Greetings and welcome to the Select Water Solutions Second Quarter 2023 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. Chris, you may begin.

Thank you, operator. 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 second 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 August 17, 2023. The access information for this replay was also included in yesterday's earnings release. Please note that the information reported on this call speaks only as of today, August 3, 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. Additionally, as was outlined in our earnings release, starting on June 1, 2023, the company made certain changes to its segment reporting structure. These changes were driven by several factors, which John and Nick will discuss in more detail. Changes in segment reporting have no impact on the company's historical consolidated financial position, results of operations or cash flows. However, 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 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.

Thanks, Chris. Good morning and thank you for joining us. I'm pleased to be discussing Select Water Solutions again with you today. The second quarter saw strong margin improvements, meaningful free cash flow generation and higher net income and adjusted EBITDA. Our continued focus on operation integration and improved efficiency across the business, along with the strength and resilience of our infrastructure and specialty chemistry solutions led to a 4% sequential growth in our gross profit before D&A. While we saw a modestly declining rig and completion activity environment over the course of the second quarter, we still were able to grow net income by 65% sequentially to $23 million, and increased adjusted EBITDA to $70 million, a 4% increase relative to the first quarter '23. On the cash flow side of things, I am pleased with the progress we made during the second quarter. Nick can touch on the components in a bit more detail, but our focused effort to reduce our working capital are paying off and helped deliver $102 million of cash flow from operations during the second quarter. Adjusting for the $36 million of net CapEx spend during the quarter, we were able to pull through about $66 million of free cash flow, nearly matching our adjusted EBITDA for the period. We continue to make additional strides in this working capital reduction effort, but still have a meaningful room for improvement. I expect to see more progress on reducing working capital over the back half of the year, providing a significant opportunity for generating outside -- outsized free cash flow. Strong free cash flow provides us with many attractive options for capital allocation. During the second quarter, we returned about $44 million to shareholders through dividends and buybacks, funded $36 million of net CapEx, heavily weighted…

Thank you, John, and good morning, everyone. Our focus on cash generation and operational efficiency paid off in the second quarter with a strong free cash flow yield and higher gross margins for the company. Net income and adjusted EBITDA both advanced quarter-over-quarter even as the surrounding macroenvironment softened during the quarter. Our business model meets the market's need for advanced sustainable water solutions benefited by proprietary chemistry technology and we expect to continue growing our profitability even at today's lower rig count and completions activity. Streamline our operations and investment decisions, we've pruned legacy freshwater sourcing and temporary water logistics operations from the Water Infrastructure segment, moving it into Water Services and focused our Water Infrastructure segment purely on the full water lifecycle through fixed assets. We invest in contracted water networks around our multi-basin fixed infrastructure, connected by gathering and distribution pipelines, recycling and treatment facilities, and disposal solutions. While this segment realignment doesn't impact our consolidated historical financials or represent a major overhaul of our day-to-day operations, we expect it will provide additional transparency and accountability for investors around the impact of our growth investments in Water Infrastructure. The bulk of our growth capital investments remain targeted towards this reconstituted segment with an advantageous margin profile that should grow as these investments reach their operational go live dates. As John mentioned, we made tremendous progress on cash collections during the quarter, reflected in the $102 million operating cash flow benefit to the company. This is the result of the dedicated team work across multiple Select departments to integrate our recent acquisitions, implement new technologies, and consolidate a rebranding of our various businesses into Select Water Solutions. Accounts receivable declined by $62 million during the quarter and our previous target of reducing AR by $75 million between first…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jim Rollyson, Raymond James.

Good morning, guys.

Good morning, Jim.

Great to see the progress this quarter and kind of across all the fronts on margins and cash flow generation and free cash flow generation. Kind of circling back to something you said a minute ago, Nick, on the -- we think about margins for Water Infrastructure as they are -- as we're classified now, which it looks like, you'll be able to actually show the growth, a little more isolated than maybe the way it was reported before, but we’re north of 40% margins kind of guiding obviously pretty stout growth sequentially up to 200 basis points to 400 basis points? As I think about that business when the new project start hitting late 3Q, 4Q and really impact next year, just maybe some sense of where can that low 40s-percent margin go to? I mean is that something that as these projects hit -- I know you've said margin accretive, but is that something that's in the mid-40s, in the high 40s? Just maybe some sense of how that looks and any color you might provide just on how you all are thinking about incremental revenue opportunity for that business just based on what you have already underway?

