Select Water Solutions, Inc.

At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris George. Please go ahead.

Thank you, operator, and good morning, everyone. We appreciate you joining us for the Select Energy conference call and webcast to review our financial and operating results for the first quarter of 2021. With me today are John Schmitz, our Founder, Chairman, President and Chief Executive Officer, Nick Zweika, Senior Vice President and Chief Financial Officer, and Michael Skarke, Executive Vice President and Chief Operating Officer. Before I turn the call over, I have a few housekeeping items to cover. A replay of today's call will be available by webcast and accessible from our website at selectenergy.com. There will also be a recorded telephonic replay available until May 19, 2021. The access information for this replay was also included in yesterday's earnings release. Please note that the information reported on this call speaks only as of today, May 5, 2021, and therefore time-sensitive information may no longer be accurate as of the time of the replay listening or transcript reading. In addition, the comments made by management during this conference call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of SELEX management. However, various risks, uncertainties, and contingencies could cause our actual results, performance, or achievements to differ materially from those expressed in the statements made by management. The listener is encouraged to read our annual report on Form 10-K for the year ended December 31, 2020, our current reports on Form 8K, as well as our quarterly report on Form 10Q for the quarter ended March 31st, 2021, which we expect to file later today, to understand those risks, uncertainties, and contingencies. Also, please refer to our first quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures. Now, I'd like to turn the call over to our founder, chairman, president, and CEO, John Schmidt.

Thanks, Chris. Good morning and thanks for joining us. I'm excited to be discussing Select with you today. Having been back in the CEO seat for about four months now, I believe we continue to have good direction for executing and improving our strategy to strengthen and set apart our position as the market leader in sustainable, full livestock water and chemical solutions. My primary strategic objective remains as outlined last quarter. We will drive value in this company. First, through improving and growing the base business in a recovering activity environment by creating value for our customer base with our integrated full lifecycle fluid match solutions, which should drive market share gains and gross margin improvements. Second, through deploying our expertise in water and chemicals both across the energy value chain and and into other industrial applications as a value-add solutions company. And third, through sourcing and evaluating strategic investment opportunities, and M&A focused on consolidation, diversification, and advanced technology. I'd like to start by addressing our progress toward each of these objectives before Nick takes you through the recent financial performance and outlook in more detail. First off, Looking at the performance of the base business, the first quarter's financial results were challenged by severe winter weather that impacted operations in February. That said, we saw revenue growth across each segment with 8% sequential revenue growth overall. I'm certainly disappointed in the regression we saw in terms of profitability. And while we have to realize the February weather hit select hard given our operating footprint, we still underperformed. However, we expect a solid recovery and further growth in quarter two. Additionally, we continue to look for more ways to improve the business. In doing so, we recently completed an organization realignment in April, led by the appointment of Michael Skarkey as COO. Michael, who I've asked to join us here today, has been a longtime partner of mine. Having joined Select back in 2009, shortly after I founded the company, Michael has served in a number of leadership roles within the organization across both operations and finance, most recently serving as EVP, corporate development, sales, and operational support. With other previous leadership roles heading up our water infrastructure segment, our formal water solution segment, and our corporate finance function as treasurer. Michael will oversee all aspects of operations, including sales and technology, with a high focus on integrating our efforts to support our fluid match approach to our sustainable full life cycle water and chemical solution. This realignment will also emphasize commercialization of our integrated solutions on a regional basis. ensuring we have the right people in place to drive sales, direct pricing, control cost, and improve margins in every region. This will allow us to first capitalize on our strong operating leverage to more efficiently take advantage of our large geographic footprint that covers all active unconventional basins. Second, to have real-time visibility and control over our costs. And finally, to leverage our key position in advanced technology to drive our integration initiatives to capture more wallet share around sustainable full ice cycle water and chemical fluid match solutions. As an example, our efforts, focus, and leading position is showing up with two recent wins. And we have commenced operation on these previous announced recycling facilities. We have partnered with two blue chip operators in the core of the Permian Basin to operate two water recycling facilities backed by long-term contracts. These fixed infrastructure facilities streamline our customers' water logistics, reduce their cost, improve their results, and help them achieve their ESG targets by reducing their environmental impact through decreased fresh water usage and decreased waste stream. These recycling projects began operation in the first quarter and are off to a very good start. We have already seen success in further commercialization of these facilities with two more customers now either currently sending or contracted to send volumes during the second quarter. This is in addition to the base load volumes that underwrote the project. As an added revenue driver, we're also pulling through other service lines related to operating these facilities as well. With a solid activity backdrop, a streamlined organization, a strong technology platform, and a market-leading position led by our sustainable full lifecycle water and chemicals fluid match solution, I feel very good about our continued growth prospects in the quarters ahead. Looking at our two remaining strategic objectives, I believe we made a small but unique investment in the first quarter that advances our efforts across both areas. We are innovating and finding new ways to diversify our capabilities and drive our initiatives around energy transition. As part of this effort, we are pleased to announce a strategic investment in ICE thermal harvesting. ICE is a new venture focused on providing zero emission geothermal electric power from flow back and produce water to the oil and gas industry, as well as to industrial customers across multiple sectors. We are excited to collaborate with the ICE team as both capital and strategic partners and look forward to the growth opportunities ahead for the business. We believe Select has much to learn and much to offer to the energy transition, and we will continue to evaluate ways to participate through organic and inorganic growth opportunities. Thinking about the industrial diversification more broadly, we continue to advance opportunities to deploy our assets and expertise into new areas, but we still are developing our long-term strategy. On the corporate development front, We will certainly continue to pursue smaller strategic investments and acquisition opportunities in areas such as technology, energy transition, and ESG solutions. Additionally, there is still a broad set of M&A opportunities with both small and large-scale value-add opportunities, consolidation with meaningful cost energies, as well as opportunities to add strategic diversification and earning stability. We sit in a strong position in the marketplace with no bank debt, strong cash flow capabilities, and a substantial cash balance. In addition to this financial strength, we have the ability to leverage our competitive strengths as the oil and gas industry's leading sustainable water and chemical solutions provider to expand into new areas or other industries to take advantage of the energy transitions in ways that many of our competitors cannot. We are very excited about our recent recycling and energy transition investments, and we continue to believe that additional opportunities lie ahead. We fully expect to see growing activity, improved operational and financial performance in the second quarter and into the back half of the year. With that, I'll hand it over to Nick to discuss the financial performance and outlook in more detail.

