Select Water Solutions, Inc.

Greetings and welcome to Select Energy 2022 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A 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. I would now like to turn the conference over to your host, Chris George, Senior Vice President. Please go ahead, sir.

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 2022. 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 August 17, 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, August 3rd, 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 10-Q to understand those risks, uncertainties, and contingencies. Also, please refer to our 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 thank you for joining us. I'm excited to be discussing Select Energy again with you today. The second quarter's results represent a meaningful step forward in the continued execution of our strategy of improving and bolstering our base business, advancing our technology, sustainability, and diversification efforts, and executing on our strategic M&A. The second quarter saw strong sequential revenue growth, increasing 14% quarter over quarter, with our chemical segment producing all-time record revenues during the quarter. Our water services segment saw quarterly revenues grow 20% during quarter two, getting back to levels not seen since quarter one of 2019, well before the pandemic began. Meanwhile, our infrastructure segments achieved quarterly revenues higher than the quarterly average of either 2018 or 2019, and within striking distance of all-time highs. Combine these revenue levels with our significant investments in technology, continued operational efficiencies, and consolidation benefits, and we generated strong 83% growth in net income and 48% growth in adjusted EBITDA. Pair it all together, and I believe we are demonstrating that the industry activity and pricing does not need to fully recover to pre-COVID levels for select to get back or exceed pre-downturn levels of financial performance. Even so, it has become clear that U.S. unconventional resources will be the primary growth driver to supply global energy needs over the next few years. As the market continues to tighten, we are well positioned to help meet that need through our advanced technology solutions, strong balance sheet, and the flexibility provided by our recent acquisitions. Our asset-light business model does not require large amounts of reactivation or maintenance capex, and we believe will generate substantial free cash flow through the cycle. As we advance our market leadership, we continue to make progress on the integration efforts of our recent acquisitions, and I believe we will continue to capture additional efficiencies and synergies in the second half of the year. These integration efforts and continued rapid revenue and working capital growth impacted cash flow during the second quarter. However, we are back to producing positive free cash flows, and I feel confident in our ability to generate meaningful free cash flow during the second half of 2022. On the sustainability front, during the second quarter, we issued our inaugural sustainability report And I encourage listeners to give the report a full read, which is available on our website. As a market leader in sustainable water and chemical solutions, we take our commitment to water stewardship seriously. We're proud of the accomplishments we've achieved to date and remain confident in our ability to set the bar high with ambitious targets to water stewardship in the future. To that end, we commenced operations at our two newest contracted fixed recycling facilities during the second quarter, adding an additional 75,000 barrels per day of capacity. This takes us to more than 600,000 barrels per day of recycling capacity and puts us well on our way to achieving our full year 2022 recycling targets. Additionally, we continue to find new and creative opportunities to expand on our existing infrastructure footprint. During the second quarter, we signed a five-year agreement to connect an operator's existing water distribution and gathering pipeline in Upton County, Texas with two of our existing recycling facilities. This interconnection will allow us to efficiently gather produced water, transport recycled volumes between our two existing facilities, and dispose of water when necessary. This significantly expands the commercialization opportunities of the facilities and allows for more efficient management of water needs across multiple operators in the area. We continue to see strong demand from our customers for the integration of our water and our chemistry solutions And I believe we will continue to build on our recent success with more long-term contracts and infrastructure development opportunities in 2022 and beyond. While the second quarter saw a meaningful double digit percentage increase in drilling activity, completion activity continued to modestly lag during the period with a single digit percentage growth. However, we believe this activity ratio is starting to normalize and we expect to see more completion activity during the third quarter supported by a continued strong overall commodity price environment. Underpinned by growing activity, strong commodity prices, further price increases, and continued operational efficiency gains, we expect to see further improvements to our financial performance including meaningful free cash flow during the second half of 2022. Substantial free cash flow supported by a strong balance sheet, healthy net income, and a growing stream of contracted and production-related cash flows will provide us with additional shareholder return options. With these financial conditions in place, we will continue to evaluate incremental shareholder returns in the coming quarters. This is a core priority to us and to many of our investors, and I look forward to expanding on this in the near future. 