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Rattler Midstream LP (RTLR) Q4 2019 Earnings Call Transcript

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Rattler Midstream LP (NASDAQ: RTLR)
Q4 2019 Earnings Call
Feb 19, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Rattler Midstream Q4 2019 Conference Call.

[Operator Instructions]

I would now like to hand the conference over to your speaker today, Adam Lawlis, Vice President of Investor Relations. Please go ahead, sir.

Adam Lawlis -- Vice President, Investor Relations

Thank you, Josh. Good morning, and welcome to Rattler Midstream's fourth quarter 2019 conference call. During our call today, we will reference an updated Investor Presentation, which can be found on Rattler's website.

Representing Rattler today are Travis Stice, CEO; and Kaes Van't Hof, President. During this conference call, the participants may make certain forward-looking statements relating to the Company's financial condition, results of operations, plans, objectives, future performance and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements due to a variety of factors. Information concerning these factors can be found in the Company's filings with the SEC. In addition, we'll make reference to certain non-GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon.

I'll now turn the call over to Travis Stice.

Travis Stice -- Chief Executive Officer

Thank you, Adam. Welcome, everyone, and thank you for listening to the Rattler Midstream's earnings conference call covering results for the fourth quarter and full year 2019. Rattler's fourth quarter results ended the year on a high note as all four operated midstream segments exhibited strong quarter-over-quarter growth and our operating team continued to accommodate this exceptional volume growth both effectively and economically. Produced waters in the fourth quarter were 26% higher than just the first quarter of 2019, and 26% of the sourced water volumes in the fourth quarter of 2019 were recycled from Rattler produced water, up from less than 10% in 2018, our much lower absolute volumes. This performance reflects the strong relationship between Rattler and Diamondback as well as the benefit of just-in-time capex resulting in a high return on capital employed at Rattler.

Fourth quarter financial results reflected the strong operational performance in the quarter as Rattler grew net income 7% quarter-over-quarter to over $52 million and adjusted EBITDA over 6% quarter-over-quarter to over $71 million in the fourth quarter. The Company is also proud of the fact that full year 2019 financial results exceeded pre-IPO estimates despite lower-than-expected contribution from equity method investments, with full year net income of $186 million and adjusted EBITDA of $265 million. The Company continued the build-out of our various systems, spending $54 million on midstream capital expenditures in the quarter and contributing $261 million to the equity method joint ventures, including closing the previously announced joint acquisition of Reliance Gathering with Oryx Midstream. Most importantly, Rattler today also announced a 16% increase to our quarterly distribution to $0.29 effective immediately, which is also ahead of pre-IPO expectations.

Looking forward to 2020, we are reiterating our previously announced guidance, which implies 42% year-over-year adjusted EBITDA growth, including base business EBITDA growth of over 25% year-over-year, while reducing base business capex by 12% from 2019. Furthermore, remaining contributions to equity method investments are expected to be a $135 million to a $150 million in 2020 and a $170 million to $185 million overall to complete all outstanding commitments on our equity method joint ventures, including our newly announced Amarillo Rattler partnership.

Rattler has entered into a 50-50 joint venture with Amarillo Midstream to own and operate a natural gas gathering, compression and processing system in our Spanish Trail North asset. The joint venture will also construct a new 60 million a day cryogenic natural gas plant for the system that is underpinned by an acreage dedication on the asset Diamondback acquired from Ajax Resources in 2018. Together, with the joint acquisition of Reliance Gathering with Oryx Midstream and Rattler's investment in Gray Oak and EPIC Crude and Wink to Webster long-haul pipelines, the Amarillo Rattler joint venture is another example of leveraging the Diamondback relationship and significant visibility as an upstream operator to pursue attractive investment opportunities.

To conclude, Rattler will continue to execute on our core business of fulfilling its long-term fixed fee contracts with Diamondback. The underlying organic volume growth on the Diamondback dedication, combined with the declining capital expenditures as the various gathering systems approach peak required capacities is expected to drive earnings and free cash flow growth in per share in the years to come.

