Select Energy Services, Inc. (NYSE:WTTR) Q3 2023 Earnings Call Transcript

Select Energy Services, Inc. (NYSE:WTTR) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Greetings, and welcome to Select Water Solutions Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] It is now my pleasure to introduce your host, Chris George, Senior Vice President, Corporate Development, Investor Relations and Sustainability. Thank you, Mr. George. 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 third quarter 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 November 15, 2023. The access information for this replay was also included in yesterday's earnings release.

A hydroelectric plant with a large dam and water flowing through its turbines.

Please note that the information reported on this call speaks only as of today, November 1, 2023 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 consolidated 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 the results of those operations from the Water Infrastructure segment. Historical segment information re-casted to conform to the new reporting structure is available as supplemental financial information in the Investors section of the company's website at 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'm pleased to be discussing Select Water Solutions again with you today. During the third quarter we delivered substantial operating and free cash flow and continue to see steady growth in our Water Infrastructure segment. On the free cash flow side of things, I'm very pleased with the progress we made during the third quarter. Nick will touch on the components in a bit more detail, but our focused effort to reduce our working capital are paying off and help deliver a $118 million of cash flow from operations during the third quarter. After accounting for the $34 million in net CapEx spent during the quarter, we were able to pull through about $85 million of free cash flow, well exceeding our adjusted EBITDA for the period.

We made tremendous strides in our working capital reduction efforts during the quarter, substantially outpacing our full year performance targets a quarter early. Strong third quarter free cash flow enabled us to execute on a number of capital allocation priorities including repaying all the outstanding borrowings on our sustainability linked credit facility, increasing shareholder returns by raising our upcoming quarterly dividend payment by 20%, and funding more than $35 million of capital expenditures heavily weighted toward our water infrastructure growth capital projects supported by long-term contracts with attractive returns. Having now repaid our remaining outstanding borrowings during the third quarter, I expect to see a growing cash position building towards year-end.

Replenishing our cash war chest provides us with ample opportunities to review our capital allocation priorities including continued to weigh incremental - shareholder returns against additional organic growth projects and bolt-on and strategic M&A opportunities. We remain steadfast in our vision to be the recognized leader and trusted partner in sustainable water management solutions and believe our continued dedication to achieving operational excellence across the entire organization will further enhance that vision. Our focus for 2023 has been on acquisition integration, improving efficiencies and operational margins across the organization, and executing on infrastructure projects and free cash flow generation. While we have made great progress in many of these focus areas, especially around integration, infrastructure growth and free cash flow, there is still more work to be done around the efficiency and operational excellence.

While we did see some downward impact to the consolidated revenue of the business for more than a 10% decline in U.S. onshore completions activity, according to industry data our Water Services and chemical technology segments both outperformed the activity levels overall with revenue declines well inside of the overall activity levels. Although we were able to hold chemical technology margins relatively steady during the third quarter, we took a modest step back in water services margins during the quarter. We can and must find continuing margin improvements in this segment and I am firmly committed to getting to both our near term and long-term targets of mid to high 20% gross margins before D&A respectively. We continue to look closely at the entire scope and scale of the company where appropriate, make the continuing determination to consolidate facilities or relocate assets across our areas of operation for certain nonperforming service locations particularly around our Water Services segment.

We remain attentive to every dollar of capital we deploy and we'll prioritize capital allocation to the most strategic areas of our business, especially where we have the most opportunity to add proprietary application of automation chemistry or recycling technology and integrate full lifecycle water infrastructure and chemistry solutions around our existing asset base. Our recent organic recycling and disposal infrastructure projects have delivered strong performance, including driving water infrastructure to 6% sequential revenue growth and 40% gross margins in the third quarter. We saw growth across all areas of Water Infrastructure segment during the third quarter of 2023 with recycling volumes increasing by 5%, pipeline volumes up nearly 12%, and disposal volumes growing by 2% as compared to the second quarter of 2023.

