Cypress Energy Partners, L.P. (NYSE:CELP)
Q4 2015 Earnings Conference Call
March 23, 2016 05:00 PM ET
Richard Carson - General Counsel
Pete Boylan - CEO
Les Austin - CFO
Praveen Narra - Raymond James
Brian Butler - Stifel
Good day ladies and gentlemen. Welcome to the Cypress Energy Partners Fourth Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode.
I would now like to turn the floor over to Richard Carson. You may begin.
Thank you. Hello, and welcome to the Cypress Energy Partners fourth quarter investor conference call. I'm Richard Carson, the General Counsel. With me today is Pete Boylan, our Chairman and CEO; and Les Austin, our CFO. We released our financial results and posted the associated press release on our Web site 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.
Good afternoon. Thank you for your interest and investment in our Company. We were pleased to announce our fourth quarter ’15 operating performance and that we maintained our distribution rate of 0.46413 per unit. We appreciate the hard work of our dedicated employees and our loyal customers. Our management team continues to focus on both acquisitions and organic growth opportunities. We have identified five additional segments in the inspection and integrity industry that we are actively looking for acquisitions to build upon our core capabilities. Today, we serve a small percentage of the available customers providing for substantial long-term growth opportunities.
Our inspection Company is now 13 years old and has grown impressively over the last decade while enjoying the benefits of minimum capital expenditure requirements. We also continued to evaluate water and environmental service opportunities including strategic opportunities to partner with E&P producers who would have led to new pipe water opportunities and may also lead to accretive acquisition and growth opportunities as producers focus on their core business of finding and producing hydrocarbons.
We have bids pending on several exciting projects in that area. The energy downturn has led several bankruptcies in the SWD arena and the closure of number facilities in various basins, this should also benefit us overtime. We have reviewed and continue to review several bankruptcies acquisition opportunities. We will remain diligent and thorough with regard to any acquisitions and believe more will present themselves this year.
The SWD business remains attractive and overtime we plan to continue to grow in other basins while expanding in our two core basins the Permian and the Bakken. When commodity prices recover, the substantial number of drilled and uncompleted wells otherwise known as DUC’s should provide great incremental cash flow with no new capital expenditures. Our facilities today remain underutilized and capable of handling over 50 million barrels per year in comparison will be approximately 90 million barrels processed in 2015.
Our strong balance sheet and credit facility allow us to pursue opportunities and during the quarter, we have seen a material increase in those opportunities in both existing segments and some new areas covered under our IRS private letter ruling. Fortunately, our businesses require very nominal capital expenditures, leading to attractive free cash flow generation unlike many other MLPs that have capital intensive activities or obligations.
Lastly, we’ve been able to recruit some very talented new hires as a result of the energy downturn that should further strength in our ability to grow organically. Our team has also been able to secure some important new clients during the last quarter and we remain focused on expanding our customer base. Today, we only serve a small percentage of the available customers in North America. We believe that our available market includes every E&P Company, all MLPs and the 110 PUCs, LDCs that we remained focused on reaching those new customers.
I would also note that on March 17th the DOT division -- the PHMSA division of the DOT issued a notice of proposed rulemaking otherwise known as NOPR that address four conditional mandates established by the Pipeline Safety Regulatory Certainty and Job Creation Act of 2011 and six additional recommended by the National Transportation Safety Board. This release can be found on the web and you will see that it proposes a number of substantial changes that if implemented could be a great benefit to our inspection franchise.
One of the keys includes the prospect that all pipelines constructed prior to 1970s and previously exempt from PHMSA regulations that include additional natural gas gathering lines and pipelines located in moderately populated areas. This proposed rule will impose additional requirements associated with integrity management repair criteria, correct dismastment methods and internal and external corrosion. Additionally, there is a proposal for some mandatory hydro testing that would also benefit our hydro testing division.
I would like to now introduce Les Austin our CFO. So he can walk you through the highlights on the financials.
