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Cypress Energy Partners, L.P. (NYSE:CELP)

Q2 2014 Earnings Conference Call

August 14, 2014 11:00 A.M. ET

Executives

Richard Carson – VP and General Counsel

Peter C. Boylan - Chairman and CEO

G. Les Austin - VP and CFO

Analysts

Jim Rollyson - Raymond James

Daniel Guffey - Stifel Nicolaus

Ethan Bellamy - Robert W. Baird

Operator

Good day ladies and gentlemen and welcome to the Cypress Energy Partners L.P. Second Quarter 2014 Earnings Conference Call. All lines have been placed on a listen-only mode and the floor will be open 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 and good afternoon and welcome to the Cypress Energy Partners L.P. second quarter investor conference call. I am Richard Carson, the General Counsel. With me today is Peter C. Boylan, our Chairman and CEO and Les Austin, our CFO.

This afternoon we released our financial results and have posted the associated press release on our website cypressenergy.com. In the press release you will find an important disclaimer related to forward-looking statements. This disclaimer is important and 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 it over to Pete.

Peter C. Boylan

Thanks Richard. Good afternoon everybody. Thank you very much for your interest, valuable time, and investment in our company. I am pleased with our progression as a young company and continue to believe that we have a bright future.

Q2 was a good quarter with solid results after a tough winter. Our talented management team of executives, employees made significant progress building our business during the quarter and remained focussed on providing great service to our customers. We also continue to strengthen our management team with several additional new hires over the last 90 days.

We continue to pursue some interesting growth opportunities both organically and through acquisitions. We believe that we have only scratched the surface regarding the business opportunities that we are pursuing under our existing private letter ruling.

Both segments we currently operate in have many additional lines of business our existing customers require and purchase from other service companies. Additionally we have some other business opportunities we are looking at that would continue to expand and diversify our company service offerings. To date we have been -- by the market trading at approximately 20% above our IPO price.

I am pleased to report that we continue to grow our customer base in both of our existing segments with the addition of some great new customers. Our pipeline and inspection segment, inspector headcount increased approximately 10% in Q2 versus the same period a year ago and we have lined up some nice new projects for 2015 under the leadership of our talented CEO and co-founder of the company.

Our water and environmental services business had a solid quarter with monthly sequential growth that has continued into Q3. The underlying market dynamics remain solid and the overall demand for both of our services remains robust. Our CAPEX like business model only had $66,000 of maintenance CAPEX during the quarter.

As you are aware we announced our first unplanned increase in our distribution per unit with a 2.41% increase relative to our S1 forecast. We remain confident in our ability to achieve our 2014 distributable cash flow per unit per rated for the IPO. As noted in my prior comments we remained busy evaluating a number of interesting acquisition opportunities but I can assure you we will always remain disciplined, diligent, and thoughtful regarding both evaluation and risk.

We have seen a number of transactions occur that did not make sense from our perspective. We have a good credit facility and a strong balance sheet to support accretive acquisition opportunities. The second quarter results don’t include a partial quarter like Q1 with the mid-January IPO but still have a little bit of complexity regarding the comparison with 2013 whereby we acquired control of TIR in late June of 2013.

At this time I would like to turn the call over to Les Austin, our CFO so that he can review the highlights on our financials.

G. Les Austin

Thanks Pete. I would like to take a moment to highlight some of our financial information released today. Net income for the second quarter was $4.9 million, $3.7 million of which is attributable to our common and subordinated unit holders and $1.2 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 expense, and offering cost was $7.4 million, $5.2 million of which is attributable to our common and subordinated unit holders and $2.2 million of which is attributable to our non-controlling interest holders.

Distributable cash flow for the second quarter was $5.2 million and we paid a quarterly distribution of $4.7 million or $ 0.396844 per unit which represents a 2.41% increase over our minimum quarterly distribution. 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 four days of TIR activity because holdings did not obtain control until June 26, 2013. The prior year columns are labelled 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 1434 inspectors per week for the second quarter of 2014 versus 1303 inspectors per week for the second quarter of 2013 representing a 10% increase.

We disposed 4.7 million barrels of salt water at an average revenue of a $1.27 per barrel for the second quarter of 2014 compared to disposing 4.8 million barrels of salt water at an average revenue of $1.6 per barrel in the second quarter of 2013.

