologies, Inc.
Q3 2016 Earnings Call Transcript

Published: 7 Nov 2016

[Operator:]

Good morning and welcome to the TETRA Technologies Third Quarter 2016 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note today’s event is being recorded. I would now like to turn the conference over to Stuart Brightman, TETRA’s President and CEO. Mr. Brightman, please go ahead.

[Stuart Brightman:]

Thank you, Rocco. Welcome to the TETRA Technologies third quarter 2016 earnings conference call. Elijio Serrano, our Chief Financial Officer is also in attendance this morning and will be available to address any of your questions, as well as Joseph Elkhoury, our Chief Operating Officer. I'll provide a brief overview of the third quarter results then turn it over to Elijio for some additional details, which in turn will be followed by your questions. I must first remind you that this conference call may contain certain statements that are or may be deemed to be forward-looking statements. These statements are based on certain assumptions and analyses 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 result may differ materially for those projected in the forward-looking statements. In addition, in the course of the call, we may refer to net debt, free cash flow, adjusted EBITDA, adjusted profit before tax or adjusted earnings per share or other non-GAAP financial measures. Please refer to this morning's press release or to our public website for reconciliations of non-GAAP financial measures to the nearest GAAP measures. These reconciliations are not a substitute for financial information prepared in accordance with GAAP and should be considered within the context of our complete financial results for the period. In my remarks, I would like to cover an overview of the third quarter, our perspective on the fourth quarter and the markets in general as we move into 2017. Overall, our results for the third quarter showed positive trends in many areas and were consistent with our internal expectations and assumptions. We have seen a significant increase in fluids EBITDA and adjusted EBITDA margins, each of which approximately doubled. Our Offshore Services business continued to improve sequentially, however, the operating environment for Offshore Service continues to be very challenging due to the continued deferral of spending by our Gulf of Mexico shelf customers. We have seen the beginning of increased activity in North America that has favorably affected our Fluids, Testing and Compression segments and during the quarter we continue to take appropriate measures to strengthen our balance sheet with the additional capital raised for CSI Compressco. During the third quarter we've seen the expected increase in our fluids profitability primarily associated with two factors as previously stated in August earnings call. We continue to execute the backlog of Gulf of Mexico deepwater activities, which includes TETRA CS Neptune. We executed one project during the third quarter and expect to start another during the fourth quarter. The successful execution of TETRA CS Neptune product in 2015 and 2016 has been a major contributor to our ongoing earnings. We continue to feel confident of this going into the future and continue to focus our R&D Group on expanding the capabilities of Neptune. In addition with the increase in North American production and rig count, we have seen significant ramp up in our Water Management business. A portion of this is due to the proprietary technology we have introduced associated with TETRA STEEL, automated blending and recycling and reuse of produced water capabilities as well as increased market share in active area such as the Permian and MidCon Basins. We continue to believe water management will be a big part of our business as we move into 2017. Overall like others we will be impacted in 2017 by the expected lack of activity in the Gulf of Mexico, particularly in the deepwater. We still see several projects for next year that exploit our technology, however overall we believe the activity level will be down. Our Production Testing business revenues increased sequentially by 13% several factors contribute to this at such as stronger activity levels in North America reflected by higher rig count in completions, as well as deposit of seasonal aspect in Canada. We continue to focus on improving market share in North America, with those customers increasing their production activities. Our International business will continue to be subject to significant pricing pressures, but we believe