Thanks, Pete. I would like to take a moment to highlight some of our financial information released today. Adjusted EBITDA, which we define as net income plus interest expense, depreciation and amortization expense, income tax expenses, impairments, offering costs, non-cash allocated expenses and equity based compensation was $6.1 million, $5.6 million of which is attributable to our common and subordinated unit holders and $0.5 million of which is attributable to our non-controlling interest holders.
Distributable cash flow for the fourth quarter was $3.7 million, and in February we paid a quarterly distribution of $4.8 million, or $0.406413 per unit, which represents a 4.88% increase over our minimum quarterly distribution, and is consistent with the prior quarter distribution. Our common unit coverage ratio was 1.52 times given that 50% of our units remain in subordinations following our IPO, providing substantial protection of our common unit holders.
Net income in the fourth quarter was $1 million which included an additional impairment charge of $1.1 million on some of our SWD facilities as a result of the downturn. We review our property and equipment for impairment whenever events or changes in circumstances like the current energy environment indicate that a decline in recoverability of their carrying value may have occurred. This net income is comprised of $1.2 million attributable to our common and subordinated unit holders, $340,000 attributable to our non-controlling interest holders, while we had a net loss of $465,000 attributable to our general partner.
In addition to the financial highlights on net income, adjusted EBITDA and distributable cash flow mentioned previously I would also note, in a time that counter party risk is more critical than ever I am pleased to report that over 85% of our revenues are generated from investment grade customers. More than 90% of our inspection clients are investment grade. We averaged 1,330 inspectors and 30 field personnel per week for the fourth quarter of 2015. We disposed of 4.3 million barrels of saltwater during the fourth quarter of 2015. Average revenue per barrel declined from a $1.07 in the fourth quarter of 2014 to $0.68 for the fourth quarter of 2015, primarily due to the decline in volumes of residual oil sales and the average price we receive for these sales which represents approximately 42% lower between the quarters.
The other material driver was a decline in the average price per barrel of flow back in the Bakken which has been materially higher in the past in comparison with Texas. Despite the impact of lower drilling activity, oil prices and disposal rates, the water and environmental business continued to generate fourth quarter gross margins of 53% and strong adjusted EBITDA with nominal maintenance capital expenditures which is attractive relative to many service businesses serving the energy industry. During the quarter we had a new record of approximately 98% of our volumes being produced water and approximately 37% being piped. The percent of piped water continues to grow and we now have nine pipelines in to five of our facilities.
Our leverage ratio as calculated on our credit facility was 3.07 times versus a covenant of 4.0 times and our interest coverage ratio was 4.58 times versus a covenant of 3 times reflecting a strong balance sheet with 24.2 million in cash and substantial availability. Maintenance capital expenditures for the three months ended December 31st, 2015 were $53,000 reflecting the limited maintenance capital expenditures required to operate our business. This remains a key differentiator for Cypress versus virtually all other MLPs.
Revenue per barrel metrics are comprised of five factors, disposal price per barrel, flow back and produced water are different in the Bakken and higher than Texas. Volume of barrels disposed, volume of skim oil. Net realized price per barrel of skim oil and third party management fees including reimbursements of labor expenses associated with the same. We continue to gain efficiencies from aspects of our new enterprise resource planning system that went live in January of this year. We plan to have a full implementation completed by the end of the second quarter. Our sponsor has made this multimillion investment on behalf of the partnership to benefit our unit holders, and with that I will turn the call back over to Pete.
Thanks Les. Starting in Q3 '15 we began to see a material increase in acquisition opportunities as the market has begun to accept the new commodity price environment and the lack of a v-shaped recovery. Initially a disconnect existed between seller and buyer evaluations however the prolonged nature of the downturn has started to narrow this gap. We believe that we will continue to see additional new opportunities in 2016 and sellers appear to be more motivated. We believe the spring borrowing base redeterminations may also lead to additional acquisition opportunities as E&P companies consider divestitures of non-strategic assets. We have a strong sponsor that has material economic interest in the LP owing 65% that is interested and willing to help finance any acquisition opportunities that are larger than what the LP couldn’t handle independently today.
