TETRA Technologies, Inc. (TTI) Q4 2018 Earnings Report, Transcript and Summary

Good morning and welcome to TETRA Technologies Fourth Quarter Full Year 2018 Results Conference Call. The speakers for today are Stuart M. Brightman, Chief Executive Officer and Elijio Serrano, Chief Financial Officer for TETRA Technologies, Inc. Also in attendance is Brady Murphy, President and Chief Operating Officer. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I will now turn the conference over to Mr. Brightman. Please go ahead.

Thank you, Nancy. And welcome to the TETRA Technologies fourth quarter 2018 earnings conference call. Elijio Serrano, our Chief Financial Officer and Brady Murphy, our President and Chief Operating Officer also in attendance this morning and will be available to address any of your questions. I will highlight a few key items then turn it over to Elijio for some additional details, which in turn will be followed by your questions. I must first remind you that this conference call may contain certain statements that are or may be deemed to be forward-looking statements. These statements are based on certain assumptions and analysis made by TETRA and are based on a number of factors. These statements are subject to a number of risks and uncertainties, many of which are beyond the control of the Company. You are cautioned that such statements are not guarantees of future performance and that actual results may differ materially from those projected in the forward-looking statements. In addition, in the course of the call, we may refer to net debt, free cash flow, adjusted EBITDA, adjusted profit before tax or adjusted earnings per share, backlog, coverage ratio or other non-GAAP financial measures. Please refer to this morning's news 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. On February 25th, we issued a press release of my plans to retire at the May 2019 Annual Shareholders Meeting as CEO of TETRA and as Chairman of the Board of CSI Compressco. I plan on standing for election to the Board of Directors of TETRA at the upcoming May 2019 shareholder meeting. I would very much like to congratulate Brady as he moves into his new role as CEO of TETRA, Chairman of the Board of CSI Compressco beginning in May. This is a transition plan the Board and I have been working on since we hired Brady and he has clearly demonstrated he has the skills and capability and wherewithal to evolve the organization and further advance TETRA and CSI Compressco. We have many opportunities ahead of us and the Board and I are very confident that he and the management team will help TETRA and CSI Compressco continue to evolve as we focus on creating shareholder value, generating cash, and improving returns on capital. We have developed a very deep bench of talent within the management group that has been with us for a period of time in addition to other recent additions. I would like to reach out and thank our shareholders, our sell-side for the support, the management team and our Board for 14 years that I've been at TETRA and CSI Compressco, which includes the 10 years that I've been CEO of TETRA. I have built great relationships in and outside the Company that I cherish and expect to continue to evolve in the future. With that, we'll talk about the fourth quarter. The fourth quarter was our third full quarter under new segmentation and reporting structure, following the divestiture of the offshore decommissioning business and of Maritech. We continue to evolve TETRA's focus on fluids, water management, flowback testing and compression as we believe these segments have competitive advantages, generate stronger returns on capital and have the greatest growth opportunities going forward. I view 2018 as a very successful year for us. We have much to be proud. TETRA is a much different company today than it was at the end of 2017. And I truly believe we are in a much better position to create shareholder value. We had a very strong fourth quarter as all of our segments performed at or above our internal expectations and increased revenue sequentially, despite some of the market challenges in North America, with the crude prices dropping to the low-40s during the quarter. In a quarter of uncertainty on the onshore market, well below peak levels in the offshore deepwater market, each of our three segments delivered 20% type adjusted EBITDA margins, with fluids producing 20.2% adjusted EBITDA margins, water management flowback services delivering 19.9% adjusted EBITDA margins and compression producing 21.1% margins. In 2018, we completed two acquisitions in the Water & Flowback Services segment. We've talked quite a bit about the acquisition of SwiftWater in early 2018 to expand our presence in the Permian and Delaware basins and to add