Our leverage ratio as calculated under our credit facility was 0.79 times reflecting a strong balance sheet with ample cash and substantial availability. Maintenance capital Maintenance capital expenditures for the second quarter were $66 thousand reflecting the limited capital expenditures required to operate the business.

And with that I will turn the call back over to Pete.

Peter C. Boylan

Thanks Les. We greatly appreciate your valuable time and support. Our Board and management team remain committed to building a great company focussed on building long-term unit holder value through a thoughtful and disciplined approach to growth both organically and through acquisitions.

We are off to a good start for Q3. We look forward to reporting our Q3 results later this fall. Operator we may begin taking some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Alright and our first question from Jim Rollyson from Raymond James. Please state your question.

Jim Rollyson - Raymond James

Good afternoon guys.

Peter C. Boylan

Hi, Jim.

Jim Rollyson - Raymond James

Here in the press release you referenced lower inspector headcounts in the second quarter I believe related to annual project transitions and then you also talked about sequential improvements in July, can you maybe give us just some sense of how things are trending, like what is the inspector headcount so far in July and just maybe how to think about that. This is going to bounce around a little bit. I don’t think about that for the third quarter and going forward and maybe just remind us about the seasonal impacts again?

Peter C. Boylan

Sure, as you may recall, historically the December, January period, February is a slower period of time. And last year for a variety of different reasons, a lot of projects ran over and I think we were some odd 20% ahead of where we expect it to be in Q1 because some of those projects just lingered and took longer to get closed out for our clients.

And so there was a little slower start to Q2 and headcount than we had originally anticipated. But it was still up 10% over the same period a year ago and has really been picking up steam nicely. And we think we are off to a great start that will be something that we will all be pleased with and we look to have a strong Q3 and Q4. We have also been awarded some nice new work that will material for us in 2015 as it relates to giving you any specific numbers for July on headcount. We are not comfortable disclosing that at this time but it is sequentially improving.

Jim Rollyson - Raymond James

Okay, it is helpful and with regard to the new customer for the ads and jobs you picked up for 2015, is that just general growth in demand or is it some more additional regulatory scrutiny, or like what's driving the pickup as you see it?

G. Les Austin

Sure, good question. It's kind of a combination of all of the above. Existing pipelines are continuing to receive a lot of attention and focus and there is also a fair amount of new work and new midstream infrastructure being built to support this energy independence theme and growth in U.S. production.

So we have an active and aggressive business development initiative at TIR which I put into the bucket of organic growth and we have been calling on a lot of customers for many years and often times this is a multi-year selling effort. Each and every client, of course a different story. But our record for safety and quality is something we prize and then treasure and it becomes ultimately an important component in the whole sales process so one of these big projects that we have been awarded for 2015 is with a major public, very well known MLP and we had done very little work for them in the past and for confidentiality reasons I can't disclose the name of the client or competitive reason would not.

But we are seeing some fruits associated with our calling efforts and in fact we plan to further beef up our business development sales team and have recently hired a couple of more people that will be joining us here in the next 45 days because we have a substantial pool as you know of qualified inspectors that would like to go to work for us and probably the gating issue is our ability to get out and tell our story to clients that we are not doing work with. Although we have 80 some odd clients in 45 states, we have only scratched the surface of the number of potential clients out there that we can serve. When you look at every MLP, every E&P company that's got a gathering system, compression, station, storage terminals, etc and then of course all the PUC's that exist in every city in this country.

Jim Rollyson - Raymond James

Helpful and then the last for me just to switch gears to sell our disposable business, maybe a little color and update on where you stand from a, you know, one of your strategies you must add pipe to water contracts. Maybe kind of where you are, discussion is ongoing and what percent are you a pipe water day and just how you see that trending?

Peter C. Boylan

Sure, we continue to be very focused on pipe to water opportunities and I think last quarter we announced that we had, done a couple more connections. We continue to be in discussions with producers. I think it is absolutely clear that producers whenever possible would prefer to pipe their water instead of truck the water for a lot of different reasons but notably the fact that the producers want to keep the carbon footprint down.

Trucking is expensive, fewer labor, insurance are always rising. The road damage was not insignificant because these water trucks are 80,000 plus pounds and accidents do happen, no matter how hard everybody tries to be safe and the producers want to again whenever they can secure the ride away or work with somebody to secure the ride away if possible try to pipe the water especially with the basins we operate in where there is long life production.