we will see slow improved dynamics as we move into 2017. I also remind you that in all areas from an operational point of view, we continue to recognize the synergy at the well site, both domestically and internationally of having operational responsibility for both our fluids and production testing segments in one management group. Our Compression Division reported third quarter adjusted EBITDA of $23.1 million resulting in a quarterly EBITDA margin of 32.7%. A key metric for us has been a flattening of our fleet utilization in the third quarter as indicated by the utilization rate of 75.2% compared to 75.8% in the prior quarter. We continue to be encouraged by this flattening and see signs of progress as we move through the fourth quarter with particular emphasis in one of our areas of strength Permian Basin. We continue to move forward with our ERP integration project. The first phase is expected to be completed in early 2017. This integrated system will allow us to run the business more efficiently in the field and in the back office and prepares us for growth in the future. This is also important when we look at the cost structure in maintaining that in an area we've been very aggressive in reducing that. Offshore Services adjusted EBITDA of $4.7 million or 16% of revenue a 58% sequential improvement over the second quarter and reflected the seasonal peak of decommissioning activity in the Gulf of Mexico. We expect the fourth quarter of this year and the first quarter of next year to continue to reflect the weakness in customer spend during this downturn in the seasonal low-end of the cycle. Overall, we continue to reduce costs, evaluate asset deployment and focus on being free cash positive in this segment. We continue to monitor the progress on the NTL related to bonding, in the short-term it has delayed spending and hopefully when the resolution happens that deferred spending will be reinstated. When this happens, we are positioned very favorably to react quickly on a structurally low cost structure. We continue to execute the necessary balance sheet and capital initiatives for both TETRA and CCLP. During the third quarter, we completed an additional $30 million of Series A Convertible Preferred unit offerings to CSI Compressco. This gives us a total of $80 million. The offering has been structured to pay quarterly distributions in additional preferred units equal to an annual rate of 11% of the issued price subject to adjustment commencing in March 2017, a ratable portion of these units will begin converting into common units over the remaining 30 months. As stated on the CSI call last week, we executed an amendment to the existing secured credit facility moving the leverage ratio of covenant to 5.95 through the second quarter of 2018. TETRA only free cash flow was use of 13.9 in the third quarter excluding CCLP earnings, but including the distribution that comes back to TETRA. Several contributors to that. First, the timing of some of our larger projects through the second half of the year has been delayed and led to a deferral of collections and in several cases certain customers have pushed out their payment timing as a result. As we move into the fourth quarter, our expectations are that we will generate $5 million to $15 million in free cash flow for the full-year. This assumes the completion of several projects in the fourth quarter that have been delayed with the associated expectations that a portion of these collections will be pushed into the first quarter of 2017. This also reflects the trend of deferred spending mentioned previously on our Offshore Services segment. In summary, the second half of the year has shown most of the trends we anticipated when we last spoke in August. First, the continued uptick in activity in North America which we've seen favorable impact and expect to see a continued trend in fluids, production testing and compression businesses. Second, the execution of several large projects in the Gulf of Mexico other than the slight timing delay the overall size and impact of those projects remain consistent with our expectations. Third, continued decline in demand for our Offshore Services driven by deferral of our customers with an ongoing aggressive cost cutting action plan. Fourth, a very positive result from CSI Compressco is demonstrated by margins of 32.4% favorable trends and fleet utilization giving us optimism that as we move into the New Year we will be moving in a more positive direction for that business. With that, I'll hand it over to Elijio.

