Select Energy Services, Inc. (NYSE:WTTR) Q1 2024 Earnings Call Transcript

Select Energy Services, Inc. (NYSE:WTTR) Q1 2024 Earnings Call Transcript May 1, 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: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Select Water Solutions 2024 First Quarter Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I’ll now turn the conference over to your host, Chris George, Executive Vice President & Chief Financial Officer for Select Water Solutions. 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 first quarter of 2024. With me today are John Schmitz, our Founder, Chairman, President and CEO; and Michael Skarke, Executive Vice President & 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 May 15, 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, May 1, 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 by management. Listeners are 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 had 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 recast 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, 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. It’s been a very busy start to 2024. Overall, the business performed well during the first quarter and we sit here in a strong position heading into quarter 2. Highlights of the first quarter included growing revenues and margins in both the water infrastructure and chemical technology segments, which supported sequential improvements in the consolidated gross margin and adjusted EBITDA, which came in ahead of our expectations. I’m especially pleased with the continual progress we have made toward the execution of our water infrastructure growth strategy. In addition to the 3 previously announced acquisitions in the Haynesville and the Rockies regions that we closed in January, we completed additional acquisitions in the Permian and Bakken regions in March and April.

Each of these acquisitions demonstrates our ability to execute on strategic but value-oriented opportunities to efficiently expand our infrastructure network across the geographic footprint. With the recent Trinity acquisitions, we are adding more than 600,000 barrels per day of permitted disposal capacity, primarily in the Permian Basin across 24 active disposal wells and 9 additional disposal permits available for future development. This acquisition adds critical disposal capacity in both the Midland and Delaware basins, an area with some of our most robust growth opportunities. And with the nearly 100 miles of gathering pipelines already integrated in the acquired assets, we have significant optionality and development potential to integrate these assets with our existing Permian infrastructure networks.

Disposal remains a necessary component of an efficient full lifecycle infrastructure solution, and these disposal assets will strengthen our ability to develop efficient and creative solutions for our customers. Additionally, we have continued to add to our solids waste management solutions as well with 4 of the 5 acquisitions so far this year, contributing additional assets to our waste solution capabilities. With Trinity, we have added additional slurry well in the Gulf Coast region that adds scale to our solids waste management business in East Texas, alongside the solids treatment and disposal assets and operations we acquired from Tri-State and Iron Mountain January. Separately, with Buckhorn, we acquired 2 solid waste landfills in the Bakken with nearly 400,000 tons of annual capacity and more than 50 years of remaining potential useful life.

These facilities are strategically located in North Dakota and Montana and add significant additional capacity to our existing landfill operations in the basin. Importantly, this acquisition also expands the scope of our service capabilities through the addition of a Class 2 landfill, one of the very few active TENORM disposal facilities in the U.S., as well as Class 1 industrial waste disposal permit presenting additional opportunities for future development. We believe the addition of the Buckhorn assets will also help us enhance the revenue and margin profile of our existing landfill operations with the integrated logistics and enhance customer relationships. These facilities allow Select to further capture the full water and waste lifecycle of our customers operations, including environmental management and downstream remediation.

I’d also highlight that with both Trinity and Buckhorn, we are also adding lean but very high performing operational teams with decades of experience in disposal and waste management solution, and I welcome these new employees into the Select family. While we continue to grow our water infrastructure business through acquisitions, we also continue to grow through the organic business development execution. During the first quarter, we signed 4 additional long-term contracts for new pipeline gathering, recycling and disposal projects that will integrate directly into our existing infrastructure in the Haynesville and the Permian. Each of these contracts can be tied directly to the strength of our existing networks in these regions, including from the recently acquired asset in each basin.

While we have been quite active this year, we remain attentive to every dollar of capital we deploy and continue to prioritize capital to the most strategic area of our business, especially where we have the most opportunity to integrate full lifecycle water infrastructure and waste management solutions around our existing asset base or add proprietary application of automation, chemistry or recycling technologies. And as demonstrated by the breadth of our recent acquisitions and projects, I believe Select’s operation and geographic diversity is one of our core strengths and competitive differentiators. It also provides us with a wide array of capital allocation prospects that allows us to make the best decision to drive long-term shareholder value.

