Select Water Solutions, Inc.

Greetings and welcome to the Select Energy Services 2021 Second Quarter Earnings Conference Call. 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, Vice President, Investor Relations, and Treasurer. Thank you, Chris. You may begin.

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 operational results for the second 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 Scarkey, 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 August 18th, 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, August 4th, 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 Selects 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 31st, 2020, our current reports on Form 8-K, as well as our quarterly reports on Form 10-Q to understand those risks, uncertainties, and contingencies. Also, please refer to our second quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures. And now I'd like to turn the call over to our founder, chairman, president, and CEO, John Schmitz.

Thanks, Chris. Good morning, and thank you for joining us. I'm excited to be discussing Select Energy with you today. We have been very active over the past few months, and I am pleased with the progress we've made on executing our strategy. We are continuing to strengthen our position as market leader in sustainable full life cycle water and chemical solutions. Since the first quarter, we realized notable achievements in each of our key strategic priority areas, which are, first, improving and bolstering the base business. Second, advancing our technology, ESGS initiatives, and diversification efforts. Third, executing on strategic M&A. First off, looking at the performance of the base business, The second quarter's financial results saw a notable growth in top line with a 12% revenue increase over the first quarter. This revenue growth was led by our oilfield chemicals at 23% and our water services with 19%. While our water infrastructure took a step back in the second quarter, driven partly by the Bakken seasonality, we anticipate a very strong third quarter from this segment. On a consolidated basis, margins held flat overall as cost pressures including labor, fuel, and raw materials continue to weigh in on the margins. Looking forward, we are continuing to engage with our customers and have had positive recent discussions around pricing improvements. As a result, we expect to see margin uplift in our base business during the third quarter. In the third quarter, we also expect to benefit from the increasing contributions from our recently announced recycling projects. The first two projects were completed late in the first quarter with a subsequent expansion of one of these projects just starting late in the second quarter. The next three projects should be completed by the end of the third quarter, though their financial impact to the third quarter will be minimal. These five projects total about 15 million of combined growth capital and provide more than 200,000 barrels a day of recycling capacity. They are supported by long-term contracts with key customers, which reinforces the strengths of Select's platform to provide integrated solutions that rely on our expertise in water and chemistry. These projects not only increase efficiency, reduce cost, and improve operational results for our customers, but they also help our customers achieve their sustainability goals and ESG targets by reducing their environmental impact through decreased freshwater usage and decreased waste disposal. With a solid commodity price and activity backdrop, a streamlined organization, and a strong technology platform anchoring a market-leading position, I feel very good about the continued growth prospects of these base businesses in the third quarter. In support of these base business improvements, we also continue to find new ways to diversify our capabilities and advance our initiatives around technology and sustainable solutions for our customers. Building on this, we have further enhanced our portfolio of sustainable technologies with the acquisition of Alt Recovery, and we also have signed an exclusive supply agreement with EmissionsRx. Alt Recovery is a provider of unique patented biotechnology solutions for production and EOR application and will complement our existing production chemical initiatives. Alt Recovery's Novel solutions are derived from biodegradable inorganic nutrients, which provides an attractive environmental-friendly solutions to our customer while increasing overall well performance and improving returns. We are also very focused on application for reducing emissions for our customers. Accordingly, I'm excited about the partnership with EmissionsRx. This is a part of Select's ongoing effort to help our customers increase well site efficiency and safety while reducing emissions to limit the overall environmental impact of oil and gas development. EmissionRx combustors help our customers capture, reduce, and ultimately eliminate methane generated during flowback and production. They do this in a more efficient and environmental friendly manner than traditional oil fill practices, such as vapor release or opal flaring at both the wellhead and production facilities. Whether it's through automation, data capture, or ESG oriented solutions, technology will continue to play a critical role in our ability to provide better and more cost effective solutions for our customers. Thinking about our diversification efforts more broadly, We continue to advance opportunities to deploy our assets and expertise in new areas for industrial applications. We are still developing a comprehensive long-term strategy, but a key part of that strategy