Thank you, John, and good morning, everyone. Financially speaking, the first quarter encompassed three very different months. January, by and large, represented a continuation of the recent fourth quarter momentum. February saw a 25% decline in revenue with very little corresponding decline in expenses due to the effects of the winter storm. March's revenue snapped back to essentially the level seen in January. although chemicals raw material shortages endured due to the winter storm's impact on Gulf Coast production facilities and the cost of these raw materials spiked prior to our ability to pass those increases along to our customers. Overall, given the incipient stages of the recovery, this monthly combination did not yield the results we expected for the first quarter. While first quarter revenues increased 8% sequentially to $144 million, consistent with our forecasted range, Adjusted EBITDA of approximately $1 million declined from last quarter's results. I'll be referring to the impact of the winter storm a few times as we go through the segment detail today to properly quantify it. But one thing I want to make clear is that our general forward outlook remains the same. Commodity prices are supportive. Activity is improving. We're continuing to gain market share while carefully targeting our investments. As John outlined, we are building water recycling networks, developing advanced integrated solutions, and investing in energy transition opportunities, all while growing our overall liquidity and maintaining our debt-free balance sheet and healthy level of cash on hand. All three of our segments grew revenues quarter over quarter, even after the weather impacts. The water infrastructure segment held steady, maintaining its 30% margins, but for each of water services and oil-filled chemicals, the freeze, raw material supply disruptions, and rising fuel costs decreased margins by three to four percentage points. Based on the March and April trends and current visibility, we expect the water services segment to grow its revenues 15% to 20% in the second quarter, while restoring margins into the double digits. While rising fuel and labor costs have presented a headwind, increased activity and utilization, automation efficiencies, integrated sales efforts, and the operational realignment John discussed are yielding benefits. Competitive pressures and oversupply remain issues, but the environment is improving. The water infrastructure segment, which recently more than doubled its revenue from Q3 to Q4, advanced revenue modestly in the first quarter while holding margins at 30%. We anticipate revenues holding relatively steady during the second quarter with increased recycling revenues offsetting declines in our Bakken pipeline volumes driven by the seasonal breakup period in North Dakota. However, given the decreased contributions from our high margin Bakken pipelines expected during Q2, We anticipate margins compressing to the mid-20s range during the second quarter. Despite the supply chain challenges, the oilfield chemicals segment grew revenue in Q1 by 12%, the fastest of any segment. With these recent disruptions behind us, we expect even more rapid revenue growth in the second quarter, and more importantly, restoration of gross margins to 14% to 16%. In addition to the supply chain disruptions, We saw surging raw materials costs during the first quarter due to higher feedstock prices for products such as NAPFA, and then again in yet higher prices as a result of significant supply chain capacity being knocked offline from the winter storm. Our volumes and margins were constrained as a result of this, but as of April, we've been able to realign most of our key customer contracts to account for this higher input pricing. With our in-basin manufacturing capabilities, dedicated customer base, and success across multiple product lines, We anticipate very strong Q2 revenue growth of 20 to 30 percent, along with those 14 to 16 percent gross margins I referenced. Looking beyond the individual segments, SG&A grew during the first quarter, primarily due to the one-off impact of executive severance hitting Q1, but should revert closer to $16 to $17 million a quarter going forward, including the impact of non-cash compensation. Overall, SG&A remains a critical focus area as we seek further efficiencies. We believe our current support platform can sufficiently serve the needs of a growing business in the coming quarters, particularly as we continue to apply technology to streamline operations. Putting it all together, we expect second quarter consolidated revenue growing to 160 to 170 million with adjusted EBITDA margins of 5 to 7%. From the second quarter onward, we see a very solid activity backdrop and fully expect continued revenue and EBITDA growth in the back half of the year, driven by the continued efficiencies and wallet capture resulting from a streamlined organization, integrated sales efforts, strong technology platform, and market-leading position led by our sustainable, full-life cycle water and chemicals fluid match solutions. In terms of free cash flow, while the revenue increase and weather disruption led to some working capital headwinds in the first quarter, we expanded our overall liquidity by $12 million and finished the quarter with $160 million of cash on hand $262 million of overall liquidity and no debt. Our expectation remains that we will generate positive free cash flow for 2021, even as working capital increases along with revenue. We have an asset-light business and a disciplined approach to capital investment. We invested just $2.2 million of net CapEx in the first quarter while gaining market share. Maintaining our previously provided forecast of $10 to $20 million targeted for potential growth opportunities, we are reducing our maintenance CapEx forecast downward, resulting in a full-year net CapEx forecast of no more than $30 to $40 million for all purposes. Finally, we anticipate depreciation expense of roughly $80 to $85 million for the year, minimal interest expense consistent with our current quarter, and no material tax expense. We are actively and will continue to actively evaluate opportunities for investment and acquisition, but we'll do so within a disciplined framework. With that, I'll turn it over to the operator for some Q&A. Operator?