Importantly, each acquisition and project we’ve executed this year fits our strategy to grow and expand our production-based and long-term contracted revenue within our Water Infrastructure segment. We are well-positioned to continue to strengthen the contractual relationship we have with our customers and expand the scope of our end-to-end water services and chemical solutions that we’ve been able to provide around the infrastructure base. Our recent organic recycle and disposal infrastructure projects have delivered strong performance. As seen in the meaningful margin improvement in the Water Infrastructure segment during the first quarter, I’m very confident in our remaining multi-year backlog for both greenfield and brownfield infrastructure projects.

We’ve seen this backlog more than double over the last 2 quarters, providing visibility into continuing expansion opportunities well into next year, and I’m very excited to add the newly acquired assets into our future business development planning as well. From a customer standpoint, we continue to see consolidation in the NP space. We believe this will drive continued demand for more sophisticated and comprehensive water management and waste solutions. While we oftentimes find ourselves working for both customers on both sides of the larger deals, we have generally aligned ourselves with the industry consolidators and have an extensive business development backlog in place to meet the needs of their growing infrastructure demands. Chris will touch on the first quarter’s financial performance in more detail, but I’m proud of the continued outstanding results our team is achieving during the period of changing industry trends.

We will continue to generate a strong return on assets and return capital to our shareholders while investing in and growing the business. At this point, I’ll hand it over to Chris to speak to our first quarter financial results and remaining 2024 outlook in a bit more detail. Chris.

Chris George: Thank you, John, and good morning, everyone. During the first quarter of 2024, while we did see overall revenues modestly caught declined during the period as expected, we saw solid gains in our chemical technology segment and our Water Infrastructure segment continued its steady growth trajectory once again, achieving record high quarterly revenue and gross profit results during the first quarter. With the support of our latest strategic initiatives, we expect to see consolidated revenue and adjusted EBITDA growth during the second quarter and are well on track towards achieving our 2024 full year targets, including growing adjusted EBITDA year-over-year underwriting approximately a 100 million of new organic infrastructure projects generating more than 1/3 of our revenues from production related activities during 2024, growing water infrastructure revenue by 30% to 40% and profitability by 40% to 50% during the year, and supported by this growth, seeing our water infrastructure and chemical technology segments combined for more than 50% of our total consolidated profitability for the year.

And to reiterate, we also expect to do this while pulling through more than 40% of our adjusted EBITDA into free cash flow after all maintenance and growth CapEx for the full year 2024. Even as activity levels have seen pressure in recent quarters and commodity prices remain unsettled, Select’s ongoing transition to a more infrastructure-based production levered full lifecycle water company has aligned our future profitability and cashflow generation with critical secular growth drivers unique to our business. These trends continue to benefit Select, including increased water recycling by our customers, demand for infrastructure networks and commercial water balancing and EMP industry consolidation that demands high quality partners with the size, scope and networks to serve the largest operators.

During Q1, the Water Infrastructure segment increased revenue by more than 4% to $64 million and gross margins, which we customarily provide in terms of prior to depreciation, amortization and accretion increased by over 360 basis points to nearly 47%.We expect to see even stronger 10 plus percent revenue growth during Q2 with significant 30% to 40% growth in our disposal and waste solutions volumes supported by our recent acquisitions and enhanced utilization of existing assets. Projects we announced yesterday demonstrate our ability to add value to our existing infrastructure networks through steady incremental commercialization. For the recycling and gathering pipeline network expansions in the Delaware basin, our existing systems comprising large acreage dedications and multi-customer gathering, recycling, distribution and disposal operations create both optionality and additional contracting opportunities with new and existing infrastructure customers.