[Elijio Serrano:]

Thank you, Stuart. TETRA revenue of $176 million increased sequentially by 1%, but the quality of the revenue was meaningfully better at $900,000 sequential improvement in revenue generated of $0.10 improvement in adjusted EPS and $4 million improvement in adjusted EBITDA. Stuart mentioned earlier that fluids adjusted EBITDA was up materially from the second quarter. Offshore Services peaked with a significant increase from the second quarter. While compression and production testing services adjusted EBITDA was down only slightly. On a consolidated basis, adjusted EBITDA margins are 20.9% increased 210 basis points from 18.8% in the second quarter. We continue to generate EBITDA margins in the 18% to 21% of range over the last two quarters despite of the significant declining activity due to the stability of our compression business and from the technology office and lower cost structure of our fluids position. We continue to aggressively manage our cost. Cash cost is defined the difference between revenue and adjusted EBITDA decline an additional $3.1 million from the second quarter to the third quarter from $142.7 million to $139.6 million. If you evaluate over the past eight quarters, we have achieved our cost structure. You will note that from the timing completed the acquisition of CSI in August of 2014. We have reduced SG&A cost by over $45 million on an annualized basis when comparing the fourth quarter of 2014 to this recently completed third quarter of 2016. The cost associated with our field organization referencing in field offices personnel and all related field expenses have been reduced for the same time period from $491 million on an annualized basis, so approximate $208 million also on an annualized basis this past quarter. Our reduction of over $182 million or 37%, when combined with the SG&A cost reduction I previously mentioned, we have been able to take our approximately $228 million of fluid related and SG&A cost without compromising our footprint, service offerings or exiting any key area. These aggressive cost actions have allowed us to remain EBITDA positive while many in our industry continue to struggle. The diversity of our revenue stream from onshore and offshore, domestic and international, oilfield services and industrial, product and services, well pad and infrastructure have been a differentiator during this downturn. As part of this cost reduction we have eliminated layers of management, consolidated support functions, combined service centers and shifted manufacturing to optimal locations to take advantage of the lower input costs. The next major initiative underway is the implementations of our new ERP system for CSI Compressco that will allow us to use technology and change the way we do business and permanently further reduce base costs. This new initiative will save us over $4 million per year beginning at the second half of next year. When activity levels rebound we tend to use this technology to keep costs from increasing commensurate with stronger activity levels. It is clear to us that deepwater Gulf of Mexico will take longer to rebound compared to our onshore markets. With this in mind we will continue to attack our cost structure and keep shifting cost. Our cost basis to extract as much margin of possible reduced revenue levels. With respect to free cash flow, we have historically generated the majority of our free cash flow in the third and fourth quarters due to the seasonality and timing of our revenue. Offshore Services for example peaked in the third quarter and we collect those receivables in the third and fourth quarter. Historically for all our TETRA revenue peaks in the second quarter and declines gradually in the third quarter then declines minimally in the fourth quarter. This year we are seeing third quarter revenue be slightly above the second quarter and are expecting fourth quarter revenue to be stronger than the third quarter. As a result we are not in a position to convert receivables into cash and bring working capital in the same patterns as we have historically. This will result in working capital building into the fourth quarter and been monetized in the first quarter of next year. Other than Offshore Services that sees a seasonal decline in fourth quarter, we are expecting sequential revenue improvement in the fourth quarter for fluids, production testing and compression. With respect to the balance sheet, we have taken a series of steps over the past two quarters to strengthen our balance sheet. We have completed equity offerings for TETRA and CSI Compressco levels and have amended our debt covenants to give us more cushion to manage during this extended downturn. When combined with the cost reductions previously mentioned and the diversity of our revenue stream, we believe we remain uniquely positioned to remain EBITDA and cash flow positive in this challenging market. From a housekeeping perspective, I’ll address the unusual charges incurred in the third quarter. The third quarter included $10.5 million of special charges with the vast majority concentrated in CSI Compressco. These $3 million of cash costs associated with our equity offering and bank amendments are reflected primary in SG&A. And $6.3 million of non-cash charges related to a mark-to-market adjustment to the recently issued convertible preferred notes are reflected in other expenses. Given that these notes will be settled in CSI Compressco equity, we are required each quarter to estimate the future value of the equity we will be issuing as these notes convert into common units. When the unit price of CSI Compressco increases, the estimated value of the security increases and we increase the value of the liability. If the unit price decreases we reduce the value of this liability with a corresponding impact on the income statement. All these are non-cash charges. It is also important to reiterate what we mentioned in the press release. U.S. GAAP requires us to classify the convertible preferred units of debt but given that they will most likely be filled in equity for covenant competition purposes, the convertible preferred units are considered equity. And before I turn this back to Stuart I like to make some comments on CSI Compressco. We announced earnings this past Friday after the equity offered in the bank covenant amendments they improved the leverage ratio from 5.04 times at the end of June to 4.83 times at the end of September. The new leverage covenant is 5.95 times beginning at the end of the year through June of 2018. We believe we have their balance sheet where we want it for this environment. CSI Compressco also reported a coverage ratio of 0.99 times essentially at 1.0. After the earnings call, we had some questions arise on the consequences of running a coverage ratio below one-time. I like to put this in perspective. If CSI Compressco runs with a coverage ratio of 0.90 times this equates to only $1.3 million of cash being distributed per quarter above distributable cash flow. In the unlikely event that they ran at 0.90 times for four quarters this will only add $5.2 million of incremental debt or above 1% of total outstanding debt and makes no meaningful impact on the leverage ratio. Therefore we will be comfortable for a few quarters running with the coverage ratio below one time if we needed to. And with that, let me turn it back to Stuart.