Rattler's conservative capital structure and low leverage is expected to allow us to prioritize return of unitholder capital through distributions as evidenced by our 16% distribution increase announced today. With these comments now complete, operator, please open the line for questions.

Questions and Answers:

Operator

[Operator Instructions]

Our first question comes from Michael Lapides with Goldman Sachs. You may proceed with your question.

Michael Lapides -- Goldman Sachs -- Analyst

Hey guys. Just curious, how are you thinking about -- you're setting yourselves up to be in a significant cash flow position come -- second half of 2020 and really in the '21. How you're thinking about utilization of that cash flow for 2021 and beyond?

Travis Stice -- Chief Executive Officer

Yes, Michael, I think when we turned -- when we went public, we were very focused on establishing that we're going to grow the distribution while staying under 2 times leverage. I think, we've added some projects here on the joint equity investment or the equity side of the business that's going to allow for significant free cash flow over time. And I think for us, excess free cash flows is going to go toward growing that distribution. While we address the distribution here three quarters in, in the future, if free cash flow looks really good and there is not capital to be spent on other growth projects, then we'll return it to shareholders.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. And just curious on the Amarillo. How can you -- the new JV, how do you think about or what's the potential and what's the physical room actually for incremental gas gathering and processing, and especially on the processing side, meaning is there room inside the fence if you needed to add another plant or two? Is it easy to do under the structure or would you do it outside of it?

Travis Stice -- Chief Executive Officer

Yes, we'll have the site set up to be able to add capacity, should we need it. I think, the unique part about that plant and where it's located is that Diamondback has a lot of other acreage that is dedicated to other people right now, which the JV will have a nice opportunity to get that business over time. Right now, Diamondback's contribution is going to fill up almost two-thirds of the new plant. So on top of that, there are opportunities to fill up that plant and add more if the opportunity arises.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. Thanks guys. Much appreciated.

Travis Stice -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Jeremy Tonet with JP Morgan. You may proceed with your question.

James Kirby -- JP Morgan -- Analyst

Hey, good morning, guys. This is James on for Jeremy.

Travis Stice -- Chief Executive Officer

Hey, James.

James Kirby -- JP Morgan -- Analyst

Just wanted to -- hey, how are you doing? Just want to start with EPIC in terms of the cadence kind of for how you guys model that throughout 2020, including how you guys thinking about 1Q for that -- I assume there's no contribution from that in the first quarter?

Travis Stice -- Chief Executive Officer

Yes. We're modeling a little bit of a drag in the first quarter and then some solid contribution going forward. I can't speak for all the operators on the system, but I know Diamondback's going to be sending 80,000 plus barrels a day, which is above our take-or-pay commitment for most of the year. So we're excited for early -- for a full start-up, also excited for full start-up on the Gray Oak side as Diamondback is not shipping on that today, but will be a large shipper on full start-up of both Gray Oak and EPIC.

James Kirby -- JP Morgan -- Analyst

Great, thanks. And then, it looks like fresh water utilization stepped up quarter-on-quarter pretty significantly over 80%. In terms of modeling that also for 2020, is the -- is that a good run rate or are there other drivers there?

Travis Stice -- Chief Executive Officer

Yes. Fresh water still moves around a little bit, because some of the assets still sit at Diamondback, the Energen-operated fresh water asset and that dedication still sits at the Diamondback level. So it's really about where the frac spreads move as operated by Diamondback. I can say, for the first half of the year, there is a big, a heavy Pecos County component as well as a ReWard component from the Diamondback side, so that's going to contribute solidly to the fresh water volumes, but those do move around a little bit. But if we do, at some point, get all of those assets drop down, then you can more accurately model fresh water as being essentially a 100% of Diamondback's needs for eight to nine frac spreads.

James Kirby -- JP Morgan -- Analyst

Okay, excellent. And just one more. The Amarillo footprint kind of looks like it overlaps with the Reliance Gathering System. Are there any like synergies there? Or what's kind of the thinking in terms of the footprint there?