incremental service offerings, mainly water treatment and recycling. That acquisition has been a great success as SwiftWater provided a much bigger Permian footprint for our water business, it also has outperformed our financial expectations, our focus and a big part of our overall strategy in the Water & Flowback Services segments to take advantage of our multiple service offerings by integrating them, and combining with automation technology to be the lowest cost per barrel, safest and most efficient water management service provider. Since the rollout of our integrated solutions project strategy that we noted at our Investor Conference in May, as of Q4, we were on 16 different integrated solution projects across multiple basins, up from 11 that we reported in the prior quarter. This is something to be extremely proud of as we are adding value to our customers and creating better margins through these projects. These integrated projects allow us to differentiate ourselves from the competition, allow us to remain at the job site longer and allows us to be more efficient and generate higher margins. I believe this has contributed to the strong fourth quarter that we just reported. In December 2018, we completed a smaller tuck-in acquisition in the Water & Flowback Services segment in the Appalachian region to significantly increase our water management offering in that region, further boosting our integrated project strategy. That acquisition is now nearly fully integrated and in the first couple of months with TETRA has generated margins and returns above our initial expectations. We will continue to look at strategic opportunities to add to our footprint and offering at the right value on the right basins. We are highly focused on returns as we pursue any future acquisitions. Fourth quarter revenue was modestly up and adjusted EBITDA was unchanged for Water & Flowback Services from the third quarter, despite a challenging lower 48 market as crude prices drop to the $40s around Christmas and with some customers shutting in early for the holidays. I think the segment performed well during the fourth quarter given the volatility of the market. Even though there has been some pullback and fracking activity in some areas, we continue to be bullish on this segment long term, as this is an area where water volumes are going to continue to increase and the amount of produced water continues to become a bigger challenge to our customers. This is why our approach toward integrating and automating the services are becoming differentiators, especially when combined with some of our proprietary technologies such as TETRA STEEL 1200 and the Automated. Blender. Additionally, we are investing funds and resources to automate our services to reduce the amount of required personnel around the well site, which will boost our margins. The combination of automation and a broader service offering is becoming a differentiator. Our segment adjusted EBITDA margins of 19.9% was slightly below the 20.3%, which we achieved in the previous quarter. We've now seen three consecutive quarters with some of the strongest margin in this segment over the last three years. This segment is expected to continue to grow, despite some of the short-term challenges. And we will continue to add capital organically as well as look for inorganic opportunity to aid its growth. During the year, we looked at several other acquisition opportunities and we continue to have the discipline to go after those that fit the strategy only and give us the returns we're looking for. Completion Fluids & Products segment revenue increased modestly from $63 million in the third quarter to $64.7 million in the fourth quarter, driven by increased offshore domestic and international sales. Adjusted EBITDA margins of 20.2% is the highest in a quarter since the last quarter of 2015 without the benefit of CS Neptune revenue and are up 40 basis points sequentially. This is the first time we have crossed 20% EBITDA margins mark as we previously have seen adjusted EBITDA margins in the segment, most in the low teens in quarters without the benefit of CS Neptune. The segment can generate 20% EBITDA margins in deepwater market without the benefit of CS Neptune, which reflects our virtually integrated business model that provides us a cost at bromine supply advantage. The industry is going through a period of rising bromine prices, but our supply agreement is allowing us to capitalize on our vertically integrated business model that provides a cost advantage in a period where our competitors are seeing higher cost of bromine. We continue to see the segment strengthening even when we exclude the benefits of TETRA CS Neptune. We previously reported that the CS Neptune projects anticipated for the fourth