TETRA Technologies, Inc. (TTI) Earnings Call Transcript & Summary

Good morning, and welcome to TETRA Technologies Third Quarter 2020 Results Conference Call. The speakers for today's call are Brady Murphy, Chief Executive Officer; and Elijio Serrano, Chief Financial Officer. [Operator Instructions] Please note, this event is being recorded. I will now turn the conference over to Mr. Serrano. Please go ahead.

Thank you, Marliese. Good morning, and thank you for joining TETRA's Third Quarter 2022 Results Call. I would like to remind you that this conference call may contain statements that are or may be deemed to be forward-looking. These statements are based on certain assumptions and analysis made by TETRA and are based on several factors. These statements are subject to several 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 results may differ materially from those projected in the looking statements. In addition, in the course of the call, we may refer to EBITDA, adjusted EBITDA, adjusted EBITDA gross margins, free cash flow, net debt, net leverage ratio, liquidity or other non-GAAP financial measures. Please refer to yesterday'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 addition to our press release announcement that went out yesterday, we encourage you to also refer to our 10-Q that we filed yesterday. I'll now turn it over to Brady.

Thanks, Elijio, and good morning, everyone. Welcome to TETRA's Third Quarter 2022 Earnings Call. I'll summarize some highlights for the third quarter, our current outlook as well as provide an update on our low carbon initiatives before turning it back to Elijio to discuss cash flow, the balance sheet, income taxes and liquidity. In the third quarter, we achieved some strong financial results but also some very key milestones with regards to the strategic direction of the company, which we communicated 21 months ago following the sale of our controlling interest in CSI Compressco. And when we introduced our strategy to leverage our core strengths around [indiscernible] evolving but rapidly growing low-carbon energy technologies. Starting with our financial results, our total third revenue and adjusted EBITDA were $135 million and $18.6 million, respectively. Adjusting for our seasonal decrease in our Northern European industrial chemicals operation, revenue and EBITDA increased approximately 7.5% and 12% from the second quarter, respectively. Adjusted EBITDA, excluding unrealized losses on investments of $0.5 million was $19.1 million for the quarter. Our results were led by our Energy Services business, which grew revenue 15% and EBITDA 33% quarter-on-quarter. A compelling data point on how well we have executed on our Water and Flowback multiyear strategy is that our annualized third quarter revenue for this segment equals the full year revenue in 2018 when the average frac crew count was 441 or 35% above the third quarter of 2022. This segment also increased adjusted EBITDA margins from 15.1% in the second quarter to 17.4% in the third quarter. Both segments, Water & Flowback Services and Completion fluids and products increased their EBITDA margins from the second quarter. With regards to our strategy, we executed exclusive technology agreements for recycling produced water from oil and gas wells for the purpose of beneficial reuse. These are also key enabling technologies for the extraction of lithium from our Arkansas brine leases as well as the extraction of key minerals from operators produced water, a rapidly increasing interest from our customers. We are currently in a produced water beneficial reuse pilot project from one of the largest North American shale operators with many other opportunities in discussion. An additional key strategic milestone for the quarter was a positive inferred resource report, which solidified the previously announced bromine and lithium brine resource estimates in our Arkansas Brian leases. Our bromine inferred resource estimate was 5.25 million tons for our approximately 40,000 gross acres of brine leases and within 5% of the midpoint of the previously announced exploration target, while the lithium inferred resource estimate was 234,000 tons of lithium carbonate equivalent, or LCE, which was 26% above the exploration target midpoint for our approximately 5,000 gross acres that are not covered by an option granted to Standard Lithium. Now turning to the segments. Water & Flowback services revenue of $76 million improved $29 million or 62% year-on-year and $9.9 million or 15% quarter-on-quarter. Adjusted EBITDA of $13.2 million improved by $8 million or 158% year-on-year and $3.2 million or 33% quarter-on-quarter. This marks the highest adjusted EBITDA since the fourth quarter of 2018. Our Water and Flowback business continues to grow significantly faster than the active rig count and frac crew count, while expanding margins for the sixth consecutive quarter. Our significant market penetration is 3 things: first is the introduction of our BlueLinx automation, which reduces manpower by up to 40% on an integrated water management job. In today's market, when labor is tight and with growing operator concerns on safety from short-service employees, this is an invaluable benefit. Second, is the introduction of differentiated technology, including our patented sandstorm, which has proven to be a game changer for operator flowback sand management. And third is our focus on produced water, including treatment and recycling. With increasing seismicity events, operators are moving rapidly to increase their recycling and explore alternatives to disposal. The month of September is the first month ever at our Permian operations managed and transferred only produced water with no freshwater operations. Contributing to our strong quarter was our early production facilities being online for the full quarter in Argentina, which are longer-term projects with stable, predictable revenues, margins and cash flows. As mentioned in our previous call, we received an award for an additional early production facility, which is on track to commence operations in the first half of 2023. Our fleet of sandstorms advanced iPhone equipment remains