Sure, Jim. Thank you. So as we look forward on that Water Infrastructure segment, I'd like to be at a 50% run rate at some point late 2024. Now how do we get there? We announced $34 million of infrastructure projects in our last call. As you know, we like to underwrite contracted projects with a three-year payback window with additional upside potential from third parties or expansions. So you do a little bit of math there and that gives you a pretty healthy EBITDA, $10 million, $12 plus million just from those projects alone. We do expect to come back and detail some additional projects over the next quarter and into the back half of the year here, that will add to that and add to it at accretive margins of 50% or better. So that's the real growth engine here of when we look forward, taking that segment from around 40% where it is today to an exit rate of around 50% with additional optionality as we continue to expand these networks, as we continue to bring recycling, not just in the Permian but in other basins and develop many of the assets that we've acquired over the past couple of years.

And, Jim, this is Michael. Just to expand on something that Nick said in terms of timing, which was part of your question. You think -- when you think about it, when we execute a contract to underwrite an infrastructure buildout, most of our buildouts are going to take, and it varies on the project, but seven to nine months. And then once construction is complete, then you have to work through the operational and commercial issues. And that can take a little bit of time as well. And then at that point, you're going to really start to see the full run rate of that project contribution.

Kind of steady -- absent new projects, that kind of sounds like steady ramp as we go through the next few quarters. And you obviously highlighted there's still opportunity out there in Permian and elsewhere. Are we talking kind of similar size projects to what you guys have been underwriting over the last 18 months or so or are there any larger, more material projects on top of that? We've kind of been hitting singles, doubles, and obviously great margins on top of that. But just curious, as you have rebranded and people are starting to see what you guys are capable of, if there's actually any larger sized opportunities as well?

And as John mentioned, we are pretty confident that we're going to be able to deliver more projects in the back half of the year. We're getting a lot of interest, whether it's through the rebrand or just executing for our customers. We're getting a lot of interest on projects really in all basins across our footprint. They range from small deals to quite large deals, bigger than anything we've announced. I would say, the average is still kind of within the range of what we're talking about, something that looks like a $6 million to $10 million build-out. But there are definitely things that are smaller and larger. And it's my hope and expectation that we'll be deliver -- be able to deliver on both.

Fantastic. And just one last question. John, on the M&A front, you guys were busy consolidating a bunch of things at pretty attractive prices. And then you've kind of spent a good chunk of this year focused on integrating everything, overhauling the business and the rebranding efforts. Curious just what the outlook or opportunity set is for M&A as you kind of get past the integration phase, given that you guys are obviously going to be generating a lot of free cash flow and probably can't re-buy your shares, buy all your shares back forever, given your market cap today. So just curious kind of the opportunity set here over the next couple of years?

Yeah, great question. We were busy and we did put a lot of transactions together, lot of companies. But most importantly, what we've put together as a footprint with this asset base across -- really across the lower 48, but in some areas it's really number one position and the opportunity around them -- that asset base that we put together, Jim, is the opportunity we're really, really focused on. If you ask me if there's M&A, as long as it fits within that asset base and that opportunity to enhance that, if there's a way to expand or add volumes or bring something to the table that is a very good opportunity for capital both for our customers and us, we're all for it. But right now we are very focused on this infrastructure asset base that we put together because it's very unique. And to Michael's point, there is a lot of conversation, there's a lot of opportunity outside of the ones we've announced already and they are -- some of them are large in size but a lot of them are small and the small either pipelines to bring water to the asset base that we have in place or hook up the asset base to each other to become more of a network versus a singular. Some of them things are very quick paybacks. They're not 36-month paybacks and there's a large quantity of that and I would also add to, yes, the rebranding is very important, because it tells our customer base, our investors, somewhat ourselves, who we are and what we are, but really the network and the asset base we put together is really what's driving the opportunities of either just pipeline infrastructure or overlaying water recycling facilities, long-term contracts over this concentrated water position we put together now.