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. As John outlined, our financial performance continued its strong momentum during the second quarter, with large gains across revenue, adjusted EBITDA, and net income. All three of our segments increased both the revenue and margins, and the trajectory both through the quarter and upon exit remains positive. Our revenue grew by 14% from $295 million to $336 million. While a full quarter of revenue from legacy Nuvera assets boosted this total, the majority of the increase was derived from pricing and activity improvements. While cost inflation remains a challenge, pricing recovery has accelerated in recent months. Even with recent commodity price pullbacks, Our customers are generally highly profitable in this commodity environment and recognize the value our advanced technology brings, especially around integrated water and chemistry solutions such as water treatment, reuse, and recycling. These solutions leverage the combined firepower of our three business segments and have helped drive the chemical segment in particular to its highest quarterly revenue and gross profits we have reported as a public company. Gross margin for the company improved from 8.4% to 10.6% in the second quarter, and adjusted EBITDA increased 48% from 32.2 million to $47.7 million. Net income of 14.6 million grew 83% from 8 million in the first quarter. Despite working capital headwinds, free cash flow returned to positive territory at $1.1 million on 11.1 million of cash flow from operations, as the company continued its targeted recycling and infrastructure development program while cycling out unneeded equipment and real estate related to our recent acquisitions at a favorable time in the market. Investments in new recycling facilities and gathering pipelines, among other core business assets, led to gross capex of $15.5 million or net capex of $9.9 million after asset sales. The $18 million of cash proceeds from the sale of excess non-core or obsolete assets and equipment year-to-date from the acquisitions provides an attractive financing source for recycling and other integrated infrastructure investments like the one John mentioned. While the pace of these asset sales will slow during the second half of the year, we continue to have additional opportunities, particularly on the real estate side. We retained our net cash position with $25.7 million on hand and no bank debt and have more than $220 million of total liquidity when considering our sustainability-linked asset-backed lending facility. We expect to accelerate our free cash flow generation over the back half of the year as we complete the integration of these acquisitions. Overall, our integration and consolidation efforts are proceeding on course. We are realizing cost synergies through rationalized footprints both in the field, where margins are increasing, as well as in corporate support, where SG&A declined $1.6 million quarter over quarter. We've largely executed on the identified SG&A cost savings and have turned our focus increasingly to improving operational efficiencies and enhancing revenue by making targeted investments that utilize our portfolio of complementary infrastructure assets. There are significant growth opportunities here through adding recycling facilities, pipes gathering systems, and capacity enhancements. Our water recycling volumes continue to grow We are on pace to exceed our 2022 target of 1.3 billion gallons or 31 million barrels. Turning to the individual segments, the water services segment exceeded our expectations in the second quarter, growing its revenues by 20% to 196 million, while advancing gross margins over three percentage points to 19.4%. About 30% of the $32 million revenue growth was derived from the full quarter presence of Nuvera assets, versus a little over a month of activity in the first quarter, while the segment benefited more broadly from pricing improvements that took place from late Q1 onward. Looking forward to the third quarter, we expect mid to high single-digit revenue growth, supported by activity growth and continued pricing gains, with margins reaching 20% on fuel cost relief, coupled with pricing improvements and continued operational efficiencies. Water infrastructure revenue increased by 3% to just over 60 million in the second quarter, with higher recycled volumes offset by seasonal restraint in the Bakken. Legacy Newvera assets, most notably the Haynesville Pipeline Gathering System, added about $6 million of revenue relative to the abbreviated contribution during the first quarter. Margins increased to 25.5% in Q2 through the increased recycled volumes and accretive Newvera assets, and we anticipate margins in the high 20s percent range, primarily due to recovery in pipeline and related pipeline logistics activities. We forecast that these trends should drive third quarter revenue growth in the mid single digit percent range, while new recycling as well as brownfield investments should continue to propel accretive growth over the future quarters. The chemical segment continued its revenue expansion, increasing by 10% to nearly 80 million. Margins grew slightly to 14.6% for the second quarter, with raw materials still an area of focus. This segment does not include any assets from the recent acquisitions, And with its recent rapid organic growth over the last few quarters, we expect third quarter revenue to consolidate slightly higher than that of the second quarter. On the gross margin side, we forecast advancement beyond 15%. SG&A for the quarter declined to $26.7 million from $28.3 million due to a reduction in transaction costs as well as realizing integration synergies. We achieved our targeted reduction of SG&A below an 8% of revenue threshold we expect to remain under that threshold despite the inflationary pressures in this environment we expect to invest roughly 15 to 20 million of gross capex per quarter in the back half of the year offset by asset sales a little below 5 million per quarter if realized this should put us at the low end or even slightly below our previously estimated net capex range of 45 to 60 million for the year generating robust free cash flow will be our top priority for the remainder of 2022. As we move into the final innings of the integration work, we expect to see a reduction of working capital along with continued improvements in profitability. We did not execute any buybacks or other forms of shareholder returns during the second quarter, but as John noted, as we prove out this free cash flow underpinned with healthy levels of net income, evaluating additional shareholder return options becomes a greater priority. Our pronounced gains across multiple critical financial metrics illustrates both the strong macroeconomic backdrop as well as the gains Select is making with our customers at a time of rapid change in the energy industry. Our sustainable full lifecycle water solutions integrated with advanced chemistry capabilities are truly unique in our space, and we expect to further capitalize on our market leadership in the quarters to come. Thank you, and with that, we'll open it up to questions. Operator?

