ARIS - NYSE

Greetings, and welcome to the Aris Water Solutions First 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, David Tuerff, Senior Vice President, Finance and Investor Relations. Thank you. You may begin.

Good morning, and welcome to the Aris Water Solutions first quarter 2023 earnings conference call. I am joined today by our President and CEO, Amanda Brock, our Founder and Executive Chairman, Bill

Thank you, David, and thanks, everyone, for joining us this morning. Aris is off to a strong start in 2023. From a market perspective, we have seen activity levels consistent with our expectations of steady volumetric growth so far this year. And as we look forward, some of our customers have indicated publicly that they are forecasting additional production to be online in the back half of 2023 and early 2024. While commodity prices continue to fluctuate, we have not seen any material impact to our customers' activity levels or our water volumes. We believe this is reflective of the strength of our primary large contracted operators who have made long-term commitments to the Permian Basin and continue to invest as planned through the commodity price cycles. The industry's need for high-capacity water handling with the flexibility to deliver high rates of recycled produced water continues to expand. We are fortunate that our primary areas of operation are located in some of the best acreage in the Permian Basin, which has supported the consistent growth of our produced water volumes since inception, including our 23% volume growth in 2022. While we will continue to grow alongside current and new customers by investing in our infrastructure to support their growth, capital efficiency and shareholder returns remain core priorities as we evaluate opportunities. Coming out of the challenging second half of 2022, we have focused on improving internal business processes, driving operational efficiencies and cost reduction initiatives. While there is still more progress to be made, we are beginning to see tangible impacts to the bottom line and are pleased with our performance going into the second quarter. We are also encouraged that our proprietary treatment processes have potential applications outside of the oil and gas industry. I'm proud of our team's execution thus far in 2023 and our prospects for the rest of the year. With that, I'll turn it over to Amanda.

Thank you, Bill. We are pleased with our improved operating results and positive progress in the first quarter. Our continued focus on driving operational efficiencies and improving internal business processes has already delivered substantial improvements, particularly in skim oil recovery and working capital. The cost savings initiatives we referenced in our first quarter earnings call, including electrification of field infrastructure and reducing rentals are proceeding as planned and are expected to deliver meaningful incremental margins in the second half of the year. For the quarter, we grew our total water volumes by 5% and adjusted EBITDA by 6%. In our produced water business, as customer volumes came in higher than forecasted, we saw volumetric growth of 3% as compared to the fourth quarter of 2022, averaging 971,000 barrels per day. We also saw the benefit of significantly higher skim oil recoveries in the quarter, which were the result of operational changes we made, which drove incremental skim oil capture, and as a result, recovered volumes that we believe were not captured in the fourth quarter of 2022. Going forward, however, we believe we can consistently increase skim oil yields by at least 10% as compared to 2022. Our water recycling and sourcing business grew sequentially by 11% in the first quarter as we sold 405,000 barrels per day. This growth was benefited by some pull forward of demand as a portion of water scheduled to be sold in the second quarter was sold in the first quarter due to operator changes in contracted completion schedules. The Permian Basin, like other areas continues to be impacted by the effects of unprecedented inflation in 2022. While the rate of inflation has tempered in 2023, we have not yet seen prices materially decrease. As a result, we continue to be extremely focused on our cost reduction initiatives and identifying additional opportunities to reduce costs over the remaining course of the year. Our project to convert booster pumps from diesel to permanent power is tracking well. We have nine locations scheduled to be completed by the end of the second quarter and another 10 scheduled to be completed in the second half of the year. As we mentioned last quarter, we are working closely with our regulated power provider in New Mexico to try and maintain the timelines they provided us to connect our newer reuse facilities to line power. These conversions to permanent power should deliver annual savings of approximately $4.4 million once complete. Similarly, our project to replace rental pumps at numerous locations with company-owned assets is progressing well with one location complete, equipment deliveries for three more sites scheduled in May and the remaining four locations expected to be off rental equipment in the second half of the year. We still expect the annual cost savings for this project to be approximately $3.2 million. From an organic growth perspective, we continue to work closely with our contracted customers to expand our system and capacity to accommodate their development plans. We also continue to focus on incremental growth and are evaluating numerous opportunities. However, we will be selective as it relates to executing new contracts as we focus on capital efficiency and underwriting new transactions to ensure accretive growth. We are pleased with the progress we've made on our beneficial reuse pilot project with Chevron, ConocoPhillips and ExxonMobil. As we previously indicated, the purpose of this pivotal pilot is to identify, evaluate and develop proprietary treatment processes to support cost-effective beneficial reuse of treated produced water outside of the oil and gas industry and support water sustainability in the Permian Basin. Following a detailed evaluation process, the pilot team has selected thermal and membrane desalination technologies for field testing with a full pilot phase expected to be completed in the first half of 2024. Contemporaneously with our pilot studies, we are also actively evaluating and identifying potential avenues to collaborate and partner with various companies in the chemical, agricultural, fertilizer hydrogen and power sectors who can potentially utilize treated produced water or minerals and trained in the [indiscernible]. We are also pleased to announce that after a detailed review, Aris has been selected as one of only four finalists in the water reuse project of the Year at the Global Water Intelligence 2023 Global Water Awards in Berlin in May. This recognizes Aris' accomplishments to date and water conservation as a result of our water reuse efforts in the energy industry. \ In conclusion, we finished the quarter with positive momentum carrying into the second quarter, and I'm