These expanded networks will see enhanced utilization and water balancing capabilities that make the expansions highly accretive. And even though natural gas prices have contracted, long-term gas demand is very robust, particularly with electricity demand rising rapidly and new LNG demand slated to come online in 2025 and 2026. Accordingly, in a gas basin like the Haynesville, long-term water gathering and disposal agreements from steady production sources remains an attractive growth option, especially when integrated with our market-leading disposal footprint supported by our uniquely positioned gathering pipeline network. While the second quarter may see some expenses related to integration and standardization of our newly acquired assets, we expect to retain steady margins in water infrastructure during Q2 and believe we can continue to push these margins up over the coming quarters into the high 40s.

Looking out more medium-term, we continue to believe that with a very strong project and deal backlog, water infrastructure will become the largest component of our profitability by the end of 2025 underpinned by repeatable, predictable, high margin and contracted revenue streams. Chemical technologies revenue grew by 4% sequentially in Q1 with margins back up to about 17%. The business benefited by the non-recurrence of certain insurance and inventory adjustment items that impacted Q4’s results, but overall, it was good to see the strong recovery in margin performance. Looking forward to Q2, we expect to see continued low single digit percentage revenue growth and margins improved to the 17%-19% range. We believe there are opportunities to continue to improve the operating efficiency of our manufacturing operations and enhance our in-basin delivery logistics, which should continue to provide modest margin improvement opportunities.

While the more completions levered water services segment was impacted by modestly lower activity levels during the first quarter, about 85% of the revenue decline during the first quarter came from our fluids hauling and well-testing service lines. These are more commoditized areas of the business where we continue to focus on cost efficiency and consolidation and elimination opportunities. We have made decisions in multiple regions across these service lines to consolidate operations and pair back certain non-core offerings and geographies such as fluid hauling in the Powder River Basin Wyoming, for example. In order to streamline our operations, improve our margin performance and focus on strategic service offerings that are critical to our full lifecycle solutions.

These decisions will result in additional low single digit percentage revenue decreases in the second quarter for water services. However, we should start to see the benefit of these decisions on the margin side, and we expect to see gross margins and water services increasing to 21% to 24% during the second quarter. SG&A during the first quarter decreased by 5% or $2.4 million as compared to the fourth quarter, while the rebranding costs slowed during Q1 relative to Q4. With the recent acquisitions, we continue to incur a balance of transaction related costs during Q1. Looking forward, we expect SG&A to decline to the low $40 million range, though transaction costs related to our recent acquisitions will remain during Q2. Altogether for the second quarter of 2024, we expect consolidated adjusted EBITDA of $64 million to $68 million, a meaningful step up from Q1.

Driven by the substantial continued growth in our Water Infrastructure segment over the course of 2024 and anticipated margin improvement in our services and chemical segments, we are firmly on track to continue growing our adjusted EBITDA on a year-over-year basis during 2024, even with the expected year-over-year revenue decline from water services. Looking at the balance sheet, we utilized our sustainability linked credit facility in addition to cash on hand to help fund 4 acquisitions for $108 million during Q1, ending the first quarter with $75 million of outstanding borrowings. This has ticked up to $100 million outstanding since quarter end with the subsequent acquisition in April for approximately $29 million, but still leaves us with ample liquidity and a very conservative balance sheet.

We will remain disciplined in our use of leverage, but with the growing contribution of our higher margin production levered and contracted revenue streams, we have good visibility into our ability to repay these outstanding borrowings in a relatively short period of time while still generating cash flow to fund the growth of the business organically. We continue to return capital to shareholders with our increased dividend of $0.06 per share, equating to $7.5 million of capital return to shareholders during Q1. We have $21 million remaining authorized on our share repurchase program, and while we remain open to tactical buybacks from within cash flow in a strong balance sheet in the near-term, we are prioritizing execution on infrastructure projects and integration of our infrastructure asset bolt-ons as a primary use of capital, while we maintain our commitment to the recently increased regular dividend and overall capital allocation flexibility.