Thank you very much. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 is from the line of Don Quest with Johnson Rice.

Please go ahead.

Good morning, gentlemen. How are you all today? Good morning. Doing well. I wanted to touch on pricing. I mean, obviously, there's been a lot of pricing uplift with demand over the last couple quarters, but where do you see pricing as we move into the back half of 22 and 23? Do you see things stabilizing, or do you think that there's significant uplift potential as we kind of move into 23?

Sure, Don. This is Michael Scarkey. I'll take the first part of that. So, Pricing thus far this year has largely been to cover our costs. We've seen a pretty significant increase in fuel and labor and in the raw materials on the chemical side. I think we've certainly kept up with pricing so far this year. For the back half of the year, there's kind of two factors. One is how do we expect those inflationary pressures to continue, and then what do we see with supply, demand, and balance? In terms of our cost, we think fuel is going to be relatively flat for Q3. Raw materials we're forecasting relatively flat for Q3. On the labor side, we think we're going to continue to see inflationary pressures there. So that's something that we're targeting to make sure that we're able to pass through to our customers. And then looking at the market to see where there's a supply-demand imbalance and who we're able to work for at a fair price. So I would expect us to continue to get price in Q3, and that's going to be in part because of the music I mentioned, but also what John covered in his remarks about increased completion activity, which is one of our primary drivers.

Don, if you look at our customers' results, they're doing very well. This is a great commodity price environment for them. So you're seeing in the first quarter reports in the second quarter, very high profitability. as well as some upward CapEx movements and acknowledgement of further pricing increases. So that also supports our view there.

And as it kind of goes to pricing on the other side of the fence, as your recycling picks up, can you give us, I don't know if you have the number in front of you, just a percentage of freshwater sourcing that you're displacing from your recycling efforts? Because I know you probably charge to take away water and then charge back when you give that fresh water back to them or recycle water back to them. Just trying to get a sense of what the potential uplift is and how much you're displacing today from a freshwater sourcing perspective.

Right. So our recycling and sourcing of produced water relative to fresh and brackish water has kind of continued to to shift over the last year or two. Really, I'm seeing an increase in the treaty produced and produced water on a quarter over quarter basis. I don't have the exact figure in front of me, but for the current quarter, we're gonna be moving about 35 to 40 million barrels of produced water that would be directly replacing fresh water.

It's definitely picking up for sure. And just one final one for me. I mean, everybody knows about the demand in the Permian Basin and how that moves into 23. But can you talk about your other areas, maybe mid-continent and the Rockies, and what the demand picture looks like there for further growth?

Are you talking about recycling or just the general demand?

Just general demand, because I know a majority of the rig count is in the Permian today. I just didn't know what the infrastructure needs would be in those other areas that you operate.

Sure. So you're absolutely correct. The majority of the rig count is in the Permian, and that's an area that we're very active in spending a lot of time in a primary focus area. But everywhere right now is pretty active. And to Nick's point, the economics, whether it's oil or gas, is attractive really across our footprint. So we're seeing increased demand for all of our services, for services for chemistry and for infrastructure. We obviously announced that we went live on the recycling project in Colorado, which was a step out for us from the Permian. and we're evaluating other infrastructure projects really across our footprint today.

I appreciate the color. I'll turn it back and get back in queue.