at high utilization with continued market penetration and improved pricing. Our early production facilities in Argentina include our SandStorm technology. We will continue to opportunistically add to the fleet to meet this growing demand. Adjusted EBITDA margins in our Completion Fluids & Products segment also improved sequentially despite the progressing from the seasonal uplift of our Northern Europe Industrial Chemicals business. The improvement was led by international markets and higher shipments of TETRA PureFlow, which increased by 42% quarter-on-quarter. As a reminder, our PureFlow fluid is a high-purity zinc bromide based electrolyte, which is part of a rapidly growing long-duration energy storage technology. Completion Fluids & Products third quarter 2022 revenue of $59 million increased year-on-year by 22%, but decreased from the second quarter of 2022 by 21%. We remain very positive on the longer-term outlook for the offshore and deepwater markets and our strong market position is validated by the 2022 Kimberlite annual completion fluids and wellbore cleanup tool supplier performance report. The Kimberlite report indicated that TETRA holds the second highest market share in completion fluids in the Gulf of Mexico at 30%. Within the report, Kimberlite mentions "TETRA Technologies continues to be as the top-performing supplier in the Gulf of Mexico and receives the highest customer loyalty ratings as measured by the Net Promoter Score." This was further supported by a multiyear contract renewal for one of the most active deepwater super majors in the Gulf of Mexico that was executed in the third quarter. As the offshore and deepwater markets continue to improve, our pipeline of TETRA CS Neptune completion fluids opportunities continues to grow as well. We're currently executing a smaller TETRA CS Neptune completion fluid job in the U.K. and have a job confirmed and expected to be delivered in the first quarter of 2023. The disruption to our European supply chain that we mentioned in the second quarter is to improve. And although not yet back to full production, we have growing confidence that we will be well prepared for the seasonal peak sales in the second quarter of next year. Now turning to our low carbon initiatives. I've mentioned during the third quarter, we also announced the completion of our maiden inferred bromine and lithium brine resource estimation report. The technical report reflects the bromine resource are in approximately 40,000 leased acres and the lithium resource are approximately 5,000 leased acres, which is a subset of the 40,000 acres where TETRA holds the lithium mineral rights. We're currently well into an initial economic assessment for the bromine resource development and production, initially from the aforementioned 5,000 acres that we expect to complete by year-end. We are also finalizing a detailed reservoir model and are planning to drill another well on our 5,000 acres in the first quarter of 2023 that will use to further refine the reservoir characteristics as well as the estimated lithium and bromine volumes. Pending the results of our detailed reservoir modeling, our current plan is designed and position next well as our first of several production wells from this acreage. The initial economic assessment will essentially communicate a business plan and returns on our bromine assets. This will be the first time we will communicate to the market the expected uplift in revenue and margins of bringing this bromine resource. As also noted in our fire resource report, our research team has demonstrated successful pilot unit results for a direct lithium extraction process that we will continue to validate in the coming months. This will involve proving out each step in the process from the lithium-rich brine production from the wells of our Smackover leases through the DOE and purification process to a high-purity lithium chloride solution. We continue to believe that we are in a unique position with a U.S. resource rich in 2 key minerals, Romine and Lithium for the energy storage markets and the ability to produce both minerals for much of the same brine production wells and pipeline infrastructure. Looking forward to the fourth quarter, despite some improved adjusted EBITDA margins in the third quarter, supply chain and inflation continue to be challenging issues, especially with certain chemicals and raw materials. In North America, key raw material prices are still inflated, and as we exhaust our yearly contractual supply of roaming, we are fulfilling demand with spot market bromine, which will impact our margins in the fourth quarter before resuming to our long-term contract supply volumes and pricing starting in the new year. As one of our primary customers of PureFlow electrolyte, EOS announced yesterday they will be shifting some of their planned Q4 deliveries into 2023 to allow our customers to take advantage of a significant tax credits under the Inflation-Reduction Act. Although this will impact our planned Q4 delivers to EOS, the long-term benefits under the significant to energy storage providers and to TETRA as a uniquely positioned U.S. provider, which also adds to the tax benefits. We expect each of these issues to become onetime events for the fourth quarter. Despite the short-term challenges, our management team and employees have done an excellent job in helping us navigate the company in the right direction. As we look to the future, there is a lot to be excited about. We believe we are well positioned to continue generating positive momentum as our technology investments are paying off, giving us opportunities to grow and continue expanding margins into 2023. Our focus on low carbon energy markets, which requires critical minerals and chemistry expertise is creating significant growth opportunities for the company and are already contributing financial benefit with more to come. And finally, we continue to find new markets for our existing products, which collectively contribute to a broader earnings base and higher growth market opportunities. I'll turn it over to Elijio for some additional commentary, then we'll open it up for some questions.

