Q3 2022 Select Energy Services Inc Earnings Call

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 November three 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.

Ali 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 measure.

With that I'd like to turn the call over to our founder Chairman President and CEO John Schmitz.

Thanks, Chris and good morning, and thank you for joining us I'm excited to be discussing select energy again with you today.

The third quarter's result, combined with our recent acquisitions display our continued ability to execute on our core strategies of improving and bolstering our base business at.

Advancing our technology sustainability and diversification efforts and executing on strategic M&A.

Third quarter saw strong sequential revenue growth, increasing 12% quarter over quarter with all segments showing solid improvement during the quarter.

Our water service segment saw quarterly revenues approached pre pandemic peak levels with gross margins increasing to 23%.

Meanwhile, our infrastructure said segment achieved record quarterly revenues and our chemical segment achieved record high margins.

Reinforced by steady activity levels, a challenging labor market and a tight equipment supply environment, we continue to capture market share and see pricing improvements across each of our segments.

Combined these factors led to a strong 70% growth in net income and 32% growth in adjusted EBITDA.

On the back of these strong financial improvements I'm also pleased to have announced the acquisitions of breakwater energy partners and the strategic infrastructure assets from Cyprus Environmental services.

Both of which closed this week.

Select has a long and successful track record in M&A and I continue to believe that consolidation remains an important way to drive efficiencies and further create value within our industry and more importantly for the select shareholders.

Both of these acquisitions fit us extremely well and provides strategic growth opportunities at very attractive entry points.

With these acquisitions, we are also bringing on skilled and experienced leadership and their strong operating teams who we.

We are excited to partner with going forward.

With breakwater, we're acquiring one of the market leaders in advanced water recycling infrastructure disposal and logistics solutions.

Quarter has broad capabilities across the entire Permian basin with complementary water logistics operations in the Eagle Ford.

With a core footprint of strategic commercial recycling facilities, serving the heart of the Midland Basin.

Breakwater currently operates about 600000 barrels per day of active recycling capacity at its four primary fixed facilities with an additional one 4 million barrels per day of permitted capacity available for development.

Breakwater also operates nine active modular recycling facilities with one 5 million barrels per day at throughput capacity.

Great quarters facilities are supported by 46 miles of gathering and distribution pipelines.

70000 barrels per day of disposal capacity and $4 7 million barrels.

Of storage capacity with an additional three 7 million barrels of permitted storage capacity available for development.

This footprint expands <unk> recycling capabilities to nearly 3 million barrels of total daily capacity across fixed and mobile capabilities.

Adding a number of new strategic customer relationships and strengthening existing relationships with new recycling opportunities.

Through the Cypress acquisition, we added a portfolio of strategic wastewater disposal facilities in North Dakota and at attractive value.

Further consolidating the Bakken region. Following our recent acquisition of Ocwen Labor Midstream and <unk>. We believe there is meaningful opportunity to expand in network these assets with our existing infrastructure footprint.

In addition to the strategic benefits, both transactions provide clear and immediate financial benefits as well.

On a full year 2022 combined basis, the acquired operations from breakwater and Cypress are expected to generate approximately $110 million to $115 million of revenue and more than $30 million of adjusted EBITDA.

The businesses have seen a strong trajectory through the year and there remains meaningful opportunity for growth in network expansion in 2023.

Importantly, both of these acquisitions further complement select rapidly growing portfolio of contracted and production related revenues, adding incrementals stability to our revenue base breakwater for recycling facilities and infrastructure operations are supported by a number.

Long term customer contracts, while more than 60% of stock volumes are currently delivered by pipeline with long term contracts.

<unk> by our strengthening revenue and earnings profile and recent acquisitions. We are also pleased that our board has initiated a regular quarterly dividend program during the third quarter with the first dividend payment set to be made this month initiating a regular quarterly dividend program.

Graham reflects our confidence in select operating performance and strong balance sheet as well as our commitment to generate multiple avenues of shareholder returns over time.

These factors along with our capital light business model and growing portfolio of contracted infrastructure and production related revenue streams and enable us to return capital to our shareholders, while maintaining a disciplined capital structure to support the growth of our business and continued expansion of.

Our water recycling and infrastructure initiatives.

We strongly believe in the long term earnings and free cash flow generating capabilities of our business and are excited to share the benefits of this cash generation with our shareholders.

While the third quarter saw the U S onshore rig count increased by about 7% completions activity continued to modestly lagged during the quarter with low single digit percent growth even with this disparity we continued to accelerate our revenue wallet share per <unk>.

<unk> basis, as we saw strong demand from our customers for the integration of our comprehensive water and chemistry solutions.

While we intend anticipate some modest <unk>.

<unk> during the fourth quarter customer activity remained steady overall underpinned by solid commodity price environment.