quarter of 2018 were pushed into 2019. As we mentioned in our press release this morning, one of the anticipated projects was not completed by our customer as the customer decided to cancel the completion phase of the well. The drilling phase of the second project continues in timing for CS Neptune will be dependent on the formation pressures encountered and completion timely, but most likely in the second half of 2019. We are also currently in advanced discussions for Gulf of Mexico projects scheduled for this year and believe that the downhole pressures will require CS Neptune as the solution. Beyond 2019, we are in discussions with two more major Gulf of Mexico deepwater operators for their lower tertiary development projects. These lower tertiary development projects will likely require a generations three CS Neptune fluid capable of achieving density weights of 17 pounds per gallon. This technology is increasing the number of CS Neptune applications by significantly opening the downhole pressure window and we continue to make strides in the development of this solution as well as in testing it with our customers as can be evident by the aforementioned discussions. Our overall pipeline for CS Neptune completion fluid projects continues to build and our relationship with Halliburton to identify additional CS Neptune completion fluid opportunities continues to gain traction. In the Compression segment, we reported significant sequential improvement in revenue and adjusted EBITDA. Compression EBITDA improved sequentially in every quarter in 2018, starting with the second quarter of 2018, coming out of the downturn. Compression's fourth quarter revenue was the highest in the history of CSI Compressco since the acquisition of CSI in August of 2014. Throughout the year, compression made progress, growing its revenue and adjusted EBITDA, by deploying new large horsepower equipment at high returns and recognizing the operational and financial benefits from the fully integrated ERP system deployed in 2017. While some of the industry struggles with Permian Basin takeaway constraints, we continue to see compression as part of the solution. Demand for compression to address the issues impacting demand to some well site service companies remain strong and all of the additions to the compression fleet are backed by customer commitments. Our Compression segment continues to be robust and growing. We've increased revenues for five consecutive quarters and expect 2019 to grow on a year-over-year basis. So we don't expect Q1 to be as high as Q4 due to seasonal slowdown and lower equipment and aftermarket sales within the segment. CSI Compressco announced in the press release yesterday that capital expenditures are expected to be between $60 million and $65 million, inclusive of $18 million to $20 million for maintenance capital expenditures. And they are expected to be self-funded. In addition, as Elijio will elaborate, TETRA will buy and lease the CSI Compressco an additional $15 million of high horsepower equipment, inclusive of the TETRA Capital Investment. CSI Compressco is expected to deploy approximately 99,000 of new horsepower into its fleet in 2019, all with customer commitments. This compares to the 92,000 horsepower deployed in 2018, mainly in the Permian Basin South Texas, its SCOOP/STACK and almost exclusively high horsepower units focused on gathering systems and centralized gas lift. The new unit CSI is deploying a price higher than other similar units in CSI's fleet and the incremental margins achieved on those units are materially higher than those on the existing deployed units. As a result, the new units are generating returns of capital of approximately 20%. Pricing for the CSI Compressco fleet also increase throughout 2018 as contracts rolled over when new contracts were put in place. Utilization for 1,000 and high horsepower equipment focused on gathering systems and centralized gas lift was 95% at year end, which is essentially at full utilization for the large horsepower equipment. Overall utilization of the fleet increased to 86.6%. CSI Compressco's equipment sales activity was extremely strong in the fourth quarter and was the highest since the August 2014 CSI acquisition benefiting from extremely strong bookings at the beginning of 2018. CSI Compressco ended the year with a backlog of $105 million, all of which is expected to be delivered in 2019. CSI Compressco ended 2018 with orders of almost $190 million, a record for the company. As -- 2019 delivery book is nearly filled with the two -- with the year-end backlog and orders received to date and due to lead times of certain components. With that, I will turn it over to Elijio to provide some financial details on the quarter, then we'll open it up for questions.