includes our recent hiring of Walt Dell as Senior Vice President, Industrial Solutions. Reporting directly to Michael Scarkey, Walt will oversee our industrial solutions development efforts. He brings a strong 20-plus year background in building and growing business in the industrial water and chemical space, and I'm excited to be partnered with him to grow and execute on this opportunity for Select. Now I'd like to discuss our final key strategic area, M&A. As I emphasized on our last couple of calls, Select is in a very strong position to execute on strategic M&A. We are well positioned as a market leader in water and chemicals with significant operating leverage. We also have a debt-free balance sheet, a strong cash position, and a public currency. All of this provides a solid toolbox for us to work with. Consolidation continues to be a key theme in the industry, and it's one of the most effective ways we can look to improve profitability across the oil and gas industry, and particularly the services landscape. To that end, I am excited to have recently closed the acquisition of Complete Energy Services. Complete is a business I know very well, and I believe it is a good fit with Select from both a service line and geographic standpoint. We are getting a strong market-leading production service presence in the MidCon and the Rockies, a market-leading water transfer footprint in the DJ Basin and the Powder River Basin, and new key flowback customer relationships in the Permian Basin and the Northeast. Add on to that, we've acquired a sizable produced water infrastructure footprint with over 300,000 barrels per day of capacity, and you've got a very attractive portfolio of assets to build off of. Complete's existing disposal footprint provides Significant optionality for broader commercialization, whether it's through the development of incremental gathering pipelines, or more notably, taking that produced water barrel as an alternative source to freshwater and developing produced water recycling infrastructure to meet our customers' needs. On top of operational and strategic benefits, this deal provides attractive and immediate earning accretion with more than $100 million of annualized revenue and $10 to $12 million of annualized EBITDA expected in 2021. With more than 60% of that revenue coming from production-related services and infrastructure, we are also adding an attractive layer of revenue stability to our core completions-oriented base businesses. We anticipate revenue and cost synergies resulting from this transaction, but we will be deliberate about how we approach the integration in the coming quarters. Ultimately, I am very excited about our recent M&A execution, our recycling projects, and our other sustainability-focused investments. I also firmly believe we will continue to find additional opportunities ahead. With growing activity, stable commodity prices, and improved operational and financial performance in the third quarter and into next year, the future remains exciting. 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. The underlying base business took a big step forward in terms of gaining market share with accretive incremental margins in a recovering market. so cost pressures also impacted the second quarter financial results. As we execute on the new investments and acquisitions John discussed, we expect to see meaningful accretion in our earnings along with strategic benefits, all while maintaining our strong balance sheet. Overall revenue growth of 12% quarter-on-quarter to $161 million encompassed some divergence between our segments. Water services and chemicals had especially strong quarters, both growing the top line around 20%, well in excess of industry activity growth. Water infrastructure, however, declined 12%, driven primarily by seasonal factors and short-term breaks in activity in some of the areas served by our pipelines. As I'll discuss in more detail shortly, we expect a strong rebound in revenue for this segment in Q3. Looking at the segments, the water services segment grew its revenues by 19% and its gross margins before DNA from 3% to around 8%. We expect further upside in both of those numbers in the third quarter. The complete acquisition has the largest projected forward impact on this segment and brings more production weighting to balance the completions leverage of many of our services. These assets, along with activity and pricing gains, lead us to expect revenue growth of over 30% in this segment for the third quarter. In regards to pricing gains, we expect margins progressing into the low to mid-teens during the third quarter for water services driven by recent pricing gains and moderating labor pressures. We secured a number of pricing adjustments in recent months, though these were primarily in response to the rapid labor and fuel price escalation of the first half of the year. With the expiration of extended unemployment benefits across most of our areas of operation and recently steadying versus escalating fuel prices, two of the larger recent margin headwinds have diminished in intensity. Additionally, we anticipate pricing adjustments continuing as industry activity maintains its measured expansion. While we don't yet anticipate reaching more normalized gross margins of 20 plus percent for this segment during 2021, we expect Q3 will be a healthy step forward. For water infrastructure, we expect meaningful improvement resulting from the restoration and growth of pipeline volumes, as well as the contribution of the acquisition of COMPLETE's produced water infrastructure. We expect 20% to 30% revenue growth for the segment, with corresponding gross margin improvement into