By boosting network utilization across our high operating leverage systems, we were able to drive incremental gross margins of more than 80% on every incremental revenue dollar during the third quarter. I expect to see this momentum continue in the fourth quarter and beyond into 2024. In the past 12 months the Water Infrastructure segment has seen revenues grow 86% and gross profit before D&A more than double in size growing by 113% year-over-year. Water infrastructure now accounts for more than 25% of the gross profitability of the company and I expect to see this segment continue to grow - has a contribution percentage of the company's overall profitability in 2024. Even with the recent activity volatility, we continue to experience increased demand for our new infrastructure development opportunities across all basins as water infrastructure constraints remain to be a significant challenge for our customers.

With our strategic infrastructure footprint, we are well positioned to strengthen the contractual relationship we have with our customers and expand the scope of integrated water and chemical solutions that we're able to provide around the infrastructure base. I believe our latest infrastructure project announcements demonstrate the value of our asset base and the continued opportunity to create long-term value for both our brownfield and greenfield investment projects across multiple basins. And as you saw in our recent Haynesville contracts, we also have a great opportunity to incorporate contractual service capture through these relationships as well. I'm excited about what the future holds for Select and look forward to further executing on this vision through additional profitability growth and cash flow generations in the quarters ahead.

Ultimately these profits and cash flows will provide us with the further opportunity for incremental shareholder returns and opportunistic M&A execution in the coming quarters. And importantly Select is uniquely positioned to continue to deploy technology and chemistry solutions around our growing contracted infrastructure footprint. We are firmly focused on these initiatives as I discussed, and I look forward to unlocking more cash and enhanced profitability in the quarters ahead. At this time, I'll let Nick speak to our third quarter results and outlook in a bit more detail. Nick?

Nick Swyka: Thank you, John, and good morning, everyone. I'm pleased to report that our intensified focus on generating cash out of both the business and working capital produced operating cash flow of $118 million during the third quarter which after adjusting for net CapEx yielded free cash flow of $85 million. With this sum, we completely retired the balance on our credit facility, while leaving us with $25 million cash on hand. In this era of rising interest rates and capital markets volatility, Select's pristine balance sheet and abundant liquidity through our undrawn sustainability linked credit facility enables us to both advance shareholder returns as well as expand our water gathering, recycling and distribution systems across multiple basins.

We're excited to announce new dedicated acreage and pipeline volume additions to our Northern Delaware and Haynesville systems this quarter as well as a 20% increase to our regular quarterly dividend. Growing both our infrastructure footprint and shareholder returns within annual cash flow from a solid balance sheet is the model we expect to deliver for 2023 and the years ahead. While the Water Infrastructure segment met our expectations of a solid quarterly step up in both revenue and margin, the industry's activity backdrop softened over the summer and into the third quarter, impacting our Water Services and Chemical Technologies segments. Overall, consolidated revenues declined just under 4% to $389 million during the third quarter from $405 million in the second, with net income of $15.3 million and adjusted EBITDA of $63 million during the third quarter.

With drilling and completions activity appearing to be bottoming along with the benefit of a more robust commodity price environment than we saw over the last couple of quarters, we believe that 2024 will resume upward momentum in other parts of the business in tandem with the continued positive secular growth of our Water Infrastructure segment. In the interim, the near term remainder of 2023, you should see some customer budget and seasonal constraints. Our priority for the Water services side will be a continued focus on operational excellence, closely evaluating peripheral or low-performing locations, driving down costs through procurement and operational efficiency initiatives and working closely with customers to deliver advanced solutions with technology and automation.

Industry data suggests that the third quarter saw average rig count and completions activity each decline by about 10%. Against this backdrop, our Water Services Segment revenue declined by a little under 5% with a portion of this decline coming from closed yard operations to $252 million in the third quarter from $265 million in the second. Gross margins which we customarily speak of in terms of before depreciation and amortization declined from 21.9% to 20.5%. We expect the fourth quarter to bring mid-single-digit percentage revenue declines with stable margins which are poised to positively inflect in 2024 back towards our near-term target of mid-20s with high 20s remaining our longer-term target for this segment. Chemical Technologies was also affected by the macro environment with revenue declining a bit over 6% to $79 million sequentially.