We have as you know some opportunities. We are done with our partner in North Dakota that we remain excited about, one of those pipelines is finished, the other will be finished shortly and you can look to us to continue to pursue those type of opportunities and they will eventually be brought into the MLP. As it relates to your question about specifically disclosing the percentage of piped water, that is something that we are not doing.

Jim Rollyson - Raymond James

Okay, thanks Peter.

Peter C. Boylan

Thank you.

Operator

Okay, and our next question comes Dan Guffey with Stifel. Please state your question. Dan your line might be muted.

Daniel Guffey - Stifel Nicolaus

Oh, you guys hear me.

Peter C. Boylan

Hi, Dan.

Daniel Guffey - Stifel Nicolaus

Hey, good afternoon. Congratulations on a solid quarter.

Peter C. Boylan

Thank you.

Daniel Guffey - Stifel Nicolaus

Just looking, have you guys made any forward movement on any acquisitions of additional salt water disposal facilities, and I guess can you provide a little color on third party acquisition environment in North Dakota?

Peter C. Boylan

Sure, we have looked at a lot of opportunities and as I mentioned in my prepared remarks we own a large portion of this company and we care a great deal about its long-term success. So we have continued to be very disciplined. So we have not completed any acquisitions. We have passed on many acquisitions and sometimes its price driven, sometimes it is risk driven.

The devil is on the detail on these things and each and every one of them is like a different child with a different life and different issues especially down hole when you start talking about the permeability, the porosity, how many barrels you think this thing can take the pressure considerations, the competitive landscape, etc. I am optimistic. There is some that we are working on that we will bring over the finish line. But we have seen some people pay prices that we certainly could never justify or support or they have been willing to buy dry hole recompletions or they have been willing to get involved with situations that have issues, that from a risk perspective we just would not be comfortable with.

We are proud to tell you that we continue to have our wells get inspected and certified by public blue chip E&P companies and the trend we talked about of E&P companies being very discriminate and where they will send their water continues and we are seeing EHS groups not only require pre-certification of your property before they will elect an MSA and choose to dispose a pipe water to your facility but we are also now seeing for the first time random audits where EHS will show up to your facility and check your compliance which we take as a good thing generally for everybody and in particular something we have planned for and are something that we look forward to because we think it helps us stand out from many others.

So we haven’t closed anything. We are again in active discussions. We also have organic growth opportunities so you will see some opportunities here and the near future whereby we have been involved in identifying a new location, building out a facility, and at the appropriate time we will look to drop that down into the MLP.

Daniel Guffey - Stifel Nicolaus

Okay, that's great, thanks for the color. I guess, you mentioned some you think you are going to go over the finish line and you are in active discussions. Are all of those facilities in North Dakota and/or Reeves County down in Texas. I know you guys are opposed to looking outside of those two areas considering the high competition for the salt water disposal wells across these two areas?

Peter C. Boylan

Yeah, now we are looking throughout the country and different basins and as you may recall from our discussion, we first and foremost like to focus on long life production that has a high water cut that will be recurring in nature. And we also like to really focus on produced water and there are a lot of people that focus on flow back and skim oil and that can be very lucrative for a finite period of time. But it is fair to say we are not only looking at the two basins we are in today but other locations.

We obviously have some SG&A advantages expanding in the existing basins and we obviously are very familiar with what's happening in those basins. So, both of those are huge growing markets with lots of room for growth both organically and through acquisition but we would like to continue to expand the geographic foot print and be diversified across both oil and gas opportunities.

Daniel Guffey - Stifel Nicolaus

Okay great. You guys have a multitude of ways that you can grow on the water side and on the pipeline inspection side. I am curious how far down the road are you looking at expanding set of water environmental services side in the new areas such as oil reclamation or landfills or other opportunities that maybe down the road. Are they still a year or two out or longer or are those coming into fruition maybe sooner?

Peter C. Boylan

You know we are actively looking at those and we just passed on an oil reclamation opportunity for a variety of reasons and we spent substantial time on a landfill acquisition. And ultimately when we completed our diligence and our modelling, we got to evaluation and dropped out when others were prepared to go further out the value curve and the risk curve and we think that there will be other opportunities that we will find more attractive that we are working on.