Thank you, Stu. Consolidated fourth quarter revenue from continuing operations was $282 million compared to $257 million in the third quarter of 2018 and compares to $200 million from the fourth quarter of last year. Consolidated and adjusted EBITDA from continuing operations for the fourth quarter was $46.6 million and compared to $41.8 million in the third quarter and $29.6 million in the fourth quarter of 2017. Revenue for completion services and products was $65 million and compares to $63 million in the third quarter of 2018. The modest sequential increase was driven primarily by strong year-end offshore fluids sales in the Gulf of Mexico and international markets. Completion Fluids & Products adjusted EBITDA was $13 million or 20.2% of revenue. We had no CS Neptune sales in the fourth quarter, as all of our opportunities moved to 2019 and beyond, consistent with the guidance on our prior earnings call. Water & Flowback Services revenue was $80 million in the fourth quarter, an increase of $1 million from the third quarter. Water & Flowback Services fourth quarter adjusted EBITDA was $15.9 million or 19.9% of revenue. U.S. onshore Water & Flowback Services revenue increased modestly despite concerns in the market about takeaway capacity in the Permian and Delaware basins. As mentioned in our press release this morning and in some of Stu's comments, we are making strides in our integrated management offerings and we are in the midst of being on 16 different projects at year end, up from the 11 we reported during the last earnings conference call. We have now fully integrated SwiftWater into our Permian Basin operations and are continuing to see cross-selling benefits from this acquisition. In the fourth quarter, we also completed a small water management acquisition in the Appalachian Basin and are excited to broaden our customer base and offering in that region. The integration of that business should be completed in the first quarter of 2019. We expect that 2.0 to 2.5 year payback on this investment. Compression services fourth quarter revenue increased sequentially by 20% primarily due to continued strong activity from aftermarket services and a record high new unit sales. Compared to a year ago, revenue was up 66%. Compression segment adjusted EBITDA in the fourth quarter was $29.2 million, a $4.6 million improvement from the previous quarter. CSI Compressco's coverage ratio was 28 times, up from 1.07 times in the third quarter due to the stronger earnings and the distribution reductions we announced in the December 20, 2018, press release. As a reminder on December 20, CSI Compressco announced plans to reduce the quarterly common unit distribution for the fourth quarter from $0.1875 per unit or $0.75 per year to a $0.01 per quarter or $0.04 per unit per year. With respect to the CSI Compressco balance sheet, the goal as communicated at the May 31st investor conference that we held in 2018 to improve our EBITDA leverage ratio from the current levels to 4.5 times or below. Based on the 2019 adjusted EBITDA guidance that CSI Compressco provided yesterday and in its press release, the net leverage ratio will be in the 4.5 times at the high end of the adjusted EBITDA to five times at the low range of the adjusted EBITDA, a material improvement from the current levels, reflecting a strong rebound in adjusted EBITDA that we are seeing. TETRA's balance sheet remained strong. As a reminder, in the third quarter we refinanced TETRA's outstanding debt by replacing the secured bank revolver with a $200 million Term Loan B. We also have a delay draw option available to us for $75 million that can be used for acquisitions. We also put in place an asset-based credit facility. This refinancing provides TETRA with better flexibility, trendier covenants and allows us to have the financial capacity to address opportunities as they arise. As of December 31, 2018, TETRA-only net debt was $158 million inclusive of $24 million of cash on hand. For CSI Compressco at the end of December, we had $15.9 million of unrestricted cash. The CSI Compressco new debt structure that we implemented earlier in 2018 is without maintenance covenants and no near-term maturities. CSI's net debt at the end of December was $617 million, inclusive of $15.9 million of cash on hand. And as before, I'd also like to again remind everybody that TETRA and CSI Compressco's debt are distinct and separate. There are no cross defaults, no cross collateral and no cross guarantees on the debt between TETRA and CSI Compressco. TETRA's objective in 2019 is to generate free cash flow at levels higher than we did in 2018. 2018 TETRA-only free cash flow, excluding discontinued operations, was $3 million for the full year. In the fourth quarter, we generated $15.6 million of TETRA-only free cash flow. Our objective in 2019 is to improve on this $3 million that we generated for the full year of '18, including the impact of lower distributions coming from CSI Compressco to TETRA and after funding $15 million compression investment of equipment that we will make for CSI Compressco. That equipment will be owned by TETRA and will be leased to CSI Compressco, where TETRA will make the returns normally associated with compression equipment. CSI Compressco has the option to buy this equipment at any time over the next five years from TETRA at agreed upon prices. Our guidance for 2019 is going to be limited, given the volatility of the market in the fourth quarter and the uncertainty in the short term. We continue to monitor our customers' 2019 capital expenditures' budget and expect the lower 48 overall E&P budgets to be down between 5% and 10% year-over-year, while international and offshore spending should be up modestly. However, we believe that most of our customers will not slow down as much and the decline in spending in the lower 48 is mainly due to smaller private E&Ps for whom our work is limited. Despite the challenges we are experiencing and the more subdued outlook recently, we feel 2019 will be a stronger year. We expect our first quarter revenue to be down sequentially, driven by typical beginning of the year slowdown as some of our customers are still trying to finalize their 2019 capital budgets and lower equipment sales and aftermarket services for CSI Compressco following the record fourth quarter levels. We expect consolidated first quarter adjusted EBITDA to be down sequentially on timing issues, but to increase as the year progresses. I encourage you to read our news release on this morning and CSI Compressco press release from yesterday for all the supporting details. All in all, we believe, we had a strong quarter in all our segments and a good end to the year. With that, I'll turn it back to Stu.