Travis Stice -- Chief Executive Officer

No. I mean, just a little background on the Amarillo story here. We inherited a dedication when we bought the Ajax asset at Diamondback to the old AMID, it was a public company. The gas plant there at the time just can't satisfy the needs of the growth plans that we have, and that's why we -- when we talk to the Amarillo guys, we just basically flip that contract into a new contract which improves the recoveries for Diamondback, but also allows for the growth that we have planned in the area. I think this just tags onto the lessons we've learned when we entered the Delaware Basin that we do want to control the pipes in the midstream for what we are good at, which is the oil gathering, water and water disposal side, and we want to leverage that size and scale to have partnerships and let the experts do what they do best, particularly on the long-haul side and now on the gas gathering and processing side.

James Kirby -- JP Morgan -- Analyst

Great, thanks. That's it from me.

Travis Stice -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Pearce Hammond with Simmons Energy. You may proceed with your question.

Pearce Hammond -- Simmons Energy -- Analyst

Good morning and congrats on a good quarter. My first question is, I wanted to get your thoughts on capital allocation in light of the JVs and equity investments that you've made. Should we expect more such JV formations in the future? Are you comfortable with your current asset footprint and the priority on cash moving forward will be less on investment and more on returning cash to shareholders?

Kaes Van't Hof -- President

Yes, Pearce. I think, we've done as much as we possibly can here on the JV side, leveraging anything that was available I don't think -- you won't see us being a large acquirer of third-party assets on the water side or there are very limited opportunities left on the oil gathering side. So I think we're done on JVs for now with the asset base, where it is, we're excited that the base business capex is going to decline double-digits year-over-year, while the EBITDA from the base business is going to grow 25%. That's a trend we need to see continue, which will allow us to continue to grow this distribution consistently over time.

Pearce Hammond -- Simmons Energy -- Analyst

Okay, thanks Kaes. And then my follow-up is, can you provide some additional color about the JV with Amarillo about Midstream, how did it come about, what attracted you to form the JV? And how do you see it benefiting Rattler shareholders over time?

Kaes Van't Hof -- President

Yes, like I said a little bit earlier, it came out of the Ajax deal and turning what was a negative or poor performing contract and poor performing plant into a modern 60 million a day cryo with the qualified partner. So I think for Rattler shareholders, we are now partners with a qualified operator to handle the growth that's going to come out of that area as it's -- from a Diamondback perspective has the most or one of the most undeveloped inventories in our portfolio.

Pearce Hammond -- Simmons Energy -- Analyst

Thank you.

Travis Stice -- Chief Executive Officer

Thanks, Pearce.

Operator

Thank you. Our next question comes from Jeff Grampp with Northland Capital Markets. You may proceed with your question.

Jeff Grampp -- Northland Capital Markets -- Analyst

Hey guys, was curious if we could talk a little bit about kind of the volume ramp expectations for 2020. It looked like 4Q '19 volumes came in quite a bit higher than where our model was at and it seems like they're already kind of maybe in the range for the full year 2020 guide. So I was just kind of wondering -- I know we're really a couple of months into the year, but it seems potentially conservative there on the volume front. So I was just trying to -- I guess frame expectations for how we should think about volume growth throughout 2020?

Travis Stice -- Chief Executive Officer

Yes, Jeff. I mean if there's one thing I can say, it's -- while forecasting oil is pretty difficult as an operator, forecasting saltwater disposal volumes is even more difficult. So we've always erred on the side of caution there and the water has continued to surprise us to be upside. I think -- as you know from our history together at Diamondback, we like to have a being raised type of story and Rattler here, through its first three quarters to gain investor confidence in the story and gain investor confidence in what we're trying to present, which is a business that has a 20% return on capital and our 7% dividend yield and 40% EBITDA growth. We're trying to prove that this water business, which most of Rattler's EBIT is water, should compete with the best Midstream assets in North America.