[Stuart Brightman:]

Thank you. And with that, let’s open up the lines for questions.

[Operator:]

Absolutely sir, we will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Marshall Adkins of Raymond James. Please go ahead.

[Marshall Adkins:]

Good morning, guys. Let's focus on fluids if we could. Awesome margins there. What drove those and are they sustainable going in and through 2017?

[Stuart Brightman:]

Yes, I think as I said Marshall the kind of two major contributors to that was kind of the progression of increase in activity on our Water Management business, we had referenced in prior quarters some of the projects were starting in West Texas. That's going well we had some strength in MidCon as well and we’re seeing increased utilization and great customer mix focused on our produced water capabilities. That's something that started. It's going the way we expected and we continue to - we expect to see positive trends on that through next year, big focus on how to differentiate that service line at the well site. So that was one key element, another element is and again just to go back to that as we see that trended activity onshore is not just water management, we sell a lot of product into those shale applications, so we've seen the demand for our products sales go up as well onshore. So that would be a second element with the onshore increase. And then offshore, as we said before, we had pretty good visibility at a couple of projects in the second half of the year. We had one of those come through in the third quarter, we expect another one in the fourth quarter and those are always positive. Gulf of Mexico business is always really good margin for us particularly one involves some of the new technology. So those would be the two biggest elements overall. Our industrial fluids business continues to hold up solid. No change in that normal pattern. Second quarter is the bigger quarter. Third quarter in Europe comes down from seasonal high. And those would be the main elements and again if you kind of extended to next year, offshore I think anybody that's operating the deepwater is going to have a more challenging year next year, you’ve seen all the commentary on prior calls last several weeks. We still have line of sight on some projects next year; the overall activity should be down. So again, hard to think that would be improved scenario next year, but we still should have some decent projects offshore.

[Marshall Adkins:]

Well that’s what I was trying to get to, if the margins were driven by a mix shift to the Gulf and I would question the sustainability. But it sounds like there's a big chunk of the improvement due to the U.S. which should be sustainable in most of our outlooks. Am I reading that correctly?

[Stuart Brightman:]

Yes. And I would add a little more color that we had several projects in the Gulf of Mexico. We had some in the third quarter, we have visibility in the fourth quarter and we expect less of those big projects next year, but we still have visibility. So I think if you go sequentially year-on-year, we would expect our Gulf of Mexico fluids to be down, we would expect our onshore fluids to be up.

[Marshall Adkins:]

Okay. Perfect. That's helpful. And then it seems like you have lost a lot of share in the U.S. and kind of both the fluids areas, but that's coming back. Is that fair to say that the share we lost or you lost earlier you're starting to recapture at this stage?

[Stuart Brightman:]

I don't think that's totally accurate. I view that we’ve maintained our share both onshore and offshore. In fact, I think in 2015, 2016 we’ve increased our share in the Gulf of Mexico, lot of that been driven by new technology. I think the revenue and associated margins onshore it has been all activity driven and associated pricing, but we don't feel we've lost any share and we in fact in certain areas and customers have taken share on onshore and that's imbedded in the results for the third quarter.

[Marshall Adkins:]

Perfect. So, model that the U.S. components kind of rig count driven from here then.

[Stuart Brightman:]

Yes. Kind of the understanding, we think we will take some share on the water management as we go through based on the new technology.

[Marshall Adkins:]

Perfect. Thanks, guys.

[Stuart Brightman:]

Thank you, Marshall.

[Operator:]

And our next question ladies and gentlemen comes from Jacob Lundberg of Credit Suisse. Please go ahead.

[Jacob Lundberg:]

Hey, good morning guys.

[Stuart Brightman:]

Good morning.

[Jacob Lundberg:]

Just wanted to follow-up on the Permian water project, so just looking for an update on that. And in the last call you said you had hoped to start the third pad towards the end of the third quarter moving into the fourth quarter. Has that played out as expected and then should we expect some incremental contribution in 4Q over 3Q to the degree that you didn’t get a full quarter contribution of that third pad in the third quarter?