Thank you, Elijio. And we will now open the call to questions. And Brady will also help us with some of the Q&A. Thanks.

We will now begin the question and answer session. [Operator Instructions] The first question comes from Praveen Narra from Raymond James. Go ahead, please.

Praveen, we might have you on mute.

Praveen, your line is now open.

Nancy, maybe circulate it. We'll come back to Praveen to see if he has a better connection.

Okay, thank you. Our next question comes from Kurt Hallead from RBC. Please go ahead.

Welcome. So, I appreciate the -- I appreciate the fogginess that presents here in 2019. Maybe I can kind of go along with dynamics of this. So, you've mentioned you expect free cash flow. I'm assuming that's on a TETRA stand-alone basis to be better in 2019 relative to 2018. What kind of order of magnitude improvement would you expect on a year-on-year basis?

So, Kurt, we are going to refrain from giving specific guidance, but 2018 as we mentioned was $3 million. We believe that the impact of the Neptune wells and working capital initiatives will allow us to beat that one and put us in double digits for the year.

And can you remind us on the Neptune front, with the cancellation of this one project, what sort of order of magnitude revenue would we have been looking or would you have been expecting for that -- for that project, if it were to come through?

Yes, as you know we don't typically talk about specific well, revenue, margin et cetera. I would give you a few comments then hand it over to Brady to expand, but I think overall, the pipeline we have, the advanced testing we have, the specificity of this of jobs, we feel very, very comfortable. So despite the frustration of that one project not getting completed that we believe would have been a very successful well for us. We think we have more than other capable replacements during 2019. Brady, you might want to give a little bit more color, just the overall Neptune landscape because I know that's a big element of the strategy for everybody.

Yes, sure, Stu. Yes, Kurt, so obviously the one project that we were planning for was drilled, but the completion phase was not executed, was canceled, but as we mentioned previously, those two projects that we've been tracking, one of those projects will continue into 2019, is in the drilling phase. At some point in time, we believe they will drill and complete a well that hits the Neptune pressure regime. And so, that project is still active and alive and since then, we've added another project that we mentioned in our press release in the Gulf of Mexico, typically, at least in terms of revenues, the volumes of the Gulf of Mexico wells and projects are higher than the international projects that we've mentioned previously. So again, that's that adds to our outlook and optimism for 2019 and beyond.

And maybe if I just sneak one more in, on the context of that water acquisition you acquired during the course of fourth quarter, what kind of annualized kind of revenue and profitability, Yes, well, that bring to the table?

So Praveen when we file our 10-K tomorrow, I'm sorry, Kurt, you will see when we file our 10-K tomorrow that we paid $8.6 million with $1.5 million earn out and I mentioned earlier in the transcript that we expect that 2.0 to 2.5 year payback on adjusted EBITDA basis. So that'll give you a sense of the profitability.

Our next question comes from Stephen Gengaro, who is with Stifel. Go ahead, please.

So a couple of questions. I think the first, when you look at the margins in the back half of the year for the fluids business and quite honestly, even though water business, the EBITDA margins, right about 20% and if we think about that going forward without a Neptune job in obviously on the fluid side, how do those margins evolve in '19, are they stagnant, are they -- can they trend up in a flattish activity environment like how should we think about that margin progression?

Yes, I think qualitatively in a flattish margin on the Water & Flowback side, we would expect to see continued improvement on the margins, because of the integrated projects, the automation, those will typically allow us to pull through more services get better margins. So I think that would be a positive to us. The other thing that we've seen and in the 12 months, we've owned SwiftWater and even in the two months with our Appalachian acquisition is, when you bring guys in that know the business really well, you'll start to get some revenue pull-through probably higher than you modeled. I mean I've been really impressed over the last 12 months in the integrated projects expansion, the use of TETRA Steel on -- produced water has increased even on the first two months in Appalachia. The guys up there are finding new opportunities with their existing customers to pull through some other services. So I think that kind of portfolio broadening, the recycling, the produced water all that's going to continue to be positive. On the fluid side, as we mentioned, we do feel like when we go through a period of high bromine inflation which we're clearly in today, our supply chain strategy will enhance our margins. So I think Brady and the team have been very, very focused on making sure we're allocating to the right customers and to the right regions and then when the Neptune business comes on top of that, you've seen over the last several years with the expansion on margins is with those projects. We feel really good about all three of the businesses.

Thank you. And then my second, it's a little bit detailed, but -- so when you -- so it's kind of two part. So one is, when you think about the cash flow -- only free cash flow, I wanted to a) confirm, I think, earlier you said that you'll beat the $3 million mark, and that includes the $50 million investment in equipment for Compressco, is that right?