the mid-20% range. While initial revenues from our three more recently announced recycling projects should be recognized during the third quarter, these shouldn't be material relative to their expected full quarter run rates. Additionally, their startup costs will have some burden on the third quarter to partially offset the highly accretive impact of the expected increased high-margin pipeline volumes. Despite continuing supply chain challenges, the oilfield chemicals segment expanded gross margins by three percentage points and was again the top performing segment in terms of revenue growth. Our customers' increased reuse of produced water and our further development of recycling projects, coupled with our fluid match solutions, are positive secular drivers long term for this segment. With continued success and high utilization at our Midland plant and in order to meet growing demand, We've begun preparations to reopen our Tyler Manufacturing Facility, which we temporarily closed during 2020. We expect it to be online by the end of the third quarter with minimal revenue contribution during the quarter. This facility will provide lower cost access to the MidConn, Haynesville, and Gulf Coast regions and allow our primary manufacturing facility in Midland to gain further share in the Permian. We expect modest mid-single-digit revenue growth with low double-digit margins during Q3. In the near term, the current high utilization of our Midland facility, the reactivation costs of Tyler, and continued raw materials pressure are expected to hinder this segment from taking a more meaningful step forward in Q3. Once Tyler reopening costs are behind us, we anticipate resuming the strong first half growth trends for this segment in today's market. Looking beyond the individual segments, SG&A dropped from $19.9 million to $15.9 million, primarily due to the absence of a one-off severance payment that hit Q1. Complete currently runs about $2.5 million of quarterly SG&A, which will impact our third quarter SG&A. Higher revenue resulted in a use of cash from net working capital of $12.6 million, which combined with our targeted investments in recycling infrastructure led to free cash flow of negative $13.7 million for the second quarter. We finished the quarter with $143 million of cash on hand, $257 million of overall liquidity, and no debt. For the complete acquisition that closed just after second quarter end, we used a combination of cash and equity with the $14 million of cash consideration largely funding the acquisition of approximately $13 million of working capital in the transaction. Our intention remains to always maintain a strong balance sheet. That said, the elevated cash balance of recent quarters represents dry powder for value-creating opportunities rather than our long-term target levels. we expect to continue to deploy a balanced mix of cash and equity into accretive opportunities, both organic and M&A related. Positive free cash flow also remains a core target, though the inherent impact of an ongoing integration has led us to adjust our positive free cash flow goal for 2021 to positive free cash flow for the second half of 2021. As we take advantage of value-creating consolidation opportunities in our space, We also gain the ability to make infrastructure investments to tie these networks in with our own assets through organic development. We have been and expect to continue to be successful developing recycling networks in the Permian, but we believe other basins are primed for these types of projects as well. Targeted organic development around the acquired complete assets provides further future financial upside above and beyond the attractive initial financial metrics on acquisitions. Even with the acquisition, our asset-light business model and disciplined approach to capital investment allows us to maintain our same 2021 CapEx guidance of $30 to $40 million, with $15 to $20 million targeted to growth opportunities. We invested just $6.1 million of net CapEx in the second quarter, for a total of $8.3 million for the first half of the year, while gaining market share. That being said, the third quarter should see higher CapEx spend, primarily to complete our recently announced recycling facilities. The complete acquisition should still fit at the high end of our previously guided depreciation expense of roughly $80 to $85 million for the year, with no changes to the minimal interest expense consistent with our current quarter and no material tax expense. Looking at the broader macro landscape, our larger public customers generally continue to operate within budget while generating attractive returns and paying down debt. Sustained, resilient crude and natural gas prices, both in terms of the rally in recent months and forward coverage on the strip, has allowed our customers to lock in attractive hedges and provide us with early confidence in 2022 activity. In parallel with this, we serve many private companies, some of them with very robust development programs, who are adding crews and rigs in light of the strong returns the current WTI price offers. We see a very solid activity backdrop and fully expect continued revenue and EBITDA growth in the back half of the year, both from the base business and the newly acquired operations. Our strong technology offering and market leading position, further bolstered by our consolidation efforts and investments in water recycling and energy transition opportunities, provides us with the ideal platform for continued improvement across revenue, margins, and return on equity. 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 Tom Curran of Seaport. Please proceed with your question.