[Stuart Brightman:]

Yes. I’ll let Joseph answer that. He's been out there in the last several weeks and has really good handle on that.

[Joseph Elkhoury:]

All right. So, yes we have started the third pad as expected and as communicated in the previous quarter earnings call. So to give you more color on land, we continue to focus like you said on gaining share in water management with our differentiated solutions for produced water recycling and treatment technologies as well. We see those margins improving into Q4. We’ve managed to get from our preferred customers a couple of price increases, so the margins from that segment of our fluids will continue to improve moving into 2017 as well. At the same time, we have expanded our distribution in the Permian and hope to start distributing fluids to most of the Delaware customers in Q4 and that will also contribute revenue and margin in Q4 versus Q3. With regards to chemical products we have to get some price concessions, we continue to replace some of the oil and gas customers with industrial customers and as the oil and gas activity rebounds slowly but surely in North America land we’re starting to see signs of those products coming back into our revenue stream. So that’s gives you an idea about how land, fluids inclusive with water is going. At the same time, with regards to the water management solutions we have introduced, we see a good pipeline was replicating some of this technology with high-end customers in the Permian Basin. We don’t expect to see an improvement in Q4 from those additional customers we are after that come Q1 2017; we hope to see a significant rebound and in additions to the margins from that particular segment of the business.

[Jacob Lundberg:]

All right. Great. Thanks guys. And then a follow-up on the on CS Neptune in Gulf of Mexico. I’m just trying to understand potentially a sequential decline in revenues in the fourth quarter. So in the press release, you note that you have a project starting in the fourth quarter. So is it fair to assume that you'll have in terms of just CS Neptune in the Gulf of Mexico, a sequential decline in revenues in the fourth quarter from the third quarter. And if that's the case, could we get any sense for the magnitude of the divine?

[Elijio Serrano:]

In the fourth quarter that next projects starts on time, we should not see any revenue or margin deterioration. The only issue with that that it also affecting our free cash flow guidance is that it is pushing towards the end of the year. We had expected to start this project earlier in December that are some operations related issues with the well that are pushing the timing of the project towards the mid to end of December. And that is the only thing that to be honestly we do not control and if that starts on time than there will not be any margin deterioration or any revenue deterioration, but if it pushes towards the end of December then that project will be partially invoiced in Q4 and the rest of it will invoiced in Q1. So it’s not a matter of completing the well, it’s the matter of wells [12/31 plan to 2016 to be honest].

[Jacob Lundberg:]

All right. Very helpful. Thanks guys.

[Operator:]

And our next question today comes from Stephen Gengaro of Loop Capital. Please go ahead.

[Stephen Gengaro:]

Thanks. Good morning, gentlemen. Two things, one just back to follow-ups if you don't mind when we think about the sequential improvement in operating income or pretax income? Can you help provide us maybe a little more color on how much of that was driven by the Gulf versus the land side?

[Stuart Brightman:]

Yes. I think directionally both were a component typically the lumpiness of some of the offshore’s largest, so that's a bigger component both contributed to the third quarter.

[Stephen Gengaro:]

If you look at the land side of the business alone are the incrementals north of 30 or not?

[Joseph Elkhoury:]

Yes. They're definitely north of 30. We bubbled our revenues quarter-on-quarter from land fluid related activities.

[Stephen Gengaro:]

Okay. That's very helpful. Thank you. And then, when we look at the production testing side is and we sort of think about 2017 or 4Q and then into 2017, how correlated would you expect to be with North American rig count?

[Joseph Elkhoury:]

In the short-term I would say that the pricing is the largest factor in that particular division. We don't have exactly that same differentiation. We have been able to introduce successfully on the fluid side. So we continue to suffer from pricing pressure due to all the supply in the land market. Everybody is trying to offer frac flowback services. So in order for us in maintain, retain and grow our market share we have to give extreme price utilization and see it in some of the margins and Q3 over Q2, but we hope to continue to gain quality customers as we move into the fourth quarter, but we don’t see any price improvement until mid to late 2017 for that particular division. That’s domestic.