Right, so in 2018, Stephen, we generated $3 million of TETRA-only free cash flow, which included the benefit of the distributions from CSI Compressco to TETRA. And as you know on December 20, we announced that we're cutting the distribution essentially to $0.01 per unit per quarter. We believe that our profitability in 2019 will absorb the lower distributions coming from CSI Compressco to TETRA and also will absorb a $15 million capital expenditure that TETRA will make and fund for equipment that will be leased to CSI Compressco.

Okay. That's $15 million, right?

$15 million.

And then just as a follow-on to that and I guess maybe a question for Stu or Brady, whoever wants to take it, but when we think about the long-term investment in Compressco and how that evolves, and whether it does evolve, this transaction would seem to suggest it won't evolve and I must say it's a good or bad thing, but can I read that in -- can I read into that, that you are even more excited and focused about the opportunities in compression or was the investment made with -- for other reasons?

Yes, I mean, I'll take the first pass and if Brady wants to add, that's great. Again, clearly how we continue to evolve CSI Compressco is a very strategic question and a very good question. And we've done great with that business, the cash flow it's brought to the parent company has been very beneficial. When I look at the $15 million backstop, I think I put in the context, Stephen of -- we know -- we've looked at the cash flows of the business this year given the guidance that's out there. We made a decision to pay down the Series A with cash, instead of equity, due to the stock price, which I think everybody has universally applauded. We look at next year and we see in the range of $60 million of free cash flow available for that business. So we are very focused on how we use that cash to continue to delever, which we want to get down below 4.5 judiciously reported to growth CapEx that high-return projects with busy customers that we want to continue to build out and think through the distribution policy. So the $15 million is just -- as we've looked at the capital allocation this year, we thought that was an investment we wanted to make as a company and we thought the best source of that in the short-term would be TETRA. And as Elijio referenced over the next five years, CSI Compressco has the ability to take that equipment back by it and keep it under its asset base. So it's -- I look at that as kind of a temporary one-time-ish type of investment that makes sense given all the other variables that are intersecting. I would not view that as a strategic statement of intent, one way or the other.

[Operator Instructions] Our next question comes from Praveen Narra with Raymond James. Go ahead, please.

I guess if we can talk a little bit about the integrated water uptake, obviously, a lot of projects coming up. Can you talk about both the customer profiles of those who are seeing the uptake? And if you could kind of -- can you talk about how the profitability comparison of how you guys have talked about it at the Analyst Day?

Yes. We'll let Brady handle that because he is kind of the leader on that initiative.

Yes, I mean these are very important projects to us. As far as the customer base, it really goes across all of the operators from the major IOCs to the smaller independent. So we're seeing uptake and support really across the board. In addition, we've expanded where we started in the Permian to now the other regions that we mentioned in our press release in the Appalachian region, in the Mid-Con and we're now -- and one in the Rockies as well. So the uptake across the customer base goes across the board. The margins on these projects, we believe will be -- and demonstrate better margins than our typical discrete services, primarily because of the efficiencies that we can bring utilization of people, who are on the job sites longer, the actual pricing for us is sometimes better. So Yes, overall, it's just a -- it's been a real -- its uptake has been stronger than we anticipated and continuing to gather momentum.

And then I guess following up on the prior question, just in terms of prioritization of capital. So you mentioned how at TETRA, CSI agreement kind of falls in, but how do you see future capital expenditures going forward, is it largely the build-out of these advancements? Or are there just some areas where you're getting sub one-year payback? How do you think of it?

Yes, when we look at it and I would say if you look at the profile of the two TETRA businesses, fluids is -- we've made those major investments over the years. When I look back over all the changes we have made, which I think all great changes for the future, the one consistent theme is, we've always continued to grow the fluids business and build that infrastructure. And I think we've seen in the last several years, it's a great free cash flow vehicle. So I don't see a lot of new investment going into the fluids. I think the Water & Flowback, we have a distant number two market share in that business growing, but there is still a big gap. I think the strategy we have on the integrated solutions, the coverage in all the basins, some of the proprietary technology on recycling, that's the area where you will see most of that CapEx. We expect at the middle of the cycle those are going to be 18-month paybacks. So those are the types of things, you don't have to -- you can do within free cash flow and makes sense. And again, we are very, very sensitive to the focus on returns and capital allocation and the thing nobody ever sees except management is the projects to get turned, the decisions we decide not to go forward on. So I would give credit to Brady's operating team, Elijio's team, will be very disciplined on capital, but I do think going forward water will be placed with most of that organic growth is going to come from.