Thank you, Brady. Adjusted EBITDA for the third quarter was $18.6 million in compares to $18.7 million in the second quarter, that was up 24% from $15 million in the third quarter of last year. The third quarter included mark-to-market losses of $548,000. Without the mark-to-market losses, adjusted EBITDA in the third quarter was $19.1 million. The second quarter included mark-to-market losses of $710,000. We also view doing modeling, the fluids segment results include 5,000 of mark-to-market gains from our holdings in Standard Lithium and carbon free. Corporate and Other includes a mark-to-market loss of $730,000 from our holdings in CFI Compressco. The third quarter included $2.7 million of nonrecurring charges and expenses. This compares to $4.7 million in the prior quarter. Cash from operating activities was $2.1 million. Capital expenditures net of cash proceeds on the sale of assets was $12 million compared to $10.3 million in the second quarter. Free cash flow or cash from operating activities less capital expenditures was negative $9.8 million in the third quarter. We expect total year capital expenditures in the $40 million range, which includes prior noted investments in SandStorms with payback significantly better than 18 months and in early production facilities in Argentina with strong margins and with the expectation that the client buy those project back within a 2- to 3-year period after the startup of those facilities. Working capital consumed $8.6 million in the third quarter and compares to $4 million of cash generated in the second quarter. As we had mentioned in our prior call, we expected to build inventory for some significant deepwater national projects coming up in the fourth quarter and expect the third quarter free cash flow to be negative, but to be in the fourth quarter. Free cash flow this year should be in the mid-to-high single-digit million dollars even after taking into account significant costs that we're incurring in Arkansas drilling our test well, doing the resource study, the front-end engineering and design study and the initial economic assessment. This demonstrates the value of having a strong EBITDA and free cash generating oil fuel services and industrial business to fund the start-up cost of our low-carbon initiatives in the macro formation in Arkansas without having to issue dilutive equity or incur debt to do so. Total debt outstanding was $154 million at the end of September, while net debt was $129 million. At the end of the quarter, our net leverage ratio was 1.7x, an improvement from 1.8x at the end of the second quarter. Liquidity at the end of the third quarter was $92 million. Liquidity is defined as unrestricted cash plus availability on our revolving credit facility. At the end of the third quarter, unrestricted cash was $25 million and availability under our credit facilities was $67 million. We have now been positive at the profit before tax level for 3 consecutive quarters, generating GAAP profit before taxes of $12 million. This is a good time to remind everyone that we have significant federal tax loss carryforwards in the United States that can approximately $440 million of future profits. Keep in mind that as our oil and gas and industrial chemical businesses continue to improve, and we look forward to creating more income from the incremental bromine and from lithium from our acreage in the Smackover Formation. This will allow us the opportunity to have a very high conversion of profit before tax to cash flow from operations and to fund or quickly pay back some of the expected investments from our low carbon initiatives. The $1 trillion bipartisan infrastructure build and the over $400 billion inflation reduction act that was passed earlier this year contains several grants and loan programs that we believe are very applicable to what we will be doing to bring critical minerals at lithium and bromine in the Smackover Formation to market and to build and expand manufacturing capacity to support battery storage. We are very engaged in our having dialogue with the Department of Energy and will be and have been applying for government grants and loans to support our upcoming investments. We will report the progress on these initiatives in the future as key milestones are achieved. Nonetheless, we expect to end this year with liquidity of around $100 million and expect to generate significant free cash flow in 2023 and 2024 to fund a significant portion of our expected bromine investment. When we published a bromine initial economic assessment in December, we'll essentially be communicating our bromine business plan with forward looking required capital investments and expected returns on capital. And as Brady mentioned, we'll be doing the same later in 2023 for lithium. We are very focused and have a high sense of urgency to bring both the bromine and the lithium assets to market as the demand and the returns are already there by others that are already producing such key minerals. To demonstrate how those in the lithium business are benefiting from the high lithium prices and strong market demand. Let me give you an example of such returns. SQM publicly traded global lithium producer increased their lithium EBITDA from $41 million in the second quarter of last year to $1.2 billion in the second quarter of this year, a 30x year-over-year increase in quarterly lithium EBITDA as a result of the high market prices. Their lithium revenue increased from $163 million in Q2 of last year to $1.8 billion in Q3 of this year, an 11x increase. These type of returns and high profits being achieved in the market by lithium producers when we are holding significant lithium and bromine assets in Arkansas explains why the TETRA management team are highly focused on getting these assets to market to create what we believe will be significant shareholder value in the coming years. And when you combine the above numbers that others are achieving with our significant tax loss carryforwards to minimize our cash taxes in United State, you can understand our focus and sense emergency to take advantage of market conditions. I encourage everyone to read our news release that we issued yesterday and the 10-Q that we filed yesterday for all the supporting details and additional financial and operational metrics. I'll turn it back over to Brady.