Yeah. Sounds like a great place to deploy capital. Great to see the progress. Thank you, guys.

Thanks, Jim.

Our next question comes from Luke Lemoine with Piper.

Hey, good morning.

Morning, Luke.

Good morning. Jim tackled the Water Infrastructure margin question. I guess in Water Services, nice margin improvement there, even with revs ticking down. And 3Q has the same outlook with revs down modestly but margins up. Can you talk about some of the operational improvements and efficiencies you're seeing and maybe where margins can go even in a flattish environment. It sounded like some of this might have been closing down unprofitable locations to continue to kind of rationalize the asset base. But any commentary you can provide on that'd be helpful.

Sure. So, just directly to hit the margins, our near-term goal for Water Services in the mid 20s with longer term in the high 20s. Really, the drivers in that is further integration. And part of that further integration is the consolidation and potentially elimination of some of the yards that are, one, not strategic to our integrated water and chemical pieces, and two, unprofitable or moderately profitable. And as we look to consolidate or rationalize that, it could have some downward pressure on revenue. But we're expecting margins to be flat or even improved by that activity. So that was -- and the other piece beyond the integration is really just operational efficiency. I mean, we're removed from COVID now, far enough. We've built back the organization to where it needs to be. And we need to really bring in the discipline that's required to execute a services business every day and get efficiency. So we're doing a number of things. One of the things that we brought on, a robust supply chain group to help us leverage the buying power across all segments. But there's a number of just everyday blocking and tackling things that we need to do better across services to hit those medium and long-term service margins. And the one final thing I would say and add to kind of improving margins is really around technology. We've been very committed to automation and implementing technology to provide a safer, more certain, and more cost-effective solution for our customers. I think we've done a pretty good job of that in some areas, but there's still a number of places that we can implement for good technology, which will drive profit to the bottom line. So those are really what we're focused on services, Luke.

Got it. Perfect. Thanks a bunch.

The next question is from Tom Curran with Seaport Global Securities.

Thank you. Good morning, guys. For Water Infrastructure, division entered this year with 15 sites online and operating. Will you provide us with a quantified estimate of how close those 15 are now to having maxed out their structural revenue generation potential through adding customers and tying in new branches? Just for those existing 15, are we at 80%, 90%? How far along are they?

So, on the site, it really comes down to individual points in time. And we can have some sites that are full out for a period of time. But that's typically not sustained. If you were to just apply a butter knife across them, I would say that we still have meaningful excess capacity. So I would say somewhere in the 50% to 60% range in terms of utilization. And those are a lot of the projects that we're working on is looking to tie in more customers so that we can leverage that capacity and to the extent that we start to bump up against capacity. Many of them are modular in nature so that we can expand that. And we have expanded and we'll continue to expand it to meet the needs of our customers in the market.

Yeah, Tom, one thing -- this is John. One thing I'd add to that is as we've been able to continue to develop this asset base and overlay these projects on top of this asset base, it's really turned into an opportunity of individual asset to a more broad-based system. And that system has a major effect on capacity increase as you think about moving water to needed places or removing water from produced places and across recycling our disposal assets. So the actual putting them together allows for capacity to increase meaningfully.

Because you're not limited by the single system utilization, so that you're able to work through kind of the highs and lows and to peak shape somewhat.

And Tom, one last thing with it, it's really becoming to develop itself really well now. But because of the systems or assets or overlaying recycling on top of large produced water volumes that we've been able to do, it's also allowed us now to think about how we go to market or how we really have a relationship between the Water Services business and the specialized chemistry business through this footprint of infrastructure. It's very different. And we think there's great opportunities, whether it's margin expansion or added services or bringing specialized chemistry into the mix.