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Ian McPherson with Simmons. Please go ahead.

Thanks. Good morning. You mentioned some visibility into continued positive improvement beyond the second quarter and recognizing that you're prosecuting market wallet expansion and executional uplift, et cetera, and also probably some seasonal relief. Bakken, but beyond those sort of company-specific ingredients, how are you viewing the general completions cadence from Q2 into Q3, if you can formulate any visibility on that yet at this point in time?

Sure. So, Ian, you know, we typically don't give longer-term guidance, but the positive factors we currently see The oil price is certainly very supportive, as is the forward strip. So we see more and more of our customers hedging out longer into that strip. You've seen very positive results, by and large, from those customers this earnings cycle. Clearly, they are generating cash and able to generate a high rate of return on their drilling and completion programs. And finally, our conversations with these customers have been supportive as we look through to the the second half of the year here. So putting those factors together, we think about 15% to 20% CapEx growth from the E&P side over Q4's pace. That's probably a higher number when you take into account the private companies. And so we're not going to spend a lot of money into that, but the positive factors are there and we're prepared to grow with them.

Understood. Thanks. Good to hear also that you've contracted some incremental volumes on those recycling projects on top of the foundational commitments there. So are those assets now approaching full contracted nameplate capacity? Does that green light further similar projects along those same lines, or do you think that your next project Strategic spend might be more M&A as opposed to comparable organic projects.

