Select Energy Services, Inc. (NYSE:WTTR) Q4 2023 Earnings Call Transcript
Select Energy Services, Inc. (NYSE:WTTR) Q4 2023 Earnings Call Transcript February 21, 2024
Select Energy Services, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to the Select Water Solutions 2023 Fourth Quarter and Year End 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. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Chris George, Senior Vice President, Corporate Development, Investor Relations and Sustainability. Thank you. You may begin.
Chris George: Thank you, operator and good morning everyone. We appreciate you joining us for Select Water Solutions conference call and webcast to review our financial and operational results for the fourth quarter and full year of 2023. With me today are, John Schmitz, our Founder, Chairman, President and Chief Executive Officer, Nick Swyka, Senior Vice President and Chief Financial Officer, and Michael Skarke, Executive Vice President and Chief Operating Officer. Before I turn the call over to John, 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 selectwater.com. There will also be a recorded telephonic replay available until March 6, 2024. 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 21, 2024, 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's 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.
Please refer to our earnings announcement released yesterday for reconciliations of non-GAAP financial measures. As a reminder the Company made certain changes to its segment reporting structure during the second quarter of 2023. These changes were driven by several operational and strategic factors. However, the changes in segment reporting have no impact on the Company's historical financial position, results of operations or cash flows. Prior periods have been recast to include the water sourcing and temporary water logistics operations within the Water Services segment and remove these results of operations from the Water Infrastructure segment. Historical segment information recasted to conform to the new reporting structure is available as supplemental financial information in the Investors section of the company's website at www.investors.selectwater.com.
Please refer to the company's current report on Form 8-K filed with the SEC concurrent with our earnings release for additional information. Now, I'd like to turn the call over to our Founder, Chairman, President and CEO, John Schmitz.
John Schmitz: Thanks, Chris. Good morning and thank you for joining us. I am pleased to be discussing Select Water Solutions again with you today. Overall, 2023 was a record-setting year for Select. I'd like to start by highlighting some of our key achievements over the past year and we'll let Nick speak to the fourth quarter in a bit more detail. During 2023, we grew revenues by 14% and adjusted EBITDA by 33% year over year, finishing the year with total revenues of approximately $1.6 billion and adjusted EBITDA of $258 million. As importantly, we also finished the year with record net income earnings per share and free cash flow. Each of our segments saw year-over-year revenue and gross profit gains during 2023. Most critically, we made tremendous progress, accelerating the growth and profitability of our water infrastructure segment with contributions from a number of acquisitions in late 2022 and early 2023, as well as organic projects that came online throughout the year.
We grew Water Infrastructure revenue by 84% and gross profit by 162% during 2023, as compared to 2022. Operationally, we significantly exceeded our expectations by growing recycled volumes, by more than 100% year-over-year while disposal volumes and systems utilization increased materially as well. We also continue to find ways to capture market share and improve the efficiency of our capital live Water Services and Chemical Technology segments growing gross margins by more than 200 basis points in each segment during 2023, and generating a significant amount of cash flow from these segments, to fund our growth strategy. With record operating cash flow, we were able to fund a diverse capital allocation strategy throughout 2023, including funding our modest maintenance CapEx needs, expediting our growth CapEx plans, particularly around our Water Infrastructure segment, increasing our base dividend by 20% during the year, expanding our share repurchase program while also executing six small bolt-on acquisitions.
Importantly, we were all we were able to execute these capital allocation priorities while also repaying all of our outstanding debt throughout the year and building a substantial 57 million cash position on the balance sheet, at year end. The strength of our recent financial performance including the strong free cash flow generation, from our Water Services and Chemical Technology segments, positioned us to continue to execute a number of strategic priorities already in 2024, including funding a trio of additional strategic asset, acquisitions during the first quarter of 2024, while also announcing a number of additional organic capital projects. The recent acquisitions for Tri-State and Iron Mountain in the Haynesville, as well as additional disposal and recycling assets in the Rockies, provide accretive operations and further development potential for two of our critical regional infrastructure networks.
The addition of the slurry and solid treatment facilities, also expand the scope with select capabilities in the Haynesville region, broadening our full life cycle waste stream management capabilities for our customers and adding incremental value across our pro forma position in the basin. Importantly, each deal fits our near term strategy to grow and expand our production base and contracted revenues. within our Water Infrastructure segment. Most significantly following our latest acquisition, we expect more than 90% of our Haynesville revenues to be production oriented during 2024, representing stability in the basin that may face near-term drilling and completion activity disruption from recent natural gas price volatility. As a company, we expect to see more than a third of our overall revenues come from production related activities, during 2024.
