Select Water Solutions, Inc.

Greetings and welcome to the Select Energy Services Fourth 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, Mr. Chris George, Vice President of Investor Relations and Treasurer. Thank you, Mr. Chris George. 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 fourth quarter of 2021. With me today are John Schmitz, our founder, chairman, president and CEO, Nick Swyka, senior vice president and chief financial officer, and Michael Starkey, 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 March 9, 2022. 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, February 23, 2022, 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 select 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, our current reports on Form 8-K, as well as our quarterly reports on Form 10Q to understand those risks, uncertainties, and contingencies. Also, please refer to our 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 again with you today. Overall, 2021 was very exciting for Select. Having been back in the CEO seat for a little over a year now, I'm pleased with the progress we've made on executing our strategy of improving and bolstering our base business, advancing our technology, ESG and diversification efforts, and executing on our strategic M&A. I'd like to start by highlighting some of our 2021 achievements. We finished the year with total revenues of $765 million, and adjusted EBITDA of $50 million, while seeing revenue, margins, and adjusted EBITDA grow every quarter throughout the year. On the technology and sustainability front, we continue to advance our water recycling efforts. We've invested in six facilities during 2021 backed by long-term contracts. This sets the stage for significant growth in our recycle volumes for 2022. We are also having constructive conversations with our customers every day, and I believe we will continue to build on our recent success with more long-term contracted development opportunities in 2022. We are also very active on the M&A front during 2021. As I've stated many times, I believe consolidation is very important for this industry. Through a combination of cash and stock consideration, we closed on the acquisitions of Complete Energy Services, Aqua Libra Midstream, HB Rentals, and Nolte Recovery during 2021. Additionally, we are set to close on the acquisition of Nevera Environmental Solutions. In doing so, we've added nearly $300 million of run rate revenues to an already growing base business and acquired strategic portfolio of infrastructure assets including gathering and distribution pipelines, disposal facilities, and landfill operations. Importantly, we have also welcomed more than 1,200 new skilled employees to the Select family. In a challenging economic environment and a tight labor market, these new team members will be critical to drive our continued success in 2022. Through these consolidation opportunities, we have meaningfully improved and expanded our operation capabilities and geographic breadth. I also believe we have a tremendous opportunity to create revenue synergies and capture cost savings while improving our margin profile through increased efficiency and pricing gains across the business. During 2021, We have also executed a number of strategic investments and partnerships with unique emerging technologies and energy transition platforms, including ice thermal harvesting, deep imaging technologies, ESG solutions, and EmissionsRx. As we look forward, we will continue to look for unique opportunities to invest in and advance our technology, sustainability, and diversification initiatives. While the fourth quarter was relatively stable from an industry activity standpoint, our revenue growth well exceeded the industry activity growth. We continue to see the benefits of a strong commodity price backdrop overall, with oil prices around $90 and natural gas prices of more than $4. I believe 2022 will be a strong year for the industry. with North America onshore E&P budgets expected to be up 25 to 35% year over year. Supported by our continued investment in technology, our recent acquisitions, and our strong balance sheet, Select is well positioned to grow and succeed in 2022. Select's leadership in water and chemical solutions is driven by our operation reliability, our committed focus on safety and sustainability, our leading technology platform, and our highly skilled and dedicated employee base that's now more than 3,500 strong. Our unique, integrated platform of water and chemical solutions provides a truly differentiated value proposition for our customers, and I look forward to continue to provide them with the operational excellence they have come to rely on from Select. Speaking directly to the fourth quarter, we wrapped up the year with another strong showing with revenues increasing 25% quarter over quarter and adjusted EBITDA growing by more than 70% to 26 million. In addition to the growth we've seen in the base business, we've already seen strong contributions from our recent acquisitions. However, we still have much room for improvement as our operation Integration