Good morning. Morning, Tom. First one, a two-part question for water services on a 30% plus sequential revenue growth you expect. First, when it comes to the anticipated gain in average realized pricing from 2Q to 3Q, how much of that increase has already been implemented and taken effect with customers? And then second, where are you at with staffing relative to the workforce that would be required to achieve that level of utilization?

So, Tom, I'd say a lot of that pricing increase has been implemented, but that doesn't show up a lot in the 2Q numbers. So June was a month where we had a notable number of pricing adjustments. Those have continued into July and August. So there's a little bit of difference in the run rate we currently have or the run rate you're exiting second quarter with versus the overall second quarter of revenue. As far as You know, the pace of those price increases and labor cost inflation, as I mentioned, it's moderated a bit recently. It's still an issue. It will be an issue going forward. For water services, it's more on the labor side, and for chemicals, more on the raw material side. But with extended benefits running out, we see less urgency and a more steady plateau of labor pressures versus the real sharp pressures we had earlier. I'm sorry, Tom, what was the second part of your question?

I mean, I think you mostly covered it. It was just about in terms of your current workforce size, you know, where are you at today versus where you would need to be in order to achieve the level of utilization that your 3Q guidance assumes.

And, Tom, this is Michael Starkey. I would say that we're largely there today. uh recently with as nick nick mentioned with labor uh we've been able to secure people you know cdl drivers and other things that really haven't been available over the last few months and so our headcount is trending up to support our estimates going forward all right that's reassuring um thank you for that michael and then for water infrastructure just another two-parter

Nick, would you please tell us how the seasonal impact in the Bakken this year compared to the pre-2020 norm, say, for 2018 and 2019? And then could you also quantify the margin impact of starting up the recycling projects? Just how many basis points did they collectively cost the division?

Yeah, so I'd say versus pre-2020, the seasonal impact was pretty severe for the second quarter here in the Bakken. We expect that to get better, but certainly that was an area that dropped off pretty notably as it does most years. But this year may have been a little more. Going forward as far as the recycling project cost, it will have a few basis points of impact on the third quarter here. Those projects are accretive, and we expect them to be fully operational and running by the end of the quarter. You're not going to see that impact really in the third quarter numbers other than the cost side, though.

Great. Thanks for taking my questions. I'll get back in the queue. Thank you, Tom.

The next question is from Ian McPherson of Piper Sandler. Please proceed with your question.

Good morning, everyone.

Morning. Morning.

You mentioned, Vic, that... complete will mainly fall into water services I imagine there's a portion of it that doesn't but unpacking that inorganic layer as well as this most but not a full quarter contribution from that acquisition can you describe to us what your organic top line growth in q3 from your base business looks like in the third quarter Ballpark, 5%, 15%, et cetera.

So chemicals, of course, isn't directly impacted by the complete acquisition on a third quarter revenue basis, although it certainly helps support further chemical growth organically going forward. If you take that $100 million annual run rate number and break it up into quarterly, you can see where we're falling out. a segment basis for the other two generally for services it's high single to low double-digit organic X complete growth completed as I mentioned or overwhelmingly services oriented in the current breakdown here going forward there's a lot of opportunity to invest on the infrastructure side they have a good platform of assets that are generally close together. Some of those are piped. Others have the opportunity to be networked and then to develop organically recycling infrastructure around them. And so that's where we see the bulk of the growth coming from. But currently right now it is more services related, but 60% levered to production versus completion. So it brings a little bit of a different mix into our services business that's probably a little more stable and and predictable longer term.

That's great. Thanks, Nick. You've highlighted for us really attractive economics on your acquisitions, but also on the organic side with the recycling projects, both of them from where we sit appear to be pretty ratherly scalable from what you've announced so far. Can you speak to the relative pipeline breadth

opportunity between you know building more recycling yourself versus other deals that could be comparable or maybe larger potentially than complete yeah this is John and you know there is other potential acquisitions that have the same kind of ingredients that we just executed with complete which are assets that we can build build off of more on the infrastructural side through gathering lines and long-term contracts around that asset base, as well as the ability to add the new position into that footprint of recycling. Again, that recycling position that we've been able to execute and describe today comes with long-term contracts as well. So we expect more of it, and we're going to continue to look at it. As far as the organic piece of it, we continue to have a lot of conversations around opportunities to put organic money to work in the conversion of disposal to recycling and long-term contracts around those. So we expect that we'll put more money there, and that pipeline is pretty strong, too.

Well, we'll look forward to seeing next steps. Thanks for all the detail today. Thanks. Thanks, Ian.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. That concludes our question and answer session. I would like to turn the floor back over to John Schmitz for closing comments.

Yeah, thanks, everybody, for participating today. We appreciate your time and your effort and the questions, and we look forward to talking to you the next quarter and our progress and our continuing development of the company. Thank you.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.