This is a tremendous strategic shift for our business in the span of only a few years, as less than 10% of our revenues were production weighted during our previous peak revenue years. From an organic project stand point, I am pleased to get several additional long-term contracts through the finish line in recent months. In the Permian, we were able to add substantial incremental acreage dedication to one of our largest Midland Basin recycling facilities. While we added additional contracted pipeline connections, into our recently completed flagship Delaware Basin recycling facility. In the Northeast, we added additional acreage dedication with a targeted minimum volume commitment to supplement the long-term income stream, of an existing disposal asset.
The largest project both from a capital spend and long-term value creation standpoint, however, is our Thompson pipeline system in the Bakken. This project is supported by a 225,000 acre dedication from a blue chip operator in the region. This pipeline will utilize the third and last remaining federal permit we have of Lake Sakakawea, in North Dakota. As many of you may recall, this has been a very lengthy permitting and business development effort. But I'm very pleased we've been able to partner with a premier operator in the region to underwrite the development of the system, which should come online late summer of 2024. While the Permian clearly remains the largest portion of our business and the greatest area for additional opportunities, so far this year we've already announced new projects and acquisitions in the Haynesville, Northeast, Rockies and Bakken regions in addition to the Permian.
Additionally, these opportunities have encompassed a comprehensive range of select capabilities including a water recycling, pipeline distributions, gathering and disposal, water transfer, fluids handling and solid waste management. Despite recent commodity price and activity volatility, we continue to experience increased demand for new infrastructure development opportunities across all basins, as water infrastructure constraints remain a significant challenge for our customers. I believe Select's operational and geographic diversity is one of our core strengths, providing us with an array of capital allocation prospects that allow us to make the best decisions to drive long-term shareholder value across a portfolio of opportunities. With a very strong backlog of additional greenfield, brownfield and bolt-on, infrastructure, systems, projects and acquisitions.
Select's Water Infrastructure segment is positioned to be one of the fastest growing infrastructure franchises in the industry. Accordingly, we expect to see annual Water Infrastructure segment revenues grow by 30% to 40% during 2024 with segment gross profits growing by 40% to 50% on a year-over-year basis. We expect about half the segment growth to come from M&A and the remaining half to come from organic projects. With continued organic growth and other potential strategic efforts, I believe we could potentially see Water Infrastructure gross profits reach as high as 50% of our consolidated profitability on a stand-alone basis by the end of 2025. Similar to the growth in our production-weighted revenues, this would represent a significant achievement for a segment that represented a mere 7% of the Company's profitability during our previous peak revenue year in 2018.
While we maintain a high level of conviction around the continued growth opportunities in our Water Infrastructure segment and the oil prices remain attractive at current levels for our customers, recent volatility in the natural gas prices and anticipated declines in our customers' budget on a year-over-year basis are likely to have impacts to the completions weighted revenues within our water services and chemical technology segments, though we believe we can continue to find opportunities to improve the margin profile of each segment on a year-over-year basis in 2024. Additionally, as we look for ways to further improve our margins and stabilize our cash flows, we will continue to evaluate our Water Services segment in particular for underperforming or nonstrategic locations for potential consolidation during 2024, which when combined with the modest declining macro activity outlook will drive water service segment revenues down on a year-over-year basis.
Our water services business remains critical to our overall success, as we must drive free cash flow and strong return on assets out of this segment. If there are yards or components of this segment that we determine cannot achieve these objectives, we will look to redeploy those personnel, resources and capital into other regions or parts of our business that can. We expect our water services and chemical technology segments to generate more than 70% to 80% of their gross profit into free cash flow, providing a very attractive source of capital funding for our water infrastructure growth initiatives. Accordingly, driven by the substantial continued growth in our Water Infrastructure segment over the course of 2024, we firmly anticipate growing our adjusted EBITDA on a year-over-year basis during 2024 and expect to pull through at least 40% of this adjusted EBITDA into free cash flow after accounting for all maintenance and growth CapEx, providing substantial optionality for additional strategic investment initiatives or incremental shareholder returns.
We will remain attentive to every dollar of capital we deploy, and with this free cash flow we will prioritize capital allocation to the most strategic areas of our business, especially where we have the most opportunity to grow our production weighted and long-term contracted revenues, expand our proprietary application of automation, chemistry or recycling technologies and integrate full lifecycle Water Infrastructure and chemistry solutions around our existing Water Infrastructure asset base. I firmly believe in the infrastructure growth strategy we've undertaken recently, which I believe best positions Select to drive long-term shareholder value. And ultimately, I believe that Select remains uniquely positioned in a competitive energy landscape to advance the integration of water and chemical technology solutions with high-margin long-term contracted infrastructure.