We're certainly pleased with how those are performing, and those are going to contribute a lot more revenue and margin in Q2 as they're running for a full quarter and bringing in those third-party volumes. So those are attractive. We have multiple ongoing discussions with other customers for similar type of projects, and so I wouldn't I wouldn't be surprised if we had more announcements through the year with that growth capex number that we mentioned. But, you know, M&A is clearly on the table as well, so I wouldn't want to, you know, point you one direction or the other to say this is more likely or less likely. There's good discussions and opportunities on multiple fronts.

Glad to see things are improving out there. Appreciate the comments. Thanks, Nick. I'll pass it over. Thanks, Ian.

Your next question comes from JB Lowe with Citi. Please go ahead.

Hey, morning, guys. Kind of a broader question on kind of the strategic vision for the industrial solutions group plus the recycling. I guess if you kind of bucket those into, you know, kind of your ESG portfolio, what – I guess, what percentage of revenue would you like to grow that business to? And what do you think is feasible over the next few years to grow your exposure to those businesses?

Yeah, so this is John. As far as the industrial push that we have and we've described and continue to execute on, I mean, you have two pieces inside this company. You have the first piece, which is, you know, unutilized assets, and those assets really move water, store water, deliver water. We think those assets and have proved that those assets can be meaningful, meaningfully applied to industries outside the oil and gas business. So that's short term, and we're very focused on it because we own the assets and logically need the profit. Longer term, we believe that if we execute, you know, making a match to a water molecule with the right chemistry and in a reuse fashion taking a waste stream and creating a useful stream out of it. We believe that once we really prove that up and execute that well in the oil and gas space, we believe there's areas outside the oil and gas space And inside the oil and gas space that we can expand that skill set and that, you know, that proven model across. So that longer term, we're focused on that. And that's, you know, in our description about that's the longer term plan. We're still working on it. Logically, that's people and skill sets and knowledge of other industries. So we're very focused on, you know, looking into and where does it apply and who needs to be our partner in applying it.

Okay. I wanted to ask about the geothermal investment you made. Could you just kind of describe what you guys would actually, or what that company would actually be doing? Would it just be as simply as, I mean, you said it was for geothermal, you know, electric power to oil and gas companies. Would this just be like going out and drilling a geothermal well at a production facility and then providing power that way? I guess just some, you know, kind of details on what the company is actually planning on doing would be great.

Yep. I appreciate that. I'm going to let Michael Skarkey talk to this investment. He was very involved in it, and I think he can explain how it relates to our synergies through our company and what we do to the oil and gas space, but an overall thesis for the investment we made in it.

Sure. So ICE Geothermal, to start, it's really a platform with two entrepreneurs that we know and are really excited to support and be partnered with. Their initial plan is to harvest heat off produced and flowback water and use that for electricity on a near location. And so logically, there's a fit there with our well testing and flowback services to where we think we can help them get in with the operator and execute on that plan. Now, the strategy really goes beyond just harvesting heat from flowback and produced water and moves into industrial and then other geothermal solutions as well.

Cool. We'll have to dig into that a little more. Last one for me is just, you guys mentioned consolidation, opportunities, and also you mentioned, Nick, I think, getting some market share. Could you just talk about which product lines you think that consolidation is A, most likely, and B, something that you guys could participate in? And then same question, where are you guys getting market share? Thanks.

Yeah, I think we are getting market share both in our of our organization and to this regional or basin focus. So we have put together teams that are very directed to certain areas. Logically, one of those big areas is the Permian Basin and how we can bring value to the customer. But through that value, we're going to capture more of their spend. And you can think of water and chemistry and how that fits together and how we make Our two worlds come together in a regional basis, especially in the Permian to do that. Recycle facilities that we described is a perfect example of that capture of water and chemistry applied. And then our drag-through service offerings that really are the highest margin when we match those services to the water itself on it. So, you know, that is a really big focus on ours, but, you know, Outside of that, logically, there is needed consolidation in our space. We all know that our revenues are not anywhere close to what they were. These revenues are across management teams and cost structures that need to come together and, to be frank, need a portion of that to go away. So the elimination factor through M&A is a a really big need for the industry as well as a big target for Select. We think about it a lot. The last piece is, you know, our M&A is very focused on technology and advancement of, you know, a value add or an ESG, a capture, and we've just seen that with ICE. And we continue to look for technologies of that way. We continue to do them in-house. as well as M&A. So we're very focused on the potentials of technology through M&A as well. But a large transaction that has a lot of eliminations in it is something that's definitely on our screen as well.

