Cypress Energy Partners, L.P. (NYSE:CELP) Q1 2019 Earnings Conference Call May 13, 2019 10:00 AM ET
Richard Carson - SVP and General Counsel
Pete Boylan - Chairman and CEO
Jeff Herbers - VP and CFO
Conference Call Participants
Richard Dearnley - Longport Partners
Good day, ladies and gentlemen, and welcome to the Cypress Energy Partners First Quarter Investor Conference Call. All lines have been placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation. [Operator Instructions]
At this time, it is my pleasure to turn the floor over to your host for today, Mr. Richard Carson. Sir, the floor is yours.
Thank you. Hello, and welcome to the Cypress Energy Partners first quarter 2019 investor conference call. I am Richard Carson, the Senior Vice President and General Counsel. With us today are Pete Boylan, our Chairman and CEO; and Jeff Herbers, our Vice President and Chief Financial Officer. We released our first quarter 2019 financial results and posted the press release on our Web site, cypressenergy.com earlier today. In the press release, you will find an important disclaimer regarding forward-looking statements. This disclaimer is an essential component of our remarks, and it is important that you review it. Also included in the press release are various non-GAAP measures that we have reconciled to financial measures under Generally Accepted Accounting Principles. Those reconciliations appear toward the end of the press release.
With that, I will turn the call over to Pete.
Thank you, Richard, and good morning. I appreciate you all joining us today and thank you for your valuable time and interest in our company. We had a very good quarter, and I am proud of our team. The first quarter is historically a slower quarter due to the seasonality of our business and how energy companies [of the world work] [ph] at the start of each year. Our pipeline inspection segment experienced a 49% increase in revenue, and over a 50% increase in gross margin compared to the prior year. In part, as a result of our wining the largest contract award in our history, which began in the fourth quarter of '18 and is expected to continue through this year.
Our other segments generally have not performed up to our expectations in Q1, primarily driven by adverse weather conditions that delayed the start of numerous projects, especially with the wet weather in the Southwest and the winter in North Dakota. We expect these segments to have a solid second quarter, and the results should remain strong through the remainder of the year. With the strength of our pipeline inspection segment's first quarter results, we still had an impressive 39% increase in revenue, 58% increase in adjusted EBITDA attributable to limited partners, and a 145% increase in distributable cash flow. We continue to enjoy diversity and strength in our customer base, and firmly believe that there is a high level of long-term demand for the services we offer.
As previously disclosed, our sponsor, Cypress Energy Holdings completed two acquisitions in the second-half of '18. We continue to make solid progress with both of these acquisitions and intend to [indiscernible] the partnership once we have completed certain developmental goals. These acquisitions will move us into several new higher margin services including inline inspection, water treatment, equipment rental, which could be converted into service businesses before offering this to the partnership, and offshore pipeline process services.
We remain excited about entering the ILI industry with next generation high-definition technology capable of helping pipeline owners and operators better manage the integrity of their assets in both the energy and the municipal water industry. The municipal water industry is obviously an entirely different market that is also regulated and is a mission-critical part of our everyday lives. In all of our business segments, we continue to invest in talent, technology, and equipment that we believe will drive organic growth, expand the number of customers we serve, increase margins, and deliver attractive returns on capital.
Despite the decrease in crude oil prices in Q1 '19 compared to '18, the outlook for global supply and demand dynamics remain solid, and crude oil prices have improved from the end of last year. We remain confident that Cypress has a winning strategy centered on providing essential services that are required by our customers. We have a solid balance sheet with modest leverage at 3.2 times trailing 12-month EBITDA, and with our strong organic growth and these two dropdown acquisitions, some attractive opportunities to enhance that growth. We remain a leader in North America in the inspection and integrity industry, and continue to grow the breadth and depth of our service offerings. We continue to believe that the industry is poised for attractive long-term growth, given the aging energy infrastructure in North America whereby over half of the infrastructure is now over 50 years old.
I also remain excited to have the opportunity to serve the large municipal water industry with our inspection services. The inline inspection services for the municipal water industry are not MLP eligible qualifying income, and we will be required to pay taxes on those activities. The future of our partnership will continue to strategically focus on pipeline inspection and integrity services. These services already represent over 95% of our revenue. Management and insiders continue to be fully-aligned with our minority unitholders given their 64% common ownership of the partnership, and approximately 76% common ownership upon the future conversion of our preferred units, which is truly rare in our industry. The future [addition] [ph] of the aforementioned acquisitions should also position us to eventually resume increasing our distributions.
At this time, I will turn the call over to Jeff Herbers, our VP and CFO, so that he can share some additional financial highlights.
Thank you, Pete. The quarterly results are outlined in our earnings release and in the 10-Q that will be filed later today. I would also note that our pipeline inspection segment, the headcount of our U.S. operations was 39% higher in the first quarter of 2019 than in the first quarter of 2018. We deployed an average of 1,432 inspectors per week for the first quarter of 2019 compared to 1,030 inspectors in the first quarter of 2018, which yielded revenues of $86.2 million, an increase of $28.3 million or 49% over the prior year.