Daniel Guffey - Stifel Nicolaus

Great, and thanks guys and good luck in the second half.

Peter C. Boylan

Thank you.

Operator

And our next question comes from Ethan Bellamy with Robert W. Baird. Please state your questions.

Ethan Bellamy - Robert W. Baird

Good afternoon gentlemen. Few questions for you, first what is or are the negating factor or factors on getting the other part of TIR dropped down?

Peter C. Boylan

Yeah hi. There really aren’t any gating factors and that TIR is doing very well and we are excited about the growth prospects for it, not only organically but we are also looking at some acquisition opportunities. And so, we have no urgent need obviously to proceed with the drop down of all of the remaining 49% or half of the remaining interest or some permutation there.

But it is something we have begun to think about and obviously it is related party transaction and is something we would need to review with our conflicts committee and so at this point in time we are not guiding anybody to a specific timeline and/or percentage of that. But I think it is fair to say and think about it as a tool in our toolkit and something that we plan to do but we are always continually looking at the fundamental growth organically the business, the acquisition pipeline opportunities, and yet. So it is not a question of it that is just a question of when and that's kind of where we are at on that if that provides any color.

Ethan Bellamy - Robert W. Baird

Okay. And with respect to the per barrel fees on disposal hovering around $1.30 is that a good number to think about going forward, should we expect that to compress at all?

Peter C. Boylan

I will let Les take a crack at that and then I will provide my own color.

G. Les Austin

Yeah, we have said in the 10-Q that we released that it is a combination of increased management fee revenue, the hire fees that we received in the Bakken and the oil sales. There is always a risk for compression on the fees that we get for our services but I will let Pete speak to that.

Peter C. Boylan

As you guys know there is differential pricing not only geographically but North Dakota, you know flow back commands a different rate than produced water. We are in Permian, there is no differential pricing and because of the competition rates are much lower. So we as you know is a matter of strategy are focussed on produced water and I think you would be very pleased with the mix of our business.

It continues to be a produced water business. And I think you are also aware that there are takeaway pressures and therefore per barrel differentials in the Bakken and the Permian off WTI. So as Les said you have got a combination of volume, mix of business, rates, and the difference between North Dakota and Texas and then ultimately where WTI is and what's going on with the takeaway capacity and the discount. That all boils into a mix that happens to end up with this blended number at the end of the day. So I think that both markets remain competitive. We have to compete for business everyday on service and quality and environmental compliance but I think the rates we are running at appear to be sustainable but we also recognize that we have got to be competitive with the marketplace if it does change.

Ethan Bellamy - Robert W. Baird

Are you seeing any degradation in the ability to pickup skim oil from produced water or are the E&P getting more efficient at collecting before they send the water your way?

Peter C. Boylan

Great question and it is a different answer with each and every producer and each and every load and some producers are very, very good at massaging the water before it leaves their tank batteries and sending very little skim. Some are very -- becoming very diligent when they complete the well and in the old days everything was moving so quickly just send the flowback straight from the hole to the disposal with a lot of skim oil in it and some of the more sophisticated operators are not doing that and so you can have very significant variability in the amount of skim out of flowback as well as produced water. And then of course when you choose to pursue pipe water which we always would prefer to have for the obvious reasons, it by definition has very little skim oil in it. So, a complicated answer to a simple question.

Ethan Bellamy - Robert W. Baird

Okay, last one, Les is there any -- should we have any expectation about lumpiness in either inspector headcount or maintenance CAPEX spend, I think in the forthcoming quarters there is flagging ahead of time.

G. Les Austin

I think, just to reiterate was Pete said, the third quarter and fourth quarter are traditionally our stronger quarters as you would expect to see an increase in the inspector headcount numbers as we move into those quarters. And as far as the maintenance CAPEX numbers go it is a very low maintenance CAPEX business on both sides and so we wouldn’t expect significant variability there either.

Peter C. Boylan

Yeah, but no big contracts rolling off or anything like that that would stair step down. Not that we see at this point in time, we hope that before quarter (ph) it will be up.

Ethan Bellamy - Robert W. Baird

Me too, thank you appreciate it.

Peter C. Boylan

Thank you.

Operator

Okay and there don’t appear to be any more questions in the queue.

Peter C. Boylan

Okay, well thanks everybody. We appreciate your time and we will look forward to talking to you next quarter.

Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.

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