These two recent acquisitions and breakwater, especially add additional scale and experience.

Further advancing.

<unk> ability to offer an innovative integrated water chemistry solutions.

I believe we will continue to build on our recent success with more integrated offerings, along with additional long term contracts and infrastructure development opportunities in 2023.

We anticipate continued operational efficiency gains and growth opportunities from our acquisitions.

And we expect to see further improvements to our financial performance, including meaningful free cash flow generation next year 2023 is shaping up to be a very strong 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.

The third quarter exceeded our expectations from both a revenue and margin perspective, and with the acquisition of breakwater along with the Cypress infrastructure assets. We're poised to continue this momentum.

Revenue of $375 million grew by 12% or $39 million.

And 59% of this revenue increase sell through to higher gross profit.

All three of our segments increased their gross margins from second to third quarter, resulting in our highest quarterly net income and adjusted EBITDA since the third quarter of 2018.

Net income increased by 70% to $24 7 million and adjusted EBITDA by 32% to $62 8 million.

Slight volatility in commodity markets and in the daily headlines our customers are in the strongest financial position they've been in years and demand for secure and dependable oil and gas production from the United States continues to grow.

As we partnered with our customers to produce natural resources in a safe cost efficient and environmentally friendly manner. We've also demonstrated the value of <unk> unique ability to connect chemistry with full lifecycle water management and share in the value of this partnership creates.

Produced water recycling is a prime example of this value creation and the breakwater acquisition brings a substantial growth opportunity with a large footprint of new fixed recycling infrastructure in the Midland Basin.

Along with consolidating certain Texas, and new Mexico water logistics services. This infrastructure network furthers, our goal to increase contracted and production levered revenue streams and enhances our established commitment to growing our recycled produced water volumes.

While we were already well on pace this year to exceed our 2022 target of 31 million barrels of recycled produced water through our fix facilities. The breakwater acquisition with its current 600000 barrel per day recycling capacity provides strong additional momentum in this area and puts us well on our way to meeting our 50 million barrel future.

Annual commitment.

With the addition of the breakwater leadership team and over 300 skilled employees and the combined revenue and adjusted EBITDA run rate John mentioned earlier, we expect the breakwater acquisition to generate considerable value for our shareholders in the months and years to come.

The initiation of a regular quarterly quarterly dividend also marks a milestone in our corporate maturity and commitment to shareholder returns are phenomenal recovery and growth over the past two years expansion of contracted and production Levered revenue streams, all executed while maintaining a net cash position opens up new opportunities to create.

And return value.

We will continue to make targeted investments to advance our infrastructure network, while benefiting from the expansion of this more stable cash flow stream.

Turning to the individual segments. The water services segment grew its revenue sequentially by 13% to $221 million, while advancing gross margins over three percentage points to 22, 8%.

This segment benefited from continuing pricing improvements driving incremental gains of nearly 50% to gross margin before D&A.

Our water services segment will be both benefited and impacted by the breakwater acquisition and integration in Q4, which makes forecasting the fourth quarter a little more difficult.

We will of course have a more fulsome forward view on our next earnings call in parallel with 2023 budget development.

For now we see water services is generally steady in the fourth quarter balancing out the integration than usual seasonality with continued momentum in recent outsized gains relative to general industry activity.

Water infrastructure saw the most significant revenue gains in the third quarter growing by 23% sequentially to $74 million in the third quarter.

The recent investments we've been making around both acquired infrastructure assets and Greenfield recycling facility development are now generating meaningful revenue and profitability for the company and we expect both of our latest acquisitions to continue this trend.

With this revenue growth gross margin before D&A increased to 27, 2% in Q3, and we anticipate margins in the high <unk> percentage range with low double digit revenue growth in Q4, driven primarily by the acquisition.

While the chemicals segment had seen tremendous organic revenue expansion over the last few quarters.

Third quarter marked a consolidation of that higher revenue at a remarkable margin expansion.

Quarterly gross margin before D&A increased sequentially from 14, 6% to 18, 8% as we reallocated manufacturing production and resources away from certain lower margin commoditized products into a more specialized proprietary chemistry.

This segment will not be directly impacted by the acquisitions announced yesterday, but even with typical seasonality, we expect to be able to grow revenues by mid single digits in the fourth quarter, while maintaining margins around the Q3 level.

Our SG&A as a percentage of revenue remained below 8%, while increasing in dollar terms from $26 7 million to $29 8 million.

This figure includes $700000 of transaction costs in Q3.

We expect will increase in the fourth quarter due to the size and impact of the Brightwater acquisition.

Looking forward, we expect to maintain SG&A as a percentage of revenue at a consistent level prior to giving consideration to one off transaction costs.