Our pipeline and process services segment generated revenues of $2 million during the first quarter of 2019, compared to $4.4 million during the first quarter of 2018. The decrease was due primarily to adverse weather, which delayed several large projects that were scheduled to begin in the first quarter of 2019. We have a healthy backlog of projects that we began working on in the second quarter of 2019. The water services segment generated a gross margin percentage of 64% and an EBITDA margin of 33% in the first quarter of 2019, with nominal maintenance capital expenditures.
On a consolidated basis, maintenance capital expenditures for the first quarter were $0.1 million, reflecting the attractive business model we have in our portfolio of businesses that have limited maintenance capital expenditure requirements. This remains a key differentiator for us versus virtually all other MLPs.
Our cash growth capital expenditures for the first quarter of 2019 were primarily related to supporting our growing non-destructive examination business. I expect solid operating results for the remainder of the year with our different business units. We continue to make progress collecting past due amounts from PG&E as a result of their bankruptcy filing in January of 2019. We continue to serve them and have a strong working relationship.
And with that, I will turn the call back over to Pete.
Thanks, Jeff. We're pleased to report these results. We will be filing the Q later today, especially the results in our Pipeline Inspection segment, following a great year in 2018. We remain optimistic as we look at our future and the exciting organic growth opportunities we have to expand our customer base. We continue to hire new talent and to improve and grow our business. The most exciting fact remains that we currently serve less than 10% of the available customers in the United States and Canada that can utilize one or more of our services. Most MLPs did not have the ability to grow organically like us without making substantial investments that require significant CapEx. We appreciate the investment of your valuable time, and joining this call, and your interest in our partnership.
Operator, we may now begin taking questions.
Thank you. [Operator Instructions] We will go first to Richard Dearnley, Longport Partners.
Good morning. How do you turn the equipment rental business into an MLP-able asset?
Sure. Good morning. So, when you provide a service that meets certain definitions of qualifying income, that combination of equipment and labor can be MLP qualifying, or generally speaking, just renting equipment, say, a pump or a compressor or a dryer or some iron on a standalone basis as a rental would not be qualifying. So that's how it ultimately happens. And in this particular acquisition, we have four different lines of business, primary lines of business, of which, equipment rental was one of them, and we believe there is an opportunity to reposition some of that equipment to other geographies in the country and marry it with service, but effectively that's the answer to your question.
I see. And in the new technology that the ILI acquisition would add, is that something you couldn't get or don't have or couldn't get currently as a partnership, so, could you provide…
I'm sorry. Go ahead.
Oh, yes. That's [enough] [ph].
Okay. So, we have long desired to bring inline inspection, which some people also call, smart pigging to our customer base. All of our customers spend a substantial amount of money doing smart pigging or ILI inline inspection. And as you might imagine, technology continues to evolve; the ILI industry is probably entering its fifth or six generation of technology as we're talking about moving into 5G, 5G with wireless communications. And think of it as this combination of microprocessors getting smaller and faster, think about it about power consumption, and people getting more efficient and -- power consumption, think about processing and resolution. So, if you own a pipeline, at the end of the day, when you run a smart pig or an ILI tool for your pipeline, you want to see the highest resolution possible, think of it like in TV as 4K ultra high def television, where you can see that dent, you can see that crack, you can see that pit, you can see that corrosion.
And the industry is probably back in the 720P, maybe a couple people have 10 ADI, but there's going to be a leapfrog that's occurring. And so, we looked at a number of acquisition opportunities over the years, we looked at the cost of building the business from scratch, and we instead found a really attractive opportunity with a very talented team of people that were some of the early pioneers in the ILI industry that had kind of moved to the next leapfrog in technology, where we think we will be bringing to market a best-in-class MFL, it's called Magnetic Flux Leakage detection ILI tool that will be well-received by our clients, principally because it will have higher, better resolution than the substantial majority of the competitors out there.
I see. Thank you. And then how do you plan to pay for the acquisition? Would that involve another preferred issue or something else?
It's to be determined. Obviously, we have a Conflicts Committee of the Board of Directors that would be involved in any dropdown transaction, but we kind of made it simple, when we acquired this company we basically said to investors that we plan to offer it at cost. So, we're doing the development work now privately at our holding company, and we are building the tools as we speak and hope to be in a position to come to market and start offering the product to our clients. Obviously until this business is generating cash flow, it doesn't make sense to bring into Cypress.
At the time it begins generating cash flow, we'll have obviously the incremental debt capacity associated with that cash flow, and we will obviously have the other tools available to us with taking back units or pipe or ATM and so forth. So, it's really too early to speculate what the composition of the currency might be, but this is kind of the highest margin of the entire pipeline inspection and integrity technology world -- the service world, ILI, and it's got really nice economics in it relative to many of the other services that are provided in the industry.
I see. Thank you very much.
Well, Operator, it looks like we don't have any other questions. So, thank you everybody, and have a great day.
Thank you. Ladies and gentlemen, this will conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.