Our manufactured volumes in our plants were down about 10% sequentially. Our higher dollar proprietary product demand held revenues inside of that volumetric decline and our efficient manufacturing process held margins essentially flat just above 20%. We anticipate modest low to mid-single digit percentage seasonal declines to revenue and margins of 19% to 20% in Q4, but continued product research and development at our laboratory facilities along with a stable to improving activity environment in 2024 should support the resumption of the segment's growth beyond next quarter's results. Our Water Infrastructure segment delivered to our forecast growing revenue just under 6% or $3.1 million quarter-over-quarter pressing just beyond our targeted gross margins of 40%.

The backlog of development opportunities for this segment remains very strong. In addition to the multiple new contracts announced yesterday, we are actively evaluating well over a dozen additional organic opportunities in partnership with customers as well as other growth avenues. We expect this segment to grow sequential revenue by mid-single digits again during the fourth quarter and to advance margins another 200 basis points to 300 basis points on higher utilization and continued system build outs. I previously outlined a couple of 2023 targets related to cash flow and working capital. First, we targeted to reduce accounts receivable by $100 million between the end of Q1 and 2023 year-end. And second, we planned to exit the year with a debt-free balance sheet.

I'm pleased to report that we exceeded both of those goals a quarter in advance with accounts receivable declining by $137 million since Q1 and us having paid down the remainder of our credit facility balance during the third quarter with $25 million of cash on hand leftover. As our systems integration efforts progress, our consolidated accounts receivable days sales outstanding reduced to a level not seen since the third quarter of 2021 before we began our recent M&A acceleration. Select now has ample liquidity to capitalize on a range of potential strategic opportunities and we expect to continue making additional progress on the cash flow and working capital front to finish the year. While I'm pleased with the progress we've made, I do believe there is continued opportunity to improve DSO further in 2024.

Additionally, with the investments we've made, the Company is in a much better position to manage and absorb future acquisition integrations. SG&A increased sequentially to $39 million, up $4.7 million from Q2 due primarily to an approximately $3 million increase in transaction and rebranding costs. We will be finishing the current rebranding initiative and related costs by year-end, which should provide for a modest reduction in SG&A from current levels by early 2024. Our third quarter net CapEx of $34 million was similar to the previous quarter's $36 million with new infrastructure development representing the majority of that number. We are actively investing in our strategic infrastructure development in multiple basins where we feel we have strong advantages such as our established Permian and Haynesville systems.

Accelerating the build-out pace of our systems were backed by long-term contract opportunities is a core priority for 2024. Our 2023 net CapEx forecast remains within its previous range with a tightening to $120 million to $130 million after giving effect to roughly $15 million and expected full year asset sales. We expect depreciation and amortization expense to continue at around $35 million per quarter and both tax and interest expense to remain minimal through 2023. We added more than $55 million of liquidity during the quarter to finish with approximately $250 million of total liquidity. Coming one year after its initiation, we recently announced an increase in the regular quarterly dividend by 20% to $0.06 a share. We plan to continue to evaluate our dividend on an annual basis at a minimum.

In addition to the dividend we have about $12.5 million remaining capacity on our stock buyback program and may seek to utilize or add to that capacity as we monitor operating and capital market conditions. With shareholder returns at our core and substantial infrastructure growth investment opportunities ahead, we believe our blended model of growing both committed and tactical shareholder returns while deploying enhanced cash flow into long-lived contracted water solutions networks across multiple basins all accomplished from a solid balance sheet substantial value to investors over the long term.

John Schmitz: Thank you. And with that we'll open it up to questions. Operator?

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