That all makes sense. And then two more questions in the line of inquiry here on Water Infrastructure's opportunity set. I believe you had been pursuing a total of 12 projects as of your last update that you gave us. Could you update us on that number? Has it held the same, increased, have any dropped out? And then of the current total number that you're chasing, how many of those entail full lifecycle recycling facilities?

So the number is obviously fluid. Deals can come and go. And you never really know if it's going to cross the finish line until you get two signatures on a piece of paper. Generally speaking, the opportunity set, some have fallen out, but the opportunity set is increased from where it was last time. So we would be above that today. And at least half or better would be kind of full lifecycle water projects. So there’s -- that’s -- we're focused on everything around our existing footprint as it ties into the infrastructure and the water chemistry components that we've talked about from big to small. But really, what we're getting a lot of interest in is that full lifecycle solution. And again, it starts in the Permian because that's where so much of the produced water is. But we're having those conversations across our footprint.

Wow. That's not surprising, but sounds very promising. I'll return to the queue.

Thanks, Tom.

The next question is from John Daniel with Daniel Energy Partners.

Good morning. Just a few completely random questions here. I guess the first one would be if all of the projects that you're evaluating were to be realized, what type of CapEx could that look like next year?

John, certainly we hope to get better handle on that heading into next year's, kind of, budget for you. If they are all realized, it would be a number that's much larger than today or larger than 2023 certainly. We do have opportunities that are larger, as Michael mentioned, and ones that are similar to the ones we've been -- we've announced most recently. What's important to us is it will be within cash flow. So we pursue high return projects. We pursue it with knowing that Select, we control, we have care and custody over an immense volume of water nationwide. We can recycle that water. We can dispose it. We can move it across basins, across customers. Ultimately, we hope to be able to use that water in beneficial reuse. And that's really what all these projects are furthering, is that goal, that system, and the ability to drive greater economics through better connectivity. So we do have potential to expand. We also have potential to apply some of our solutions beyond oil and gas and beyond what we've traditionally done. We're going to be very thoughtful and judicious about that, of course, but a lot of exciting things on the horizon that I hope to get into more in future calls.

Got it. Now, I really what's driving the question, I’m trying to get a sense for whether you think the demand for all of your services is actually accelerating relative to growth you might have experienced in the last year or so?

Yeah, as Micheal mentioned, we have certainly more projects under discussion than we did six months ago, and that's a long-term contracted projects when we talk about those.

Hey, John. Before we get off that subject, because I don't know if it's direct to your question, but I believe it's an answer related to it. What we are finding as we build out this opportunity set in the Water Infrastructure, it adds to the ability for us to do more services and that more services could be around that actual facility as well as the interaction between the facility and the job and it is driving something different than what we had before as we develop it, John.

And the same thing would be true for the chemistry component. Really around the recycling fees, but as you put in more recycling facilities and you're managing that produced water and making it into a usable frac water again, applying Select chemistry to that, which really focuses and specializes on matching complex water with the right chemistry, there's an augment -- augmentation effect there as well. So it's services and the chemistry piece.

Fair enough. Interesting. I’ll have to follow up the line on that to learn more. On the projects are -- at this point, I know you said you're -- in all the -- in various different geographic basins, but I'm curious if you're seeing any new potential projects and new areas outside of where you presently operate?

Short answer is yes. I mean the distribution is still largely focused on the Permian, because that's where so much of the activity in the produced water is, but we are seeing in areas where we've been in the past, like the DJ as well as in new areas where we haven't -- where we don't have projects or haven't announced them. So I think you're seeing other basins continue to wrestle with some of the produced water challenges and the reuse opportunity or challenge, however you want to think about it, and kind of catch-up on that front. And so we get really excited about it, one, because it presents an infrastructure opportunity for us, really oftentimes brownfield around our existing asset base, the newly acquired asset base. But also on the chemistry side, as you start to embrace more of the reuse, there is more complex chemistry that's associated with that and that's kind of our bread and butter.

And John, typically we'll have operations in those areas, but just we may not yet have recycling facilities or major infrastructure projects in those areas but we're not looking at going to Alaska or offshore or anything here.

Yeah, I should have specified within our existing footprint.