As we reviewed last quarter, Select’s growing and sustained profitability in recent years, triggered an assessment of our taxable position at year end, and we did transition into a book taxable position during Q1. This translated into an effective book tax rate of about 25% during the first quarter. However, to reiterate, we do not anticipate material cash tax payments during 2024 as our substantial tax attributes and carry forwards will provide significant benefit during the year. We anticipate cash tax payments in 2024 to be a relatively modest $4 million to $6 million including state taxes. Though our book tax expense applied to pre-tax operating income should remain at a percentage rate around where it was during the first quarter. From an accounting perspective, this forecasted tax expense would primarily impact existing deferred tax assets in 2024 and 2025 prior to becoming a cash outlay in future years, most likely commencing in 2026.

Quarterly depreciation, amortization and accretion should tick up modestly with the latest acquisitions to the $38 million to $40 million range, 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. Net CapEx of $28.6 million was relatively flat quarter-over-quarter, though we may see a modest uptick during Q2 as our organic water infrastructure growth CapEx accelerates. However, our full year net CapEx guidance of $140 million to $160 million in 2024 remains unchanged at this time. We anticipate $50 million to $60 million of this CapEx going towards ongoing maintenance with the largest component of the remaining overall spend going towards infrastructure growth CapEx. We generated asset sales about $5 million during the first quarter and remain on track to generate up to $20 million of proceeds from asset sales during 2024, supported in particular by the consolidation and elimination efforts in water services.

While we invest in water infrastructure, we expect each of our water services and chemical technology segments to provide strong cash flows at low capital intensity during 2024, returning a combined 70% to 80% of profits and cash flows after CapEx, as we previously noted to help fund our water infrastructure growth. While the first quarter was not entirely indicative of this from a free cash flow perspective, as we incurred substantial seasonal cash impacts, including annual incentive program payouts, annual property tax payments and other seasonal cash outflow items, we continue to generate positive free cash flow during the first quarter and anticipate this ramping through the back half of the year. As I’ve outlined previously, we firmly expect to exceed our 2023 adjusted EBITDA during 2024, and we remain well on track to achieve our full year cash flow target of pulling through more than 40% of our adjusted EBITDA into free cash flow for the full year of 2024 after accounting for all maintenance and growth CapEx. We have a tremendous amount of opportunity ahead of us, and I look forward to continuing to execute on our strategy.

I’d like to wrap up by once again thanking all of our employees for their hard work and support, and with that, open it up to questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question is from Bobby Brooks with Northland.

Bobby Brooks : So really impressive margin improvement on the Water Infrastructure segment, and I know that occurred despite some detractors like acquisition integrated, integration costs and organic spending. So I was just curious, could you discuss really what drove that 900 bips year-over-year step up in margins, and are those pretty much the same factors that drove the 360 basis points sequential step up in margins for the segment?

Chris George: Yes, I’ll start and probably let Michael add on Bobby. Certainly, pleased with the progress we made earlier in the year on the water infrastructure side. The first quarter was certainly benefited by the accretive nature of the acquisitions. There’s certainly some more work to do around the integration and enhancement of the assets that we’ve recently acquired to get them integrated in the portfolio, so you may see some of that in the second quarter as well. But overall, we certainly think we’ve got the right path towards continued improvement up to the high 40s, like we indicated. It’s certainly on a year-over-year basis contributed also by the enhanced utilization of the base business, the assets across the overall portfolio and the projects that we continue to invest in are generally coming in on a creative basis relative to the second as a whole.

So you’re really seeing kind of the full benefit across the board year-over-year, and in the first quarter and second quarter, a lot of improvement driven by the accretive application of the acquisitions coming online.

Bobby Brooks : And then I know that the pipelines of opportunities for both Greenfield and Brownfield for the infrastructure segment is really healthy and expanding. So could you just maybe help frame that pipeline for us and maybe it’s best just compare it to what it is now versus this time last year, even maybe what it was 6 months ago and just discuss a bit what’s been the driver of that pipeline growth?