Obviously, we’re not interested in using our equity currency at these current yields. We truly appreciate your valuable time, investment and continued support over this last year as we have adapted to the impact of lower commodity prices. The material decline in the MLP industry and specifically our units is frustrating for everyone on our team and as a largest owner of the LP units we remain focused on execution that will lead to a recovery in the unit price. Unfortunately we can’t control commodity prices or macro investor sentiment.
In the past MLP’s were less correlated to the price of oil. Our recently read research article that indicated the correlation today has been approximately 85% this time unusual relative to historical norms. Therefore, we along with the rest of the industry appear to be tied to the price of oil. Our inspection and integrity business is definitely less correlated to oil than the substantial majority of the industry, however, the market doesn’t seem to appreciate this. High profile incidents and increased government regulations continue to drive the need for robust pipeline especially in integrity programs for our aging energy infrastructure. This again has most recently highlighted by the comment I mentioned earlier about these new proposed sub-rules [ph] that are out for public comment.
Our Board and management team remained committed to building a great Company with the focus on long-term unit holder value through a disciplined approach to growth. We look forward to reporting our Q1 2016 results in May. We also remain focused on our state of goal of growing distributable cash flow over the long term at 10% annual rate. We are fully aligned with our unit holders with regard to growing our Company, unit value and distributions. Q1 is typically a seasonally low quarter for our business as customers begin ramping up with new budgets.
Our sponsors Cypress Energy Holdings plans to continue to be supportive and we currently have no plans to cut our distribution based upon our outlook for the year.
Operator, we may begin taking some questions.
Certainly, thank you [Operator Instructions]. And our first question comes from Praveen Narra from Raymond James. Praveen please state your question.
You talked about seeing the strategic growth opportunities out there. Can you give us a sense for where you see the best opportunities for capital, is it expanding the existing business lines, water and inspection integrity? Or is it expanding into other business lines that are complementary that you guys don’t currently use.
It's actually all of the above. So, in the water and environmental services segment the Permian and the Bakken and huge places and there is tremendous additional opportunities to expand our breadth of services in both of those basins. And as you know Praveen today we only have Class 2 SWDs we’re not doing anything with solids, we’re not doing anything with recycling, fresh water delivery and a number of other activities that are needed by the E&P industry. But there are many other basins in this country that have substantial water and environmental needs and we have been looking at a number of those that are been several high profile bankruptcies that I mentioned in my prepared comments and those auctions are in process and we see a number of other situations that we think will present some compelling opportunities.
In the inspection and integrity space as I mentioned, today we have broaden the suite of services from when we started Cypress. Most recently where the acquisition of Brown Integrity and we recently hired some talent away from competitor and launched to chemical cleaning services.
I mentioned in prepared remarks, if there is at least five other things that we are focused on that in our M&P eligible criteria. Those include nitrogen services use for drying, chemicals use routing integrity and maintenance. IOI technologies, which is an acronym in line inspection, CIS which stands for Close Interval Surveys and LIDAR, which stands Light Detection and Ranging.
These are essential services four of which are federally mandated under PHMSA that we think are very important to our clients and again in an environment where all of our clients are looking for efficiencies and value. We believe there is a great opportunity to reduce the number of vendors MSAs, all the paperwork, all the insurance working in that right of way on that pipeline owners assets where it’s not uncommon to have 15 or 20 vendors, which you can imagine leads to an enormous mess from scheduling and logistic standpoint and we’re excited about the ability to expand the breadth of services we can offer our clients and provide value in the process and the clients are very receptive to that in the discussions I have had with key clients and decision makers.