strategy advances in the coming quarters. I'll let Nick speak to our first quarter and 2022 financial outlook in more detail, but I feel very good about our continued ability to grow the business, meaningfully improve our pricing, achieve cost synergies, capture market share, and generate free cash flow during 2022. With the sizable portfolio of infrastructure assets we recently acquired, we are well positioned to continue to build around these assets and further develop unique, sustainable solutions, including gathering pipelines and our water recycling and integrated fluid match solutions. We remain very focused on growing our less technical production and industrial-related revenues and adding contracted revenues through our recycling and pipeline infrastructure. Ultimately, this will further stabilize and enhance our cash flow generation capabilities, differentiate Select from its competitors, and provide incremental capital allocation opportunities. Again, I am very pleased with our recent acquisitions, our technology strategy, our recycling projects, and our other strategic investments. With growing activity, strong commodity prices, and improved operations and financial performance, 2022 is setting up to be a very exciting year for Select. 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. We continue to gain steam on our strong financial recovery, adding 25% quarterly revenue growth while expanding margins and recording positive net income. Our $255 million of fourth quarter revenue increased 50 million from the third quarter and 94 million from the second. More importantly, we are bringing more of this revenue through to the bottom line with adjusted EBITDA growth of over 70% to 26.4 million from 15.1 million in the third quarter and fourth quarter net income of 11.1 million from a 14.2 million net loss in the third quarter. To accomplish this, We are successfully leveraging all three elements of our strategy, as John outlined. We are driving recovery through our base businesses, gaining market share and strengthening margins. Our base businesses' pre-acquisitions grew revenue 14 percent quarter over quarter, while the EIA and other third-party sources estimate industry completions grew low single digits. The clearest example of this core business improvement came from our chemicals segment, which grew revenues by 22 percent quarter over quarter while improving margins by two percentage points, even though none of our recent acquisitions directly benefited the chemical segment. In regards to advancing our technology, ESG initiatives, and diversification efforts, our latest three recycling projects that came online during the fourth quarter contributed to growth in both revenue and margins through the water infrastructure segment and will contribute further during 2022. Overall in 2021, We recycled 25 million barrels of produced water through our fixed facilities, and we expect to continue driving these volumes higher. This recycling alleviates demand for fresh water sources and water stress regions, while also limiting waste disposal, which is particularly important in areas with seismicity concerns. Finally, I'll touch on our strategic M&A. We believe we executed each of these transactions at extremely attractive valuations, and they have begun to contribute materially to the bottom line. The integration of COMPLETE was largely accomplished during Q4, although we have additional efficiencies still to realize in regards to Agua Libre and HP Rentals. We expect to finish those integrations over the course of Q1 with increased margins going forward. With the closing of the Newvera acquisition, we will gain complementary service capabilities and add strategic infrastructure assets across the Bakken, Hainesville, and Northeast regions, as well as future development opportunities for our consolidated water network. Additionally, we expect meaningful cost synergies, particularly given Nuvera's standalone public company costs. Overall, we expect to have completed our integration and consolidation efforts for these acquisitions by the end of the summer, which should drive further profitability over the course of the year. In addition to the anticipated cost synergies, we also expect additional revenue synergies going forward. These water infrastructure networks and assets bring additional development potential especially in regards to linking in new gathering pipelines and recycling facilities. Given the advanced state of current customer discussions around some of these recently acquired assets, we are confident in our ability to execute on additional projects during 2022. Looking at the segments individually, the water services segment grew its revenues by 25% in the fourth quarter, while holding gross margins to between 15% and 16%. Short-term operational inefficiencies related to the acquisition and integration of Basics production services operations obscured margin improvements in other legacy businesses. Looking forward, we expect 5 to 10 percent revenue growth in the first quarter with slightly higher margins. This revenue growth and margin improvement