Michael Skarke: Sure. So Bobby, this is Michael. I’ll take a first cut at it. What I’d say is that the opportunities that we’ve got in front of us is the largest it’s ever been. Relative to 6 months or a year ago, I think John mentioned it’s doubled. So we’ve got really high interest right now. One of the things we’ve seen recently is a lot more customer inbounds, which I think is really just a testament of what we’ve been able to create here in a relatively short period of time. In terms of kind of more specifics, we’re looking at projects in every basin and across the recycling, disposal and pipeline transmission segments. So we’re really excited about it. We think we’ll continue to be able to deliver projects on a regular basis through the rest of the quarter and really fuel continued improvement on infrastructure, both in top line growth and in margin as a result.

John Schmitz: Yes. Bobby, this is John. I’ll add to a little bit what Michael’s talking about. What we really have now experienced is, we really have created systems and as we’re doing these acquisitions that you’re seeing, you’re really adding assets that are available to the systems and has that happened it created a lot of real value projects or value brought to our customers by hooking those assets up to those systems and bringing that economic value. And that is what, when Michael say we get inbounds, that’s the inbounds we’re seeing is the value that we can really bring to our customers because of interactions between those systems and those asset bases whether they’re both acquisition or added asset bases that we will do internally.

Bobby Brooks : Just the last one for me, sticking with the pipeline and I think Mike just mentioned it as well, just with the multi-basin approach. In my opinion that is a key distinguishing factor for Select is that you guys have this multi-basin asset base, so could you possibly just discuss and which basins you see organic growth as more of the focus and which basins maybe we should expect more inorganic growth and if it doesn’t differ, maybe possibly some color on why that’s the case and why it’s agnostic to basins?

Michael Skarke: Sure. So just stepping back for a minute, we want to be opportunistic, and so whether that’s organic or inorganic, we’re really open to whatever is the right solution for the customer and the most accretive answer for us. So you’ve seen us be more acquisitive around disposals than around recycling, and that’s because recycling is a newer business and we’re the largest business. And so putting organic capital to work has been much more attractive than anything inorganic. On the disposal side, we have more optionality. We’ve been able to do a number of acquisitions that have existing cash flow at or below replacement costs, and as John mentioned, we’re acquiring assets. We are networking those assets and then we’re trying to get those underwritten by customer contracts because we think they add a lot of value to that customer.

So on the disposal side, whether regardless of the basin, we’re going to be opportunistic between organic development and acquisitions. In terms of basins, we look at every basin similar. I mean, we do a full underwriting of the acreage of the customer and then we decide what makes the most sense. And so that’s why you’ve seen us make acquisitions or drill new wells in the Haynesville, but also in the Permian and everywhere else. Obviously, we’re very focused on the Permian. That’s where most of the capital’s going to be spent. That’s where the biggest water problem is. And so that’s going to be key and central for us, whether we organic or inorganic going forward, but it doesn’t preclude us from doing some of the deals we’ve done outside of the Permian either.

John Schmitz: Well, one thing I may just add on to that, Bobby, is, I mean, as Michael mentioned, I mean our general underwriting parameters are going to be consistent, whether that’s recycling or disposal or pipelines. And generally, we’re going to take that approach across the full portfolio of opportunities here and we’re starting to see the margin profiles across each of those applications of the infrastructure business become fairly normalized across the board as well as we see the margin improvement and the contribution from the recent acquisitions. So generally, that underwriting approach is going to be fairly consistent across the board, which gives us that opportunity to make the best decisions across the overall asset base.

Bobby Brooks : Understood. And I’d agree that’s definitely starting to show in the financials and congrats on the great quarter.

Operator: Our next question is from Jim Rollyson with Raymond James.

Jim Rollyson: And I’ll echo the same thing on great quarterly results. John, you’ve spent a little bit of time here lately, and you mentioned this in your prepared remarks kind of focused on some of the solids and landfill through your M&A activity. Just curious what’s your big picture thinking? Is this just tying into making Select a more one-stop shop from water sourcing, recycling disposal and now you can deal with solids as well or are there some other underlying drivers there? And should we expect any more M&A to kind of fill out the map there, like you’ve done on the disposal side?