Outside of those two segments that we’re in, we have also stated in the past that production chemicals, which are used for the life of oil and gas well to deal with many things, that’s a key area of focus. And then last but not least kind of the fourth leg under the stool that we would like to add is traditional midstream activities gather systems compression gas plans, et cetera. And we’ve seen a number of situations where E&P companies have decided to divest non-mission critical infrastructure and assets as they focus on replacing reserves and finding hydrocarbons during the downturn. So that’s hopefully a little better explanation of the areas that we’re focused on expanding in.
Yes. That’s helpful. And so you mentioned not wanting to use units in any of these, given where the prices, I don’t think that makes sense. I think you mentioned the sponsor maybe helping out, but how much do you think about putting on debt and using for growth opportunities. Is that even on the table?
Yes. I think our current credit facilities got about 60 million of availability, we’ve got $125 million of accordion. But our parent company Cypress Energy Holdings has access to tremendous capital. And we’ve looked at a number of situations that were quite frankly way to take for CELP to do on their own, but something we could up at the holding company and one particular situation, we’ve bid on a billion dollar plus assets that we would have financed up at our holding company and ultimately dropped down into the MLP overtime to drive growth rates.
And we think there is a lot of opportunities out there and we will always be thoughtful, because unlike so many MLPs, we do own substantial amount of the MLPs as a general partner and therefore our interests are aligned and we think like an LP not just GP.
Right, right. Okay. And just couple of other questions, you’ve talk about the significant new customer win from cross-selling that was really part of the base of the acquisition. Can you give us a sense if those were new states for Brown were they expanding out of there, I think six?
Yes. I can’t give you the names of the clients due to the confidentiality provisions in the MSAs. But they are marquee names and they move us into new geographies as well as new lines of business. One of the things I've had our team really focused on is maintenance and integrity and as I mentioned in my prepared remarks we really have three core audiences that need inspection and integrity.
Number one would be the you know hundreds and hundreds and hundreds of E&P companies that own gathering systems and tank batteries and storage facilities and processing assets that need inspection not only as just a matter of good operating practice, but sometimes state law mandates or federal law mandates. Then we've got about a 110 PUC LDCs in this country that provide natural gas to end users.
Those folks are completely insulated from commodity price. So we've really turned a lot of our attention to that in this lower for longer downturn because much like many regulated entities, they are able to spend what they need to spend and they get a guaranteed return on that capital as a regulated provider of services. And so several of our wins have been PUCs in new geographies and we'll continue to focus on that work and then last but not least has been our bread and butter in our roots which is 100 plus MLPs out there and many of the premier names we serve. If indeed these new pending proposed rules, if half of them come into play it's going to lead to some wonderful growth opportunities for us across the whole spectrum of inspection and integrity needs.
Okay, and then last one from me on the just inspection headcount, I think you mentioned through the press release a new MSA. In terms of just full year '16 can you give us a sense for how you think that's going to trend versus drilling on a year-to-year basis versus 2015?
Les, you want to take that.
Yes, you know obviously we're still not putting out guidance for '16 in any form but I think you'll see the traditional movements in our headcount probably down in the first quarter because that's our seasonally low quarter and then trending up through the balance of the year.
There is an important dynamic Praveen, that I think you're aware of which is, headcount is one metric but our integrity business can generate $1 of revenue in integrity can generate the same amount of cash flow that $9 of baseline inspection work can generate with dramatically fewer heads, so as we continue to focus and shift our emphasis on some of these, you know maintenance and integrity opportunities and away from some of the new construction you've got that kind of dynamic going on within the divisions that you saw, you know I think we hit a new record in gross margin on a combined basis in the business despite macro environment.
I think that makes sense, all right, thank you very much guys.
And our next question comes from Brian Butler from Stifel. Brian, please state your question.
Just the first one on -- you talked about the water and environmental piece contribution to the DCS in the past, is that still around 20% or is that changed.
Les, you want to.
Basically, the numbers that we disclose were the contribution from the gross margin at 53%, I think if you look in the back of the press release you can see that percentage has declined a little bit but it's still relatively close to 20% of the contribution of total EBITDA DCS.