Given the breakwater has historically been run as a lean private company with limited overhead and the Cypress assets do not come with any material corporate costs were not prioritizing cost synergies in these transactions, particularly given the tight labor market for specialized skill sets our combined teams will.

While the latest acquisitions will require some additional near term integration efforts for certain back office functions generating positive free cash flow through improved working capital management is a core priority.

Driven primarily by our continued meaningful revenue growth net working capital increased by $54 million during the third quarter, resulting in free cash flow of negative $10 7 million in Q3. However.

However, we expect to advance into positive ground over the fourth quarter of 2022 and to generate considerable free cash flow during 2023.

Gross capex of $19 8 million for the third quarter translated through net capex of $16 1 million after asset sales.

29 million of net Capex year to date, we expect to finish the year between $45 million to $50 million, reducing the top end of our previous guidance.

Looking forward, we believe our low capital intensity business model provides further support for our ability to produce substantial free cash flow in 2023.

We finished the quarter with a net cash position of $13 2 million and no bank debt and have nearly $245 million of total liquidity when considering our sustainability linked asset backed lending facility.

$221 million as of last quarter.

Breakwater acquisition includes the repayment or settlement of approximately $13 million of net debt and other obligations in conjunction with closing.

Before opening the call for questions.

Wanted to welcome our new team members to the select family.

We are eager to harness their talent and capabilities to continue to fulfill our vision to be the recognized leader and trusted partner and sustainable water management solutions.

<unk> expanded footprint of water recycling and disposal infrastructure in both the Midland Basin and the Bakken along with our other steadily improving base operations provides us with a greater opportunity set both with individual customers.

And in managing multiple customers' needs across highly productive acreage.

The growing momentum seen in the third quarter's results combined with these valuable new partnerships will bring exciting new ambitions for select in 2023.

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 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 and may be necessary to pick up your handset before pressing the star keys, one moment. Please while we poll for your questions.

Our first questions come from the line of John Daniel with Daniel Energy Partners. Please proceed with your questions.

Hey, guys.

<unk> on the two deals.

Probably it might be.

Silly question, but when you look at breakwater with the $600.

Point 6 million barrels a day of capacity today.

And you note the permits for another one four.

Can you just walk me through the process to.

To develop that capacity.

The time required to develop it and the cost.

Incremental color would be helpful.

Sure John So this is Michael <unk>.

So the permitting process breakwater has been very diligent and to permit commercial recycling facilities.

Once you have kind of a track record.

In the permanent process and you do it the right way it can be done as short as three or four months.

But initially permits could could easily take six months or more to just get them permitted.

The construction is really going to depend on the size and the type of treatment being applied but you're if I'm booking it on the low end youre going to be if everything goes smoothly you have the equipment Youre moving quickly you could get it done in four five months and on the longer end.

It's going to be not 12, but probably close to nine months.

But one of the big problems, we just commercializing it so youre not going to put forth typically.

A large amount of capital core project, it's not underwritten.

And at least partially commercialized with the ability to expand beyond that and so that's where.

Where the additional lead time could come into play.

One thing I would note I think breakwater did a great job of going ahead and permitting this in setting up.

Recycling facilities and storage.

But they really didn't have the capital.

This was true with the other transactions that we've closed in the last 18 months. There was asset the assets were under utilized and they didn't have the growth capital to expand and so we're really looking forward to working with them understanding their pipeline comparing it with our backlog and key customer relationships to see how we can do.

Develop out these systems.

And really fully commercialized it.

Okay.

Got it and then.

The transactions here.

Largely Permian Bakken can you talk about what some of the other.

M&A opportunities might be in other basins is that how act.

Are you actively looking today or just keeping you pretty busy with these two deals.

Yes, John this is John Schmitz.

I would tell you that.

Okay.

We know the market and I mean, we're actively in the market at all times we.

Product stays in tune to the market as we can.

Our.

As you've seen in the past we will remain.

Open to business in this kind of transactions.

And we believe there is still more opportunity.

Across the United States in these unconventional to do.

Water and chemical solutions.

And these kind of transactions, where we're adding asset base that really fits with our asset base assets that need capital.

Really commercialize and work in a minute position that you can put contracts and long term relationships around them.

Operating efficiencies.

And value to the customer so we're active still John and we believe there is more.

Okay Fair enough, Okay, and then the last one just a housekeeping Nick I think you said the net capex for 'twenty, two is $45 million to $50 million.

That's correct.

Or is that correct.

The framework for next year, just given that your growth through acquisition, what that might look like potentially.

So.

Yes, obviously, we'll have more detail on our next call with the whole budget, but I think we can go into.

Some of the factors here, so as we acquire more assets as activity increases.

That's going to naturally take your maintenance capex up a little bit.

So right now, we're seeing $40 million to $50 million.

As a ballpark range for for next year.