Jeff Grampp -- Northland Capital Markets -- Analyst

Got it. I appreciate that. And my follow-up. I was looking at Slide 14 I think here that goes through the oil gathering system that you guys just recently closed on. It seems like there is maybe some undedicated thing acreage that won't be too much of a stretch to tie into the system. So just kind of wondering, is that a fair conclusion and is there any capital that you guys are contemplating in kind of the near, medium term to expand that system?

Kaes Van't Hof -- President

Yes. On the Martin County side, on the east side of that position, that's all dedicated to Plains today and that was inherited from Energen. I will say the Kimberley area which is Southwest Martin County, we're working right now to get that hooked up and eventually get hooked up to Reliance. So I think that'll be a nice piece of business for the combined Reliance Rattler JV or sorry the Oryx Rattler JV, excuse me.

Jeff Grampp -- Northland Capital Markets -- Analyst

Got it. Appreciate it.

Travis Stice -- Chief Executive Officer

Thank you, Jeff.

Operator

Thank you. Our next question comes from Ujjwal Pradhan with Bank of America. You may proceed with your question.

Ujjwal Pradhan -- Bank of America -- Analyst

Good morning, guys. Thanks for taking my question. Just first one on your distribution program. Obviously we got a small surprise here yesterday with the step-up earlier than scheduled. Can you share some thoughts on that decision, and if we could expect similar unplanned step-ups in the future, given where your free cash flow is, and maybe what you think the right distribution yield is for Rattler?

Travis Stice -- Chief Executive Officer

Yes, I'll let Kaes to answer that in detail. But just like we communicated on Diamondback, when we think about dividend increases, we're looking at ways to drive both current and long-term shareholder value and dividend decisions are typically addressed on an annual basis. Kaes, you want to finish that one?

Kaes Van't Hof -- President

Yes, I think we're new to the midstream business. We've tried to address it on an annual basis. Should leverage stand at 2 times and the business outperform, and we start getting some free cash from our JV investments over the course of the next couple of years. We, with my other half has a 70% owner of the business are looking to get cash out via the distribution. So we're going to -- we're going to keep pushing that. I think it was too early to push it more than we did with the announcement today. But as capital continues to decline and our JV commitments decline, and we start getting free cash from there, it's certainly going to be part of the story.

Ujjwal Pradhan -- Bank of America -- Analyst

Thanks for that. And small follow-up on the Amarillo JV partnership there. Can you discuss the current volume profile in that acreage and what type of earnings contribution you expect in 2020 this year and '21, and also are there other operators in the area?

Travis Stice -- Chief Executive Officer

Yes, so the way we have it right now is, we won't have any contribution in 2020 because the existing plant will operate under the existing contract. When the new plant is put in place is when the JV kicks in, in mid '21. And that time, we should be producing almost 30 million a day on the Diamondback side to contribute to that plant. So it will be a meaningful contributor to the back half of '21. So I think the way we have it set up on the JV side is, the Oryx JV is contributing today, the EPIC and the Gray Oak JVs will start meaningfully contributing in the second quarter of 2020 and Wink to Webster comes on in '21 and then in the back half you have the final JV. So really setting up this backlog of cash flow coming our way over the next couple of years.

Ujjwal Pradhan -- Bank of America -- Analyst

Got you. And maybe one last one. We saw that you increased your 2020 fresh water volume guidance. Was there anything in particular that drove that increase that get you to that decision?

Kaes Van't Hof -- President

We just have more clarity on the Diamondback completion schedule and where those completion crews are going to be moving around as we're now closer to the 2020 plan. So that just boosted the fresh water volumes that we saw in the model versus where we were three months ago.

Ujjwal Pradhan -- Bank of America -- Analyst

Great. Thanks, that's helpful. Appreciate it.

Travis Stice -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Spiro Dounis with Credit Suisse. You may proceed with your question.