Okay. Thanks, Elijio. In closing, our earnings from our base business continues to improve, while the significant upside from our Arkansas resources and low-carbon energy opportunities continue to become more defined. While the frac crew count is unlikely to materially change before 2023, we believe our North American land business can continue to increase EBITDA margins and capture more share. The global offshore Completion Fluids business is subject to a longer cycle recovery, but we are pleased with the project awards we've been captured this year and expect this market to continue growing at an even higher pace in the coming years with deepwater projects providing significant upside to TETRA through to our high-value offerings for this market, including Neptune. With that, we'll open it up for some questions.

[Operator Instructions] Our first question comes from Stephen Gengaro from Stifel.

So a couple of things for me. The first is probably pretty straightforward. When you look at, the consensus has you about $21 million in EBITDA in the fourth quarter. I know the quarter we just reported had some gain stuff. How do you see the bridge in the 2 segments between the third and fourth quarter? What are the positives and negatives? I mean I understand seasonality, but how should we be thinking about the progression just for the fourth quarter?

A couple of items to consider, Stephen. One of them is that we think that our onshore business, Water & Flowback will continue to do well and the EPS in Argentina will continue to do well. Brady mentioned that EOS made an announcement yesterday that to take advantage of some of the tax credits that they were pushing quite a bit of revenue originally scheduled in Q4 into 2023. That clearly will have an impact on us as it will push some of our expected sales to them that we're ramping up quite nicely from Q4 into 2023. So I expect that one to be a bit of a headwind. Then I think we continue to see some inflation on raw material prices, but at the same time, we do have some nice big projects coming online overseas, especially in South America. So those are the items that I think you should take into account when considering the Q4 projections.

Okay. And when you mentioned the U.S., is that a sequential drop? Or is it just not growth?

Or the onshore...

For the EOS piece, you mentioned that they were pushing revenue out to 2023?

Yes. That will be a sequential decline.

Okay. Okay. And then the other maybe bigger picture question. As we sort of think about free cash generation and you have these projects that you're evaluating and thinking about funding, how should we think about– or how do you think about your CapEx versus the need to generate free cash and reduce leverage in a world where sort of U.S. service peers are all basically have no debt and are starting to give cash back to shareholders. I know you're in a different spot because you have these significant growth opportunities. But how do you sort of balance those 2?