Yes, if I could just add to that, Stu, certainly, the TETRA Steel, even with the activity declines that we've seen since the end of Q4 were sold out. In TETRA Steel, we'll continue to make investments in that technology. The recycling, as Stu, mentioned we're still seeing uptake in that even with a little bit lower activity on the completion side. And the automation component of that we -- that's a key enabler for all of our integrated projects would be priority areas for us for capital allocation.

The next question comes from Thomas Curran with B. Riley FBR. Go ahead, please.

For Water & Flowback, could you update us just -- how does the pipeline of potential M&A prospects look as we sit today? And what have you seen in your regional markets in terms of new entrants? How has the competitive landscape evolved since the last call?

I'll cover the first part of M&A and then I'll ask Brady to take the second part on the evolution of the competitive landscape over the last few months. I'd say the Water & Flowback is an incredibly fragmented market, always has been, will continue to be. Lots of opportunities for consolidation. We looked at many opportunities last year, and again, when you look at some of the adjustments in the numbers, you'll see that we had some fees associated with transactions we did, we also had some fees associated with transactions we didn't do. And we think there's a lot of others water-related companies that either have specific technology or certain geography with innovation that augments what we have, the most recent acquisition up in Appalachia is a great example. We've been in this company up in Appalachia forever in our water business predominantly up in the Northeast area, and our testing business is predominantly done in the Southwest area and we now add a really great water company to that, so I don't expect to see those bundled projects in the Southwest continues. So I think there's going to be a strong pipeline and we have very strong internal definition of what our balance sheet is going to look like. I said the last several years, Elijio has taken a lot of time with his team to remove the covenants to give us flexibility. I think we learned some lessons in the downturn of not wanting to be in a position to issue equity, when we don't want to. So I think that oversight gives us the flexibility, but we're going to do in a context of maintaining the pristine balance sheet at TETRA and we're certainly not looking to issue equity at this price point. So when the world gets better, when we hopefully see improvement to the valuation of the Company, the activity gets more predictable, I think the space we invested in will do organic and inorganic. So I'm very optimistic about the ability to grow both organic and inorganic in North America. Brady, you want to tell what the competitive landscape?

Yes, no, I'll just add a little bit of color to your comments. It is a very fragmented market. We believe, there's a lot of room for consolidation and that we are in a great position to be part of that consolidation activity. If you look at our strategy with the integrated projects where we have a strong water business, but perhaps not a strong PT or vice versa, when we add that other component to a local market like the acquisition in Appalachia, we immediately see the benefits of an integrated business, which we've already taken advantage of in Appalachia as we've mentioned. So that will continue to be something we're focused on and looking at opportunities on a go-forward basis. I actually see more consolidation because of the efficiencies that can be brought then, then we're seeing in terms of significant new entrants from our perspective.

As a follow-up, Brady, I know you just mentioned that you're sold out of the TETRA Steel, not surprising. And I'm sorry if I missed this earlier, but could you update us on where you ended 2018 in terms of total temporary transfer miles opposed both TETRA Steel and then just standard industry lay flat and based on the fact that water will be commanding such a large share of the CapEx budget this year, where you would expect to exit this year in terms of inventory?

Yes, Thomas, I don't believe we actually communicate the mileage of those externally for a single jacket and TETRA Steel is -- so I'm afraid I may not be able to answer that.

We have --

Sorry, Stu.

So, we haven't. So I just want to jump in. I'd give some color, but historically we have -- we haven't quantified miles of single or double-jacketed.

Would it be fair to say though that you'd expect to meaningfully increase it over the course of this year?

Yes, I wouldn't expect that to be the case, Thomas. Yes.

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

Thank you. In summary, I think it was a great quarter, great year. I think we're incredibly well positioned in this volatile market to perform very well in '19. I'd say most importantly as this is my last call with Brady and Elijio will handle with me, the Company is in great shape, incredibly proud of what we've accomplished and I'll leave the Company in awesome hands with these guys as well as all the other folks that are back around the world. So thank you all for your support over the years.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.