[Stephen Gengaro:]

Okay. Great and then just one final if you don't mind. Just to clarify when you talk about the cash flow and sort of the delays that were encountered in collections? Is that because of project delays and timing of the work being done? That just got delayed for - just because the customer doesn't wanted it to or was that because the customers actually delayed payment on completed work.

[Stuart Brightman:]

You've got a little bit of both. I mean the biggest part of it is the customer operational delays, unplanned things happen. And then when you get that give us some of the lumpiness, some of those delays as the work is completed during the quarter, in the third quarter as well as most likely in the fourth quarter. You see that timing of the receipt move into the subsequent quarter. And in general, as you see in the press release our collection period increase during the third quarter like you’ve seen many other companies where we just have some customers that have chosen to push the payment into the beginning of the following quarter.

[Stephen Gengaro:]

Okay. Very good. Thank you.

[Operator:]

And our next question today comes from Marc Bianchi of Cowen. Please go ahead.

[Marc Bianchi:]

Thank you. Maybe focusing back on the Fluids business, you mentioned that this additional Neptune project in the fourth quarter, is that the – they suggest Neptune well, do I have that right?

[Joseph Elkhoury:]

So just to – you remember that in early in the year we mentioned and you missed some of our guidance due to having one dry well in the Gulf of Mexico. So if you come back as well then the next the slide will be well number five correct.

[Marc Bianchi:]

Okay. Thank you, Joseph. And still on fluids but unrelated to that. If I look at the outlook for 2017 for fluids, it sounds like it's going to be down for the year compared to 2016 on a revenue basis. Is it reasonable that EBITDA could be flat or perhaps up with 2016 in fluids? Is there anything underlying there, I'm thinking if North America land is improving and there's 30 plus incrementals on that perhaps there's a chance that EBITDA could actually be better while revenues going down.

[Joseph Elkhoury:]

I wouldn't go that far at this stage it depends on the size of rebound, it depends on the commodity price and the willingness of our customers to spend budget. Few of our customers have increased their budgets moving into 2017 and we see good sign this year. But I wouldn’t bet on improving margins year-on-year at this stage. Now we have modeled how much of the weakness in the Gulf of Mexico and related margins, we will be able to offset and then accurately as we feel comfortable with our plan for 2017 but it assumes many things like the rig count activity increased completions activity particularly in the Permian Basin and MidCon areas, the Rockies and Appalachia and started recovery in kind of those as well. If you take all that we hope to be able to offset some of these gaps in the offshore activity, but at the stage I wouldn’t be able to confirm or state that we will be able to compensate for all of that weakness in the deepwater.

[Marc Bianchi:]

Sure. I understand there's a lot of variables maybe just thinking about it on a sequential basis. If you hold flat year in the fourth quarter in fluids EBITDA, can you help us understand the step down if Neptune goes away just because of you know there's a little bit of a gap in some projects. Is it something perhaps that wouldn’t below second quarter 2016 or is there anyway you can give us some kind of a guidepost there to…

[Stuart Brightman:]

I think Marc it’s awful early to kind try to be that precise for next year. We'll have a much better handle on that when we reconvene early in the year. I think at this stage, the way I would think about it as Joseph summarized positive trends on offshore. The overall activity offshore down and we do have some visibility on Neptune projects next year that hopefully will come in exact timing if it’s still unclear. We still need to get through the end of this year, see budgets, see what happens in the meetings in the next few weeks and then we'll come back and give a little bit more granular on that.

[Joseph Elkhoury:]

But I wouldn’t model anything that it’s worth than Q2 or Q1 for the Fluids Division with regards to expected margins.

[Marc Bianchi:]

Okay. Thanks Joseph. And maybe one more for Elijio, looking at a fourth quarter here where you're going to continue to do well in fluids, but you're going to roll-off a pretty good EBITDA quarter from fourth quarter 2015. If the free cash flow doesn’t come in at the range of guidance. It seems to me like you might be close to that four times covenant if that’s the case in your modeling, can you help us sort of think through the contingencies there for dealing with that if it becomes something you need to do?