And John, before we get off that subject because it's again, I believe it adds to your question and has a point of effect to your question. You take our position in the Haynesville Shale with what we got out of the Nuverra transaction, that pipeline system and that disposal network that we continue to hook together and add to has probably a big piece of the backlog that Michael is talking about, but there are really projects that continue to hook it together or add disposal or lay pipe to more produced water that's being hauled and it's a good backlog, but the interesting thing is the Haynesville contracted but we actually are adding to in the Haynesville right now and if Haynesville got active and it become an opportunity for recycle, we have a large quantity of water that’s centralized with the network that you can deliver back out to second [indiscernible].

Okay. Interesting. And I guess I'll go to my final question, which is admittedly a bit of a nerdy question. But when you think back to like the old water business, going back a lot of the fluid hauling trucks, I'm just curious how many trucks are running on the road today versus what you might have had four to five years ago? And then on that fleet, what's the opportunity set to maybe have CNG-powered factors or electric? That's it for me.

John and I are looking to each other on this one John.

I told you --

No, it's a great question, I haven't thought about it in a while, I mean, yeah, probably need to follow up with you to get you something that you can really sink your teeth in but when I think about it, all of the frac water was being delivered by truck back in the day.

Yeah.

So now granted the frac sizes are smaller, but that is a lot of trucks. And the pipeline infrastructure for the produced water and flowback was limited or non-existent as well. And so you've taken -- all of the frac water today is being delivered by hose or pipe. And the majority, at least in most basins, if not all is -- except for the northeast is going to be -- the flowback and produce is going to come through the pipe. So the amount of trucks that we've eliminated as an industry is substantial. And there's still a lot of trucks out there. And there's always going to be a need for them in certain aspects. But the reduction is pretty dramatic. In terms of CNG, we've looked at CNG and LNG over the years. Part of the challenge, as you're well aware of, there's the economic piece, but there's also just the logistics. And so you really have to kind of put that infrastructure in yourself at your yard to make it work and just make sure that you're really disciplined and thoughtful about your route planning.

Hey, John. Before we get off that subject, I think it's really important to be very clear. Tank trucks in the oilfield has a place and that place is still getting executed today, and they will continue to have a place. They are a service component and they all produce water in a meaningful way that's not hooked to pipe today. The other answer, and it would not be compressed natural gas answer directly to you, but we believe, Select believes, that the technology and advancement of automation and technology through the cab or through the motor of those trucks has not been advanced to the position it's going to be advanced to. And that will bring a different type of truck application as we go forward.

Fair enough. Thank you for indulging my questions this morning.

Thank you.

The next question is from Jeff Robertson with Water Tower Research.

Thank you. Good morning. Just a question, as operators continue to push where they can for longer laterals and larger completion jobs, does that present an opportunity obviously on the volume side for what you all can do for customers? But does it also present an opportunity for you to provide higher margin solutions to customers?

Yeah, this is John. I'll take it and try to answer it. Longer laterals and activities around completion, whether it's simul frac or longer laterals are more complicated water opportunities to the well site, multiple sources, recycling, automated manifolds, automated pumps, those jobs are getting very technical now. And that is a very good position for Select to be in as those jobs continue to get more technical. But because of use of water, the utilization or the efficiency that is demanded by our customer in a 24-hour period and the complexity of that. So it's a plus for us, but yes, it complicates things.

Does that play into your hand or your strength just with what Select can deliver to the customers for site management?

Yeah. It plays into Select's thesis, but it also plays into Select's history because if you look back across the last 10 years of Select Water or large quantity water fracs have developed and simul fracs has developed in pad drilling and longer lateral, the complexity of that job is what we’ve really built our technology around. So AquaView, automation, pump technology, aid sources for a big job that needs to be brought into the solution of delivery, it's really what our backbone is about.

Thanks for taking my questions.

This concludes our question-and-answer session. I would like to turn the floor back over to John Schmitz for closing comments. Please.

Thank you, operator. And thanks for everybody for joining the call today and giving us the interest in learning more about Select Water Solutions. And we definitely look forward to speaking to you again next quarter.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines and have a wonderful day.