And I would expect that to diminish a little further in 2016.
So that business continues to remain under the pressure you saw in the fourth quarter. Is it getting better or worst in the first part of ’16?
I think generally speaking and it's neighborhood specific, but there are less barrels of water being disposed of throughout every basin in the country because of the dramatic decline in new drilling activity and then just the natural dynamic of a decline curve of the shale well as you can appreciate.
And in the locations you’re at those decline curves, I mean what’s the average or on that in the sense that you now have I think it was 98% coming from produced water. So, when you look at those the markets you’re in in those decline curves, is that running at 3% to 5%, or is it 10% to 15%?
The problem with that question, which is a very good question is, the devil is in the detail and every formation and every area is quite different even within a same basin. And a well producing out of X zone that was completed with a certain type of technology and lateral can have a very different water cut and decline curve than something just five miles away done with the different approach and a different pay zone. And so -- but I think it's fair to say that generally the decline curves are relatively steep the first couple of years and most of the shale plays, and water track to the decline curves of hydrocarbon.
And when you think about the wells that you’re servicing, what’s the average age I guess of those wells when you think about what stage of the decline they’re in? Or are the majority of them five years old and there is less decline, or are the majority of them one year old and there is going to be a big jump?
It again we’ve got 11 facilities they’re all in different areas and we don’t track and I can’t give you some weighted average number of the age of a well. I suppose we can go back and try to pull that out. But it really varies in some cases the wells are three-four years old and some cases well was completed a year ago, it just depends on the particular well in question.
And maybe I’ll ask it differently, in the fourth quarter what was, could you tell what was attributable to produced water declines versus the lack of drilling declines?
98% of our water was produced water so that’s a significant difference from where we were compared to the fourth quarter of 2014 when we had much more flow back activity. So if you’re asking the question how much of it’s attributable to lack of flow back volumes versus produced water volumes there is a significant amount of fewer flow back volumes in the fourth quarter ’15 versus ’14.
But you did 2.9 million in ’15 versus 5.2 million, what I am trying to get at is how much of that 5.2 is from drilling versus produced?
Well, I don’t have the data in front of me, but we can have a follow up call and we go back and look at the total flow back for 2015 and see what that representative of the roughly 20 million barrels, 19 million barrels that were disposed of, it changes of course day-to-day and month-to-month to quarter-to-quarter.
And then on the pipeline inspection there was some expectation I think that things would improve in the second half of ’15. Is this still somewhat down on an inspector count and on an average weekly growth looking into ’16 I know you’re not giving guidance. But is this the right level of where we’re at now or is there something, do you need to win a lot more contracts for that to improve?
Well, as Les mentioned earlier we believe our headcount is going to ramp up, but not everything is headcount driven as I described earlier. I think in a prior call, we have noted that there were a couple of large products that we had been awarded and one that got either cancelled in one case, the client had actually bought the pipe and had planned and started construction and then cancel that. And then we‘ve had several others were either right away or regulatory approval or they just slowed down the timing on the rollout of the project.
So all of that stuff flows through and is changing real time, all the time. But we continue to bid on work and win work and depending upon the type of work, all it has different margins associated with it. One of the benefits we have seen is in some cases some of our clients have decided to reduce inspector pay, because you had a building boom that one on from 2010 through 2014 that caused a material increase and the inspector pay and now you have the opposite occurring, there is more inspectors then there are works.
And when a client chooses to do that, they can materially reduce some of their gross spend on inspection and they worked with us in a way that you can see has not adversely impacted us. And the net result of it is our working capital demands decline, but we end up with less gross revenue dollars.
Okay, I got it. And then last, just one last housekeeping. The subordination period that ends 2016 -- at the end of the 2016?
Okay. Thank you.
And there appears to be no questions at this time.
Great. Well, thank you everybody. We’ll look forward to taking to you next time.
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 good day.
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