I am very excited about what the future holds for Select and look forward to executing on this vision during 2024. At this point, I'll hand it over to Nick to speak about our financial results and 2024 outlook in a bit more detail. Nick?
Nick Swyka: Thank you, John, and good morning, everyone. As John mentioned, 2023 marked a record year for Select across many annual financial metrics. These include $1.6 billion of revenue, $74.4 million of net income, $0.73 earnings per share, $258 million of adjusted EBITDA and finally, $285 million of cash provided by operating activities. These record financial results enabled us to provide $87 million of total returns to shareholders over the course of the year, raised our quarterly dividend by 20% and retire our outstanding debt balance, finishing the year in a strong net cash position and with $307 million of liquidity. Importantly, we achieved this success despite the steady headwind from declining levels of drilling and completions activity over the back half of the year.
Select's ongoing transition to a more infrastructure base production levered full lifecycle water company as aligned our profitability and cash flow generation with critical secular growth drivers unique to our business, increased water recycling by our customers', infrastructure networks the balanced water supply and demand across customers and regions, and industry consolidation that demands high quality partners with the size, scope and networks to serve the largest operators, all continue to benefit Select Water Solutions, even as activity levels have softened with recent commodity price volatility. While the more completions levered Water Services and Chemical Technologies segments were ultimately impacted by industry activity declines.
The fourth quarter saw continued revenue and profitability gains in the Water Infrastructure segment. During Q4, the Water Infrastructure segment increased revenue by more than 4% to $60.8 million. And gross margins, which we customarily provide in terms of prior to depreciation and amortization, increased by over 300 basis points to 43%. The projects we announced yesterday exemplify our ability to add value to our existing infrastructure networks through steady incremental commercialization. We have a long history of unique access and usage agreements across many regions, which in the case of the Thompson Pipeline put us in an exclusive position to execute a new greenfield project, backed by long-term contracts. For the recycling network expansions on both, the Delaware and Midland sides of the Permian, our existing systems comprising large acreage and multi-customer gathering, recycling, transmissing -- transmission and disposal create both optionality and additional contracting opportunities with new and existing infrastructure costs.
These expanded networks will see enhanced utilization and water balancing capabilities that make the expansions highly accretive. And finally, even in gas basins like the Marcellus and Utica, long-term water gathering and disposal agreements from steady production sources remain an attractive growth option. In addition to these organic growth opportunities, we also announced three recent infrastructure acquisitions across multiple base basins in January. These are not economically distressed entities similar to our previous acquisition wave, but rather discrete, underutilized or highly contracted assets located within the footprint of two of our regional infrastructure networks. While the first quarter will see some expenses related to integration and standardization of these newly acquired assets, pushing the expected gross margin in water infrastructure down slightly to 39% to 42%.
We expect revenues to move higher by mid single-digit percentages. As we move through the year, we expect gross margins to resume their upward trajectory into the mid-to-high-40s, as we connect these acquired assets to our network to boost utilization, bring on new projects like the ones announced yesterday and continue to execute on our backlog of additional projects currently under discussion. We may also elect to move forward with additional acquisitions where we see discrete assets with the ability to provide accretive economics to our existing networks. As John mentioned we believe an aspirational, but achievable goal for this segment, is to reach 50% of our overall corporate gross profit contribution by the end of 2025, underpinned by repeatable, predictable, high-margin revenue streams.
The growing weight of these higher-margin revenue streams, allows us to provide additional certainty around return of capital to shareholders. We returned nearly 10% of our current market cap in cash to shareholders in 2023 in the form of dividends, distributions and buybacks. In the fourth quarter we raised our quarterly dividend by 20% to $0.06 a share, while completing another 12 million of share buybacks. While we remain open to tactical buybacks from within cash flow and a strong balance sheet, in the near-term we are prioritizing execution on infrastructure projects and potential incremental asset bolt-ons as a use of capital, while we maintain our commitment to the recently increased regular dividend. To fund these investments alongside capital returns, our Water Services and Chemical Technology segments each provide strong cash flow at low capital intensity, returning 70% to 80% of profits and cash flows after CapEx, as John noted.