[Elijio Serrano:]

Marc, we’ve got a couple of items working in our favor as we move towards the end of this year and early next year. We had a challenge in start to Q1 of this year and had an EBITDA loss. We don’t expect that we’ll have the same kind of EBITDA loss in Q1 that we had in 2016, so that will work in our favor. Then you’ve seen AR build up as revenue has pushed out into Q3 into Q4 then we will start monetizing that Q4 and Q1. So we think that the combination of better free cash flow and then rolling into better Q1 margins that we are okay in covenants for this year.

[Marc Bianchi:]

Okay. Thanks for that. I'll turn it back.

[Operator:]

And our next question today comes from Martin Malloy of Johnson Rice. Please go ahead.

[Martin Malloy:]

Good morning.

[Stuart Brightman:]

Good morning.

[Martin Malloy:]

On the Neptune product, are there any opportunities where you could see this used in other basins outside the Gulf of Mexico?

[Joseph Elkhoury:]

Yes. So like we mentioned earlier in the year in previous earnings calls we had a very credible opportunity in the middle of 2016 that didn't happen because our customer elected to assume operational risk when we were bottoming out on commodity prices under 30 and focused on from that particular customer on cash flow for dividend purposes. Moving into 2017, we believe that we have more than a couple of credible opportunities to expand beyond where we are today with a single customer. We expect Q1 to continue and go back to complete what we in Q3 partially addressed with our customers. So there’s been more work on well number three that we addressed in Q3. And there are few credible opportunities, one again in the Gulf of Mexico in particular, one in the Middle East that we feel confident that it's going to happen somewhere in the middle of the third quarter of 2017 and another one that we're working on provided we can have logistically the solution for the North Sea delivery process if the customer elects to use that particular product for their well. So that gives you an idea about some credible. Of Course, we're trying to expand the envelope of the application as well. We're not putting that in any 2017 plan or budgets due to the weakness in the overall spend from a deepwater activity perspective, if the commodity prices were to rebound towards November 30. And our customer see that deepwater activity maybe accretive for them and they go back to starting operation or more development projects, there's definitely a wider application for that product when the activity recovers in deepwater.

[Martin Malloy:]

Okay. And then on water recycling and the customers you've talked about there are some new high quality customers for that product line. Are these existing customers of TETRA that you're bringing in this additional service to provide?

[Joseph Elkhoury:]

Yes. I mean we focused on – in the last two years, let me take you back to the last two years. In the last two years, we have diversified our customer base towards high quality names. Names that are working in premium basins like the Permian Basin, and the scoop and stack in the MidContinent area. And we have tried to focus on customers that will also pay us on-time and have very low risk of getting out of business and not being able to meet their demands. So for us, we continue to retain those quality customers. We promised and delivered on an incident free service, both on service delivery and HSE quality and safety. And the quality names that I mentioned our customers that are today are our customers where we may not have a holistic solution to water recycling, but they are considering replicating some of the stuff that we have sold to others when it comes to the produced water recycling and water treatment solution.

[Martin Malloy:]

Great. Thank you.

[Operator:]

And our next question comes from Kurt Hallead of RBC Capital Markets. Please go ahead.

[Kurt Hallead:]

Hey, good morning.

[Joseph Elkhoury:]

Good morning.

[Kurt Hallead:]

I was wondering if – give some additional color on the TETRA standalone leverage ratio in the third quarter.

[Elijio Serrano:]

Kurt. The Q3 leverage ratio will be slightly above 3.6.

[Kurt Hallead:]

3.6 in Q3?

[Elijio Serrano:]

Yes. Slightly above it.

[Kurt Hallead:]

Okay, great. And then with respect to the revised free cash flow you guys given some additional color around elements of it going forward. Would you expect to be able to get back to that free cash flow level over the next couple of quarters or is that really not – that can be impossible to happen at this point?

[Elijio Serrano:]

Now the big opportunity we have is that as revenue starts to peak in Q4 when historically it has started to drop-off in Q4 we have an ability to monetize that AR. So we believe that we will start collecting some of the Q3 revenue that peaked in Q4 and then we will have the opportunity to collect that also in Q1 as it peaks in Q4. I would say that we’ve seen a shift in cost revenues continue to increase all those collections into Q4 and Q1.