Thank you. Our next question comes from the line of Tom Kilwin with Seaport Research Partners. Please go ahead.

Good morning. Good morning. Tom.

Nick. know when it comes to the realization of synergies and cost savings across the acquisitions it seems as if you're on track to exit the quarter with about five percent left to do it complete and alm mainly consisting of streamlining some final yards and locations and then a significant amount left to execute at nuvera with around 10 remaining on targeted staff reductions and then you know several operational and back office tasks left um could you just update us on where each stands now and what you think, you know, has the most bang for the buck to be delivered of what remains?

Tom, I think the way you outlined the acquisitions there as far as these specific companies is largely accurate. We think about overall synergy realization in three phases, and they're parallel to each other. The first one, which is the shortest, is that back office rationalization, so, you know, putting the companies together and integrating the processes. There's a lag there on cash flow, but as far as the SG&A costs, we're in the late innings on that. Certainly a lot of progress there and we've been very aggressive. The next one in the field, the operational efficiencies, understanding the best footprint we have in the field and where to serve customers out of and what operations we can sell off in terms of real estate and equipment. That we've made a lot of progress on as well. You've seen our asset sales in the first half of the year of about $18 million there. And so we're getting more and more efficient, but probably have some more opportunity there ahead of us versus an SG&A. And finally, I think the third most important one here is the revenue synergies. We're making those investments. John talked about a tie-in project there, but there's a lot of networking opportunity among the assets we've acquired. There's a lot of opportunity generate operating leverage with minimal new investment around the current utilization profile. So that's the one where it's the biggest dollar opportunity long term, but also probably where we're earliest in realizing that.

Helpful. That was a comprehensive update I was looking for. And then for water services, where is utilization of your lay flat hose inventory today versus where it peaked in 2018? And then at the industry level, what's your sense of utilization levels, you know, from loosest to tightest for the major water services assets? I'm thinking lay flat hose, containment assets, and then flow back and well testing systems.

So, Tom, I don't have the exact utilization compared to 2018 on the assets offhand. But what I would say is really so far this year, we've been looking at utilization more as a utilization of labor and less of the utilization of equipment. Labor has been tight. We haven't been able to expand with the market to keep up with the demand. And so that's been the largest constraint. However, really starting in this last quarter, and I expect to continue in Q3, that's starting to shift where you are having equipment become a constraining factor for us and for the industry in general. And in part it's just because we haven't had a ton of investment since, you know, 18 or some cases 2014. And so we are getting tight on equipment really across services. And so that's another one where labor is still tight, but equipment is starting to constrain as well. Thankfully, we do have a little more flexibility on the infrastructure side and on the chemical side, largely to our in-basin chemical manufacturing. We can expand that. We have room to grow, and we can expand organically if needed. And then on the infrastructure side, you know, we got some really good people with the acquisitions of Complete, Agua Libre, and Evera. But, you know, almost as important, we have an asset base that, in our view, was underutilized. And so we've really been working to Nick's point to expand that. So there is capacity on the infrastructure side today.

Great. And then as my last one, Michael, I have you. I'll direct this one to you as well. As you're looking at 2023, could you give us a preliminary view of your goals for the industrial solutions group?

Sure. So... You know, we're very committed to expanding into industrial solutions and really the revenue diversification. We continue to focus on it organically. Our focus is really around water and chemistry. I mean, that's where we think we have core competency and a strategic advantage. So we're looking to expand that. You know, as you would know, Tom, it really hasn't come as fast as we initially hoped this year. And I think that's partially due to limitations on people and equipment. But we're still very focused on it, and I expect that we'll have meaningful movement in industrials in 2023. We're pushing for it this year, but I think 2023 is when we can start to talk about it and to really highlight what we've been able to accomplish.

Sounds good. Thank you for taking my questions.

Thank you, Tom.

Thank you. Our next question comes from John Daniel. with Daniel Energy Partners. Please go ahead.

Hey, good morning, guys. John, this might sound like a crazy question, but you are very experienced and you live in the backyard as the Barnett for you. So I'm curious, back in the glory days, a lot of trucking and all that going on there. What are you seeing right now for your business?

What's the opportunity there? You're talking about just the Barnett, John? Is that what you're asking?

Yeah, just that area, yes, sir. This is not so much to select, but your views on it first and then to select.