Spiro Dounis -- Credit Suisse -- Analyst

Hey, good morning gentlemen. I just want to follow up on some of the questions around returning capital. What are your thoughts around a special dividend? It seems like maybe buybacks are unappealing from a flow perspective. I imagine you wouldn't want to over extend on the dividend yield side and then leverage to your point earlier is, is already fairly low and probably stays fairly low going forward. So does that kind of push you into a special dividend or something you consider?

Travis Stice -- Chief Executive Officer

It's not something we're considering right now. Certainly buybacks are off the table given we want the flow to improve or increase versus where it's been. We tried to do a large IPO to get the float up. We're very proud of the shareholder roster that we have and that's a lot of sticky money. So I think for us, growing that distribution is certainly first and foremost. I'd say second would be slight debt reduction in a great hold scenario where we don't have any cash to allocate to growth projects or return to shareholders, we would maybe consider a special, but that's not on the table today.

Spiro Dounis -- Credit Suisse -- Analyst

Okay, that's fair. High-class problem to have. And then just switching back to the Amarillo JV, certainly you've got a little bit of room to grow there and realize that maybe you can't talk to the cadence yet, but just any color around the trajectory there as you kind of grow that footprint, is one plant a year from here too aggressive, just how to think about the cadence of that growth?

Travis Stice -- Chief Executive Officer

Yes. I'm really focused on one plant right now, I'm hoping that the JV can be competitive to get some other dedications in the area from both Diamondback and other operators and should those dedications head the way of the JV, then we will be more aggressive on the growth front. I think we have a well-capitalized partner that's focused on growing this business and incentivized to do so and we'll be a supportive partner if those opportunities come up. But for right now, we're kind of just assuming the benefit of this one plant.

Spiro Dounis -- Credit Suisse -- Analyst

Got it. That's it from me. Thanks, guys.

Travis Stice -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Kyle May with Capital One Securities. You may proceed with your question.

Kyle May -- Capital One Securities -- Analyst

Hey, good morning guys. You talked about 26% of the source water volumes were from recycled produced water. Is this a good indicator for 2020? And then, also how does this impact the financial results for Rattler?

Kaes Van't Hof -- President

Yes, Kyle, so I'll speak to the financial results. It certainly helps improve margins. Rattler takes possession of the produced water barrel and then sells it back to Diamondback at a much cheaper rate than the fresh water barrel. So that's a win-win for both companies there. From a percentage perspective, it really depends on where you're operating right. I mean, in Pecos County, in some cases, we can use a 100% recycled water for our fracs in that area because there's so much water production. But then you go to an area like Spanish Trail or Midland Basin where there's so little water production that you're pulling all the water that you're producing but you sought to supplement that with some fresh water to complete the frac. So 26% was a really good number. I think for us, we're targeting on average somewhere in the mid-teens percent on a yearly basis. An upside to there would be a benefit to Rattler.

Kyle May -- Capital One Securities -- Analyst

Got it. That's helpful. And then one more from me, on the Amarillo JV and the Oryx JV, do you have any opportunity to add incremental midstream services to those?

Travis Stice -- Chief Executive Officer

Not from a service perspective, but certainly from an acreage perspective.

Kyle May -- Capital One Securities -- Analyst

Okay, got it. Thanks, guys.

Travis Stice -- Chief Executive Officer

Thank you.

Operator

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Travis Stice, CEO, for any further remarks.

Travis Stice -- Chief Executive Officer

Thanks, again to everyone participating in today's call. If you've got any questions, please reach out to us using the contact information provided.

Operator

[Operator Closing Remarks]

Duration: 25 minutes

Call participants:

Adam Lawlis -- Vice President, Investor Relations

Travis Stice -- Chief Executive Officer

Kaes Van't Hof -- President

Michael Lapides -- Goldman Sachs -- Analyst

James Kirby -- JP Morgan -- Analyst

Pearce Hammond -- Simmons Energy -- Analyst

Jeff Grampp -- Northland Capital Markets -- Analyst

Ujjwal Pradhan -- Bank of America -- Analyst

Spiro Dounis -- Credit Suisse -- Analyst

Kyle May -- Capital One Securities -- Analyst

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