[Joseph Elkhoury:]

And like we directed before with regards to the backlog from operations perspective, so cash from operations is suppose to be better than the first half of 2016 moving into the year-end and moving in the first part Q1 and early Q2 of 2017 as well.

[Kurt Hallead:]

Okay. Thanks for that. And then you provided some very good color on the outlook for fluids going out in 2017 and I was hoping that you can walk us through your viewpoints on production testing and offshore. Maybe a high level like you did with fluid, so revenues up or down 2017 versus 2016?

[Stuart Brightman:]

Yes. But I think if you look at Offshore Services hard to expect a worse year next year activity, but we haven't seen any catalyst for our customer spending yet I think there's a lot of that tied to where the industry comes out on the bonding NTL. So we've kind of cut cost, retrenched a little bit made certain that will be around breakeven free cash flow that even further reduced activity, but able to respond very quickly if we see an uplift there, so I would say that looks probably similar to this year. And then on the testing as Joseph said kind of activity picking up a lot of available capacity out there, pricing still very sticky and the opportunity to try to differentiate some of the larger customers. It's probably a little bit tougher challenge than where we have differentiation on the water and fluid side, but that the focus is kind of leverage those common customers internationally. As we've said previously some of the international markets particularly Saudi there's been a lot of challenges in the just pricing level in the market. We think our activity will pick up and testing internationally and the challenge will be to pick our spots where we have an opportunity to get some price. So we would expect to see overall positive trends next year maybe not as much as we see in North America water though and fluids.

[Kurt Hallead:]

Okay. Great. Appreciate that color.

[Operator:]

And our next question today comes from John Watson of Simmons & Company. Please go ahead.

[John Watson:]

Good morning. Joseph touched on this briefly, but could you elaborate on the pricing pressure within frac flowback and maybe when you first see improving activity leading to more favorable oil pricing?

[Stuart Brightman:]

Sure. Joseph, continue that dialogue.

[Joseph Elkhoury:]

Yes. So similar to modeling for overall fracking. What is happening is that capacity has not completely have been removed from the market so for services companies to really be paying some of the market share for us, but I would call it not very much differentiated service, you still have to give price concession now our EBITDA margins and no way compared to the negative EBITDA the margins on track, so we have been able to retain quality customers. In some cases some of our customers have quizzed us on what would it take for you to be EBITDA neutral, so we are working with some customers domestically to make sure that we are on EBITDA neutral. In that whole mechanism what we're also trying to do is make sure that in every 30-day period we're running the volume price – model if you will so that we can dictate how much price concessions we can gave. In some particular basins domestically we have elected not to do or conduct any business and relocated some of our equipment to say the Permian to go after quality names and volumes of completions activity. That’s really been the problem. We do not want to make or achieve or go after more revenue and lose more money. That’s not the objective; the objective is to compensate for the price concession by loading our equipment and utility base in a 30-day period rather than over the quarter itself. So that's how we plan to continue to drive towards the EBITDA neutral in the short-term and try to use the volume to start seeing EBITDA positive margins for that frac flowback domestically. Internationally, we have seen signs of pricing stabilizing a little bit, but we continue to go after quality projects where we're not just doing a frac flowback, but we are doing production testing and well testing in some particular cases. We have a couple of big large opportunities and if they were to happen if that depends on the award, but if they were to happen we would see the visible improvement in 2017 over 2016 from an international production testing margins perspective.

[John Watson:]

Okay. That's helpful. Within frac flowback it still a spot market at the moment do you see a shift to maybe a term contract with a concrete price in the near term?

[Joseph Elkhoury:]

We have some customers where we have longer-term contracts about six months, one-year where they are starting to lock pricing so that they control pricing erosion moving into higher commodity price maybe higher volume where they may think that capacity will be coming to equilibrium, but most of it I would 80% to 85% is spot market pricing, yes.

[John Watson:]

Great. Thanks guys. I'll turn it back. End of Q&A

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Brightman for any following remarks.

[Stuart Brightman:]

Well, thank you very much. Great questions as always and we'll look forward in February to updating everyone on the year-end conclusions and our views on 2017. So thanks again.

[Operator:]

Thank you, sir. And we thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful day.