We'll be adding to that some targeted growth opportunities.

Okay, not only around the.

<unk> previously announced acquisitions, but as we get our hands around the breakwater in Cyprus steels and understand the great opportunities there.

You will have fewer asset sales than we had in the.

Year to date period, so far.

But as far as the growth investment.

Really our third quarter infrastructure performance reflected putting a lot of money.

The money to work.

On our previous acquisitions.

I think the infrastructure group.

A healthy trajectory in front of it not just from those but on an ongoing targeted capital light basis here.

Okay.

Good starting point. Thank you very much for letting me ask some questions.

Thank you John .

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

Good morning.

Nick.

I think this quarter is a big working capital build that consumed $54 million as CFO and then.

Related step down in cash on the balance sheet to just $13 million is has spurred some consternation following on the heels of your regular dividend introduction, obviously as usual at this point and in all of this up cycle.

<unk> need to build working capital.

He has a very high quality positive challenge, but could you expound on.

How exactly you expect it to reverse.

Working capitals.

Hello in <unk> with specific leavers.

Or are you planning to Paul for it to become a source of CFO and <unk> and then.

How do you expect to constrain it as you move through 2023.

Sure Tom So these are high quality customers, we work for.

The biggest majors large independents and very high quality smaller independents.

Private equity backed custom.

Customers as well.

So as you're well aware, we've had a number of integrations recently.

I'm going to try not to get too deep into the weeds here, but we're also upgrading.

Various ERP systems into one <unk>.

Consistent ERP across the whole company right.

Right now we have three.

Each of those Youre operating separate groups billing customers from from different historical accounts.

And that just.

Provides a little bit of confusion.

And Neil.

Need to integrate teams and processes and accounts going forward. So.

Disappointed by the working capital build in the third quarter, but we do see great opportunity.

Not just in the fourth quarter to turn that around.

But in 2023 to deliver substantial positive free cash flow.

We've been focused on these these recent acquisitions.

To a large extent recently.

We will have some working capital needs as it relates to that revenue that we're bringing on.

However, we think for the entire company, we have a large opportunity here going forward to unlock that.

You saw on our liquidity number.

That was up $25 million.

We are very well capitalized we are still net cash positive no bank debt.

And so all of those things provide us with a lot of opportunity here.

And as your team has had a chance to dig into the receivables.

You've inherited via the acquisitions are there any day.

No.

We have seen an increase in risk profile, where.

Yes.

<unk> seen an increase in the possibility.

Being able to collect to the extent you thought or potentially having to create a reserve.

No Tom No surprises our reserve is.

Very.

Very conservative it is appropriate for.

Our ongoing business and our ongoing revenue that our no surprises in any of these acquisitions, it's just getting everything connected on the same wire.

Pulling those in.

Got it and then <unk>.

Existing <unk> of your seven existing recycling facilities I believe six we're still at utilization levels of less than 50%.

Could you update us on.

How those six progressive or <unk>, and where their utilization rates stand now.

Sure. So Tom this is Michael when we look at the recital of fixed facility recycling facilities, we have.

All of whom this was the first quarter when we had all of them contributing for.

For a full quarter. So we're certainly trending in the right direction from that standpoint, and as I look at Q4, I think we're going to continue to commercialize, particularly the newer facilities and see utilization continue.

As I think about kind of your more specific question.

I would say about a third of the utilization for Q3 was higher across the board than it was for Q2, but half of our facilities are still.

Really new and emerging and underutilized. So we have the ability to continue to commercialize <unk>.

Really all of them, but at least half I would consider under utilized today.

Thanks for that Michael and then last one for me.

Could you just clarify did you enter into the negotiations with <unk>.

Cypress creditors, while it was.

So going through chapter 11 restructuring.

Did you did you close.

I just don't know if it's actually emerged yet so could you just share a bit of color on.

How do you actually pursued in <unk>.

Keith on that opportunity.

Yes, Tom this is John Schmitz.

Yeah, we did have conversations.

Prior to <unk>.

The transaction that did happen.

Which I believe was an out of court restructuring, but we actually did the transaction with.

The group that bought the whole.

Cypress they were wanting the pipe inspection business out of it and we were wanting the.

The disposal assets that we ended up getting so.

We actually bought it from the party that.

Participated in.

And restructuring the company.

Got it.

Thanks for that additional color John I'll turn it back.

Thank you.

Mr. Smith, there are no further questions at this time I would now like to turn the floor back over to you for closing comments.

You bet thanks, everybody for.

For talk.

Talking about select today.

And look forward to.

The next quarter.

And.

Again welcome all the.

The employees of the transaction a suite team members. Thank you.

Yes.

Thank you. This does conclude today's conference call you may disconnect. Your lines at this time. Thank you for your participation and have a great day.