will come through a combination of pricing improvements, market share gains, the consolidation of Basics operations, and contributions from Nuvera. That said, these margin improvements will be balanced by modest friction from the initial Nuvera integration efforts in the coming weeks. Water infrastructure revenue grew by 27% to $47 million in the fourth quarter, driven by increased activity around our New Mexico pipeline, additional recycled water volumes, and contributions from newly acquired Agua Libre assets. Additionally, gross margins increased by over three percentage points as well. We anticipate that activity growth combined with the full quarter contribution from these recycling facilities and additional contributions from the Agua Libre acquisition should result in a 10% to 15% revenue growth in the first quarter, with gross margins in the mid to high 20% range. I touched on oilfield chemicals segments fourth quarter performance earlier. But to reiterate, our recent research and development activities have led to new treatment technologies for produced water reuse that have gained additional traction and led to market share growth. We expect chemicals to see revenues around the same level in the first quarter as the fourth, with modestly higher gross margins as pricing improvements outdistance higher raw material costs for oil-linked polymers. Our reactivated Tyler facility is performing well and enabled margin improvement through reduced freight costs during the fourth quarter. Looking at SG&A, transaction costs accounted for about 2.3 million of our total SG&A of 25 million during the fourth quarter. While we likely will see additional transaction and integration-related costs for another couple quarters, we are targeting total SG&A of under 9% of revenue for the year as we continue to drive cost synergies across our existing platform from recent acquisitions. Free cash flow in the fourth quarter came in at negative 6.4 million. While capex declined in the fourth quarter relative to the third, our strong revenue growth required an incremental 23 million of cash usage for working capital, Overall, our cash on hand decreased by about $22 million during the quarter to $86 million. Cash was also impacted by the $16.1 million of consideration used for the acquisitions of the Agua Libre and HB Reynolds assets. Overall, our total liquidity at year end was $203 million with no bank debt, and we expect this to increase over the course of 2022. We've tried to judiciously balance the use of cash and stock in our recent acquisitions and our impending Nuvera acquisition fits this model. We'll be issuing approximately 4.15 million shares as full consideration for the equity and anticipate retiring the approximately 19 million of Nuvera bank debt with cash on hand for total consideration of around $50 million. Combined with higher working capital needs amid continuing integration efforts, this will reduce our Q1 cash balance, but we expect solid free cash flow for the full year. Looking towards 2022, the Newvera acquisition will partially contribute to Q1 results, but we will still be integrating the business, which may result in near-term inefficiencies through the first half of the year. That said, the incremental segment guidance I provided earlier, combined with the positive macro environment, leaves us optimistic that quarterly adjusted EBITDA will continue to move sequentially higher from the 26 million seen in Q4, and that we will generate solid net income in 2022. In the fourth quarter, we were able to execute strong growth with just 4.1 million of net capex, finishing the year at just 28 million of net capex, meaningfully under original guidance. We will continue to fund a large portion of our investments in infrastructure such as gathering pipelines and water recycling facilities and other initiatives through asset sales from our acquisitions. We are constantly seeking to maximize return on assets and cash flow by optimizing our asset base, consolidating operations, exiting inefficient operations that cannot be economically consolidated, and using a portion of that cash to exploit higher return opportunities. We anticipate 2022 net capex of 50 to 70 million, depending on the ultimate execution of numerous contemplated, contracted, fixed infrastructure and recycling discussions, with about half of that expected spend tied to maintenance capex. The difficult steps we previously took throughout the downturn in 2020 and 2021 have enabled us to better capitalize on the changing and improving environment of today. We will continue to make targeted investments to meet our customers' growing demand for sustainable water and chemical solutions, consolidate a fragmented industry into stronger, more dynamic networks, and create enhanced value for our investors through disciplined capital management. Thank you, and with that, we'll open it up to questions. 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. One moment please while we poll for questions. Our first question comes from the line of Ian McPherson with Piper Sandler. Please proceed with your question.