I mean, the biggest movement, and we all know it, is that the assets have changed hands into different companies and they become primary. So there's new activity related to that asset changing hands. And there's new... There's also new people that are executing that activity, John, that showed up in the basin. There was a lot of wells that really didn't have a lot of attention for a four- or five-year period. And that renewed attention, whether it's a producing well, a shut-in well, a re-completion, or actually a new drill, that activity is way different in the Barnett today than it was you know, before these transactions.

Right. But do you see it as an, I mean, is there much of an opportunity over the next one to two years in that market for you, for the industry?

Yeah, we're still very well positioned in that. We're seeing actually increased activity in, you know, our well testing or water transfer or, you know, opportunities around either refract or new drills and

completion so it's a good position for us it's still a smaller market compared to sure almost any and the only thing I would I would add to that it is obviously the most mature market and you know costs have come down and competitors have exited and so I don't see a lot of competition returning so if you do have a good position either with services or infrastructure when you get that uptick in activity it becomes a decent little market like John said and you shouldn't be as much competition just because the activity just hasn't been there over the last couple of years.

That's what I was thinking. Okay. Turning to a market that's a little bit bigger, the Permian, the five-year tie-in agreement that you all had, how many opportunities exist out there for you to do interconnecting various facilities? Is that a one-off, or do you see more opportunity?

It's definitely not a one-off, John. So, you know, that was a greenfield project, recycling project for us. And the way that those work is we generally have, you know, one or some cases two customers underwrite the project economics. And then the goal is to expand those to offset operators to really, you know, service the area. But you have it underwritten by you. But the idea is to fully commercialize the system. while giving priority to your cornerstone customer or anchor tenant. And so whether it's a greenfield project or an existing, you know, underutilized, if you're talking about Permian, you know, for us, that would largely be an Agua Libre asset. We have a lot more opportunity to further commercialize, tie into other operators or other operator systems. And it's something that we're actively focused on daily. And it really developed a team focused on the team specific to the Permian focused on those opportunities. John?

Yes, sir.

Something that is real and primarily is because we did these transactions.

I mean, we now have positions where we got additional assets in, you know, good growth

places across the United States where drilling rigs are running, where completions are happening, new water's coming online, and we now have four disposal wells out of four different transactions along with the disposal wells we had. And that footprint is a different footprint, and the value of those assets between each other in interconnect or recycling opportunity or just logistics efficiency is way different than it was i mean if you think about this company and what it ran at its height back in 18 you look at that asset base you think of what was sold off what was developed and then you think about these four transactions and look at that asset base today that asset base is a lot different to a positive and being able to create value in both revenue and profits as well as value to the customer base and in in in application.

Early days then, I suspect.

Okay.

Two more for me, and then I'll turn it over. Just a follow-up on this agreement. Can you speak to what type of capital is required to do a project like this? Knowing that it varies based off distance and so forth, but just curious.

Sure. So, and you're exactly right. It's absolutely dependent on distance. The capital for this particular project was very minor. We were in close proximity to another operator system, and so it was, you know, under half a million bucks. Very good.

Okay, and the final one, moving over to the chemical side, can you just briefly speak to any challenges getting product on the supply chain and what you're seeing in terms of the inflationary pressures there? And I'll turn it over.

Good question. I tried to address it a little earlier, but the chemical raw material supply chain has been a real challenge. I mean, we've seen limitations on raw materials. We've seen extreme price variability. And it's been tough this year, but it really dates back to kind of the freeze of last year. The market's just been out of whack in some respects. I'd say that our technology team has worked really hard to reformulate around shortages. and make sure that we have the availability of our core products, and we've been pretty successful at doing that. You know, in terms of pricing, generally speaking, the raw materials are down slightly from their peak, but we're still expecting for Q3, the raw materials to be flat relative to Q2. You know, fortunately, as you've kind of seen in the margins, we've been able to navigate around raw material shortages, or in the revenue, rather, And in the margin, we have been able to pass through much of these raw materials through to our customers.

Fair enough. Thank you for all the color. Thanks. Have a good day, guys. Thank you, John.

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to John Schmidt for closing thoughts.

Yeah, thanks, everybody, for participating today. As you can tell, we like a lot talking about Select, and we look forward to talking to you next quarter, again, around our opportunities and asset base.

Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.