We made some significant investments for early production facilities in Latin America this year. We do expect that level of investment to occur in 2023 or likely 2024. Those are going to generate some very, very high margin returns. We also made quite a bit of investments on the Sandstorms that earns are very strong. We expect that CapEx next year will be below the $40 billion that we had this year. I mentioned the types of returns that we're seeing in the lithium business by others. They are incredibly strong. We're going to continue to generate free cash flow, pay down debt, to have the capacity to either fund from cash on hand, the initial bromine investment or to have capacity on our revolver to fund those investments. So at this point, generate as much free cash flow as we can use it to fund the initial part of the bromine, then we can evaluate the lithium second after that.

[Operator Instructions] We'll now hear a question from Tim Moore from E.F. Hutton.

Brady, you mentioned that the purchasing bromine at the spot market and continued supply chain shortages. I'm just trying to wrap my head around maybe gross margin in the fourth quarter was that impacted? And can you maybe also provide an update on the Finland calcium chloride plant that was disrupted. I mean how far along is that to getting back to normalization? Or is that more of a spring 2023 time horizon?

Yes. Sure. So regarding the bromine, you're probably well aware, we do have a long-term supply agreement to provide our bromine because our business was so strong in the first half of this year, we will consume the supply volumes that we are committed to ahead of schedule, quite frankly. And what that leaves us with in the fourth quarter because we still have great opportunities as this market is still in the early days of a recovery. We have to go to the spot market for bromine. Now that will affect our margins, as Elijio indicated in the fourth quarter, but we see that as a onetime issue that will affect us in the fourth quarter and certainly not as we go into 2023 as resume back to our contractual supply and volumes from our existing contract. Again, though, longer term, I think it points to why we are so focused on being able to develop the Arkansas resources because that will give us a significant uplift in volumes of bromine to help us not only with our Completion Fluids business for future growth, but also for the energy storage side of things. On the Finland plant, we've continued to make progress. We are from the second quarter, which had a pretty significant impact to us from almost a complete disruption of supply due to the Russian-Ukraine conflict. As we progress through the year, we're not back to 100% capacity yet or full production, but we're probably 70% to 80% of where we would like to be. And we're making progress essentially each quarter as we move forward to that. We're quite confident that we will be able to be full speed by our second quarter peak sales seasons that we need to take advantage of.

Great. That's helpful. Is there any update if you shipped out any calcium chloride for that 6-month order that you received from the international lithium processor?

Yes. We continue to deliver. That was a fairly sizable order. So it was not all shipped at one time, and we continue to have monthly deliveries to meet that commitment. We'll have completed that order before the end of the year, and then we will reassess where orders stand for next year with the supplier and others that are potentially using this same process.

That's terrific and a very good opportunity. I'm glad you won that initial maiden order. Just switching gears to your early production, Argentina facilities. We know that the first one was online for the full quarter. You mentioned on the call that the second one comes online at we've mid next year. Can you give us a rough sense of maybe what the revenue potential is there on an annualized basis between the facilities when they're both running? Is it could be $15 million to $20 million?

Tim, we have 2 units operational. They both came online early July, and they operated essentially for the full quarter. The third one is expected to come online either at the end of Q1 or the beginning of Q2. So that will be the third one that we have out there. And the revenue is actually not as significant as we might want, but the margins are very strong given that they're a bit capital intensive. So it's more on the margin enhancement and the margin dollars that it's bringing then the revenue associated with it.

Great. That's helpful. in. And one other question I just had was -- it might be too early to even comment on this, but I'm just wondering, as your customers E&P folks begin to do their capital allocation budgets, which probably started last month. Is there any initial read or take on how much the spending increase could be next year for E&P and CapEx, given that the strong oil prices and gas prices have held up so well this year?

Yes. We're expecting in the high digits to double digits, 10% level. And again, another way that we track that, Tim, is the frac companies, the service companies in terms of the frac fleets additions or bringing back into the market. And that's by our calculation, running close to that 10% level of additional frac crews. Right now, the market is constrained by available frac crews. We think that, that will help next year in terms of increasing the overall E&P spend as growth opportunities for us in North America. As far as international goes, I think it's a little too early to tell. But clearly, the international markets, I think, will exceed that 10% growth. But we'll probably give you a much better picture on our next earnings call after the E&Ps announced their budgets.