Hey, good morning, gentlemen. Morning. Morning. Just a lot of moving pieces in recent months and quarters with acquisitions and congratulations on those. It makes it a little bit foggier from the cheat seats here with respect to, you know, copying your, your business on a, on a sequential basis. But, um, obviously the chemicals, uh, business outperforming the broader market and, uh, the margins was encouraging in Q4. And I wonder if you could just speak generally for chemicals and water services, um, how your pricing negotiations are going on across the platform, uh, in this inflationary environment and how you see, um, your pricing power in 2022 in terms of being able to expand margins organically going forward, or if you think it's maybe more of a realistic ambition to maintain rather than expand margins organically.

Hey, Ian, this is John. Before we get to your question here, and thanks for your question, as you may have seen, we just released our announcement that we closed Navarra Environmental Solutions this morning. So just want to put that out there before we get started here. With that, we'll answer your question.

So, Ian, we are having success pushing pricing, both on the chemical side and with our water solutions, various business units. One thing we're mindful of is we're still in an inflationary environment here. So with that success, we are still seeing cost pressures on labor side, on oil-linked polymers, and other raw materials here. So we have been successful. Obviously, our customers are posting good results in this environment with WTI where it is, and we expect to continue to grow that margin, but we are addressing cost pressures as well.

And Ian, this is Michael Skarkey speaking specifically about chemicals. In relation to the fourth quarter, we saw an interesting adoption of our specialty FRs Those perform really well in treated, produced, and produced water. As we're seeing the market move more and more that direction, we've seen a bigger demand for our products. Kind of complementary to that is we're making good strides on the specialty FRs. We've been able to pull through some of our other products, specifically scale and biocide. It's helped us increase the revenue on a per well basis.

Super. Uh, thank you guys, John. Also just, uh, wonder if we could peek into your MNA pipeline. You've been awfully busy recently posing on the Vera this morning. Congratulations. If you were to scale the opportunity set for the year ahead relative to, um, so much that you've already done recently, uh, how, how would you compare, um, that opportunity set and, and, and your attitude towards continuing to use the balance sheet to, uh, to grow the business? Yeah.

Yeah, and we continue to be always open when it comes to M&A opportunities. We feel like we really added strategic assets and geographic footprint as we think around water and chemistry, recycling and fixed pipeline systems. And we feel like we did it at a really deep value. But we're going to judge M&A that way, go forward. It's got to fit the mold of where we want to be and what we want to do, and we want to make sure that the return is proper because we have a lot of opportunity in-house now. If you think about all these assets we put together, the different things that we can do around those assets, and then, as Michael said, matching chemistry to what the industry is doing now with produced water and recycling. So M&A's on our mind. We watch it, but it's got to be devalued. We've got to get strategic assets where we want them, and we've got a lot of opportunities that we're discussing with customers today in-house.

I think it would stand to reason that your sweet spot of bid-ask spreads may be in the rearview mirror now, but would you disagree with that?

It really, if you think about it, and maybe the bid ask as far as just M&A in general, but when you put the strategic of match, you know, matching our abilities or our asset base that we already have in and around more assets that could be on the market or potential M&A, When you look at that in total, that's where we really find deep value things, buying these assets like we bought them. We're going to continue to watch really close and find more things of that nature.

All right. Thank you, gentlemen. Thank you.

Thank you. Our next question comes from the line of J.B. Lowe with Citi. Please proceed with your question.

Hey, morning, guys. Quick question. I don't know if you went through this on your prepared remarks, but in terms of water infrastructure and the visibility you guys have into the Bakken over the next couple of quarters, I'm just wondering what do you expect that business line to do kind of in Q2, Q3?

Historically, Q2 is the breakup season in the Bakken. So typically, we do see some retreat there. However, with Nuvera coming into the fold here, we have picked up some great assets in the Bakken that can work with our systems and infrastructure there. We expect longer term beyond Q2, but we'll have some real opportunities to build out a broader network there, but as you've noted, Q2 historically with Bakken is not the peak of the year.

Fair enough. Other question was just on, and this is kind of, it might be kind of a tough one given all the moving parts, but what do you think your base business, and I guess, I guess it also kind of depends on what you define as your base business, but kind of X the integration costs that you guys expect over the next few quarters. What do you think incrementals could do maybe on a segment by segment basis or just on a corporate basis? If you guys have any insight into that kind of X the transaction charges.