JB, on a segment level market share, I think I'd point you to our chemicals division that had the fastest revenue gain in Q1. And then looking at our Q2 guidance there, we certainly anticipate some additional market share pickups there. So we've been Very successful, I think, in meeting the demands of the industry and having the latest products. Our in-basin manufacturing capability, I think, allows us to be a little more nimble than larger diversified coastal suppliers. And so that's an area where we're very excited about in the near term here.

Yeah, just touching on that real quick, Nick, how much has the WCS acquisition helped out on that front?

A lot, and it's really, you know, when John talks about the bridge there of treating water both mechanically and with chemicals and through our fluid match system, you know, WCS is a key part of that bridge and kind of integrating the full product offering here. Awesome. Okay. Thanks. Thank you.

Once again, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question comes from Daniel Burke with Johnson Rice and Company. Please go ahead.

Yeah, good morning, guys. Morning. Let's see. Incrementals in the water services guide for Q2 look pretty healthy. And, you know, of course, you have the ability or the benefit of recovering from the weather event in Q1 as a contributor. But it was encouraging to see mention of pricing improvement in this segment as well. And I was wondering if you could expound a little bit about what you're seeing in pricing in water services and then maybe give some generalized thoughts on what incrementals in that business could look like in the second half of 21.

Yeah, Daniel, we have been able to start asking for and getting pricing, but it's needed. We all know that. There's a pressure on labor. We know fuel cost has went up. You know, as Nick described in his part about the chemicals getting pricing pressures through their base commodity, you know, we need pricing, but we are applying that through the field and we're applying it to our customer base and we are getting priced and it is needed price in this industry right now. Nick, you got...

Yeah, with the impacts of the storm, the incrementals are a little wonky for Q2 here, but when we talk about kind of a longer-term growth in the second half, 30% to 40% is what we've seen historically and what we anticipate for that. We have good operating leverage in a lot of our segments here. Water services, as John mentioned, if we're hiring people and putting equipment back to work, then we will need incremental price to get an attractive return on assets there and So those are all things that are pointing in the right direction.

Got it. That's helpful. And maybe I'll take a run at a question I think Ian already broached. Nick, I think last quarter you talked about expecting 180 to 200 frac fleets in the back half of this year. And there's a lot of maybe different places to source that, but we're probably nosing up against that type of level at this point. So just thinking about your optimism for second half 21, continued growth, Have you upgraded your thoughts on completion activity versus a quarter ago, or is this more about the market share gain potential you see out there?

Yeah, our internal count is right on with yours, and we do anticipate getting over 200 here in the near future. We're focused on that integrated service offerings, bringing more products and services to the well and driving margins that way. But activity growth is certainly helpful, and we anticipate continued moderate activity growth.

Got it. And then, Krem, one last one in. You guys have been, like the rest of the industry, very cost-focused for a long time. This latest organizational realignment, anything that you can bring to bear in terms of what that means in terms of margin that you're able to achieve with this latest restructuring you've implemented?

Yeah, we believe there's an ability to, you know, put power and communications in place that does both things. One, you know, these are high variable cost businesses, so controlling the cost at actual the job site or the yard level is very important to us, and we believe this realignment put some of that emphasis on being able to improve the gross margins in these businesses, which is needed, as we all know. The second piece is each one of these regions or basins in that wallet capture that Nick described and we've described, and a fluid match between water and chemistry is made up differently. So the Permian is different than the Northeast. And so we wanted to make sure that we put the right teams together in the right spots to make sure we can bring the value to the customer and capture that wallet and drag through these services. And we believe this realignment gives us that in our organization.

Got it. Okay. That's a helpful overview. All right, guys, I'll leave it there. Thanks for the time.

Thank you. This concludes our question and answer session. I will now turn the call over to John for closing remarks.

Yeah, thanks, everybody, for participating today, and we look forward to talking to you again next quarter. Thank you all.

This concludes our teleconference. You may disconnect your lines at this time, and thank you for your participation.