That's a great sneak peek. One other final question actually just came to mind. You mentioned the desalination produced water pilot project with the shale operator. Do you think that could be commercially viable in the third quarter of next year?

Yes. This pilot is actually going to be completed within a 30-day window, and we've already tested the results with our own pilot at our West Memphis facility. So we're very optimistic we will achieve the results. It's really more of setting it up on location, the equipment operate in real time with this customer's produced water. But after that 30-day trial, we have full expectations that we will be entering into a commercial contract. And we have a significant number of other customers wanting to get pilots of similar nature set up. But we'd like to get this first one completed first and then get a commercial arrangement in place and then move forward from there.

We now have a follow-up question from Stephen Gengaro from Stifel.

So you mentioned in the press release earlier about your supply agreements and the bromine, the needs to buy it on the spot market. I imagine that's driven by strong demand, right? And where this year, have you seen sort of the strongest demand that is maybe different than prior years that's driven yield this position? And how do you see that unfolding going forward as far as your contracted volumes versus kind of what you need in 2023?

Yes. Appropriate question, Stephen. I mean we've had some very good awards this year. The Brazil market we haven't seen really a lot of the benefits from it because those awards are just and the contracts are just getting started, but we've had to build inventory well ahead of those contracts starting. Gulf of Mexico, we've had a great market wins this year as validated by the Kimberlite report. Again, we have to build products ahead of time before a lot of that activity starts. We've had some good wins in the North Sea and even in the Middle East, where we've seen the offshore market in Saudi Arabia really pick up. So when you combine those 4 markets and what we've had to do, getting inventory prepared for a lot of these ramp-ups, that's where we've consumed our normal or ongoing supply agreement ahead of schedule. But we don't think we will see that type of pressure going into next year. But if we do, that's great. That just means we have more demand, we will channel more of our completion fluids to the high-margin opportunities such as Neptune and take advantage of that.

So when we think about the impact of those contracts and as you build inventory going into next year, should Fluids margins be creeping higher next year because of the calorie content of what you've built inventories for?

That would be the case, Stephen. We've not given guidance on next year yet. We'd like to make sure we understand the full E&P spend budgets. But for the visibility that we have of our contracts, the awards that we've won this year, the Neptune opportunities, I would fully expect that.

Our next question comes from Martin Malloy from Johnson Rice.

I have 2 questions. The first is on EOS in their announcement yesterday. They also talked about retooling their factory in preparation for the Z3, their next-generation battery coming out. And I believe that was supposed to be commercially introduced and kind of impact more second half of '23. Could you maybe talk about your expectations for the sales of PureFlow first half of next year compared to second half?

Yes. I don't want to give too much color until EOS maybe has their call and gives more guidance as it relates to that. But obviously, we've been working very closely with them with their current technology as well as their E3. We believe the E3 will be from what we know from a production process, a much more streamlined, easier to ramp up type of technology, which will allow our electrolyte flow to grow even faster than what we were able to achieve with our current technology because it is a quite complicated battery technology that they've been producing up to this point. So the only thing we will be able to communicate on that is, as they've announced, they've pushed a lot of their Q4 sales into next year. And we'll have to let them give you more color on how they plan to roll out their units for next year.

Okay. And then with respect to carbon-free, can you maybe talk about the outlook there for potential calcium chloride sales in light of the inflation Reduction Act and some of the benefits for carbon capture that were in that?

Yes. We remain in active dialogue with a carbon-free management team in terms of where they are on site selection, first customer contract, capital raise and so on. And we remain enthused about the progress that they're making and their technology. We don't believe that they're going to represent a revenue opportunity for us. Our best case, very late 2023, but most likely 2024. And we believe that a lot of the funds available from the inflation reduction act or the bipartisan bill are equally applicable to carbon-free, but potentially also to us as we create chloride production facilities that are dedicated to each of their carbon capture operations.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Murphy for any closing remarks.

Thank you very much for your participation today. This will conclude our third term quarter earnings call.