In the fourth quarter the Water Services segment outperformed overall industry activity data, with revenues declining by 4%, against a decline in completions activity of about 8% for the EIA, while margins increased by nearly 200 basis points with our cost management and margin enhancement efforts. With continued activity, volatility and some operational consolidation underway, we expect a modest mid-single digit percentage step-back in first quarter revenue with margins in the 19% to 21% range, followed by additional margin improvement later in the year. Chemical Technologies revenue declined by a bit over 8% sequentially in Q4, relatively in line with activity levels with margins down six points to 14%. The business was impacted by a bit over two million of legacy, production chemicals inventory write-downs and year-end insurance adjustments, accounting for about three percentage points of the gross margin decline.
Even so the results here came in below our expectations for the fourth quarters, even after accounting for the items I referenced, we expect both revenue and margins to improve modestly for this segment in the first quarter, due to certain key customer activity increases and cost realignments to match manufacturing throughput. While fourth-quarter SG&A increased by 7.4 million to $46 million, the majority of this or $6.2 million related to higher transaction and rebranding costs in the fourth quarter, relative to the third. We expect SG&A to decline to the low-40 million range in the first quarter, as our rebranding initiative winds down, though transaction costs related to our recent acquisitions will remain. Altogether for the first quarter of 2024, we expect consolidated adjusted EBITDA of $52 to $56 million, as customer activity and operational consolidation activities impact our Water Services segment and short-term integration related costs from our new acquisitions affect the quarter as well.
However, driven by the substantial continued growth in our Water Infrastructure segment over the course of 2024, an anticipated margin improvement in our Services & Chemicals segments, we firmly anticipate growing our adjusted EBITDA on a year-over-year basis, during 2024. The fourth quarter also saw multiple sizable tax related impacts, Select's growing and sustained profitability in recent years has triggered an assessment, that our long-standing net operating loss carry forwards covered by our Tax Receivable Agreement or TRA is likely to provide a benefit to the company under reasonably evaluated forward-looking projections in the next few years. And currently, we have recognized a deferred tax asset related to future tax savings in the TRA liability into our quarterly and annual financial statements.
These adjustments reflect forward-looking assessments and formed by independent third-party advisors and may change as time progresses and company financial performance and capital spending evolves. They also may be impacted by changes to the US tax code. I encourage all listeners to review our 2022 annual 10-K financial report found on our website as well as our 2023 10-K which should be made available this week to understand our tax attributes in the TRA in greater detail. Our fourth quarter net income of 27.6 million was positively benefited by a $61.9 million release of a valuation allowance associated with deferred tax assets partially offset by a tax by tax receivable agreements expense of 38.2 million. While we anticipate cash tax payments in 2024 to be a relatively modest four to $6 million including state taxes our book tax expense percentage applied to pretax operating income is likely to increase to the low 20% range.
From an accounting perspective, this forecasted tax expense would primarily impact existing deferred tax assets in 2024 prior to becoming a cash outlay in future years. Depreciation and amortization expect will continue in the mid to high-30 million range quarterly modestly increase from recent acquisitions and organic infrastructure development and quarterly interest expense should increase to $2 million to $3 million per quarter as we employ our sustainability-linked lending facility to execute our recent acquisitions. This facility provides an attractive cost of capital for us and we will continue to see the interest rate reduction benefits of outperforming our sustainability KPIs for water recycling and employee safety targets for the second consecutive year since the facility's initiation.
With fourth quarter net CapEx of $28 million, we finished the year at $118 million just below our previous guidance of $120 million to $130 million. We are entering 2024 with a healthy ongoing project backlog and additional development opportunities related to react to the recent acquisitions and expect $140 million to $160 million of net CapEx in 2024. We anticipate $50 million to $60 million of this CapEx going towards ongoing maintenance and about $15 million going towards margin improvement initiatives. The remaining largest component of this overall spend is for growth CapEx, which is heavily weighted towards infrastructure growth projects. Additionally, we anticipate generating $10 million to $20 million of proceeds from asset sales to net against this growth CapEx spend during the year in 2024.
As we've outlined we expect to exceed our 2023 adjusted EBITDA in 2024 and convert more than 40% of those dollars into free cash flow from operations after CapEx. As we move forward with our vision of growing long life high return water infrastructure and shareholder value in 2024, I'd like to conclude with a couple of our accomplished financial goals from 2023. We reduced our accounts receivable balances over the course of the year by over $110 million or $170 million from the end of Q1 and ended the year not just debt-free, but with 57 million of cash on hand. During 2023 we converted nearly two-thirds of our adjusted EBITDA into free cash flow to the bottom-line, while investing the dollars needed to grow water and infrastructure profitability by over 160% year-on-year.
This success is due to sustained dedicated performance across many select teams both support and operations to integrate and realize value from our investments and translate that value to dollars in the door. I'd like to thank them for their hard work. And with that I'll open it up to questions. Operator?
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