Yeah, so historically we've seen 30% incrementals. I think that's a reasonable estimate to use going forward. We mentioned that we feel from customer discussions and what our customers put out there that we'll see North America CapEx up 25% to 35%. We have seen and are continuing to see additional pricing gains here. That factors into the 25% to 35%. So I'd say the pricing environment is stronger than usual when it comes to that 30% incremental. But at the same time, the cost inflation environment is also stronger than usual, too. So I think 30% is a reasonable assumption to use across. But we do have those benefits of finding cost synergies when we're putting these businesses together. So over the next six months, we do have more cost synergies to reach here with not just Nuvera, but also with Agua Libre acquisition and HV rentals to an extent as well. Great. Thanks, Nick. Thanks, Toby.

Our next question comes from the line of Tom Curran with Seaport Research Partners. Please proceed with your question.

Good morning. For water infrastructure, on the base business side, you highlighted the contribution to sequential growth of the northern Delaware pipelines. By that, I assume you specifically mean the two big prefract systems, the legacy GRR network and then the pipeline you built for that super major anchor tenant. For those two prefract pipelines, could you tell us how utilization rose from 3Q to 4Q and what you're expecting for 2022? What sort of volume mix do you expect between the anchor tenant and spot sales over the course of this year?

So, uh, The Q4, we had really good volume for our anchor tenant, which displaced some of the spot sale activity we had during the quarter. As we look out to the rest of the year, we're going to see the anchor tenant come down off of an annualized number from the Q4, but we do expect spot sales to pick up and have already had some of those awarded. The one other thing I would note is that New Mexico, like many other markets, are moving to more recycling. And that's an area that we are participating in and working on providing more recycled water solutions in that basin as well. So while that could have some ability to bring down the pipeline volumes, we see it as an opportunity to increase overall revenue and margin.

Got it. And then turning to your existing opportunity set of produce water gathering and recycling facility, uh, investment opportunities is, is, and, and here I'm specifically speaking to, you know, what's in your existing growth capex budget that could, you know, could determine where you come out in that net capex range between 50 and 70 million. So just that existing opportunity set, does it mainly consist of, um, projects that are similar? in size and nature to the six we've just seen you execute, you know, call it that two to five million of CapEx size range? And does it include any opportunities to simply purchase, you know, acquire an existing facility that's currently owned by a customer?

So, this is Michael. I'll speak to kind of the opportunity set. You know, we're involved in multiple discussions with multiple customers, largely in the Permian, but really across the infrastructure base that we've added around recycling. And I expect that we're going to be able to deliver some of those solutions to the market, which is why we've provided that forecast. In terms of the CapEx, you're exactly right. What we're looking at would be kind of within the range that you mentioned. In terms of acquisitions of you know, other of customer systems or competitor systems, that would be outside of the capex range we provided.

Got it. And then, Michael, I guess my last one will be for you as well. It's a two-parter, sort of a wish list heading into 2022. First, for recycling, what technology, what area are you focused on investing in whether it's via bolt-on acquisitions or what you already have in-house that you're just going to develop further via R&D, where are you focused that you want to expand your capabilities in for recycling? And then turning to the industrial solutions group, what targets or strategy does Walt have for 2022?

Sure. So on the recycling, our primary focus is around building out around our existing infrastructure footprint. So we've acquired a considerable amount of assets from Agua Libre and now Nuvera. And we see opportunity around those assets to service their existing customers and nearby customers with those assets. There's also an opportunity for us to build standalone systems like we've done in the past in the Midland Basin. From a geography, you know, half the rigs from the Midland Basin, or excuse me, the Permian Basin, and that's where the recycling is probably most prevalent on a volume standpoint, so we're focused there. But we're clearly looking beyond that. We've got solutions that are involved in discussions outside of West Texas, New Mexico, and outside of Texas in general. As it relates to industrial solutions, you know, Walt has finished his market assessment. He's come up with his business plan. And we're in the early stages of building a team and staffing a group that's capable of executing that strategy. And we're expecting to start to make progress and have first revenue and really beginning gaining momentum in the back half of this year.

Great. Thanks for taking all my questions, Michael.

Thank you, Tom.

And this concludes the questions and answers portion of the call. I would now like to hand the call back over to John Smith for any final comments.

Sure, thanks everybody for participating with us and allowing us to discuss select and the opportunities that we got in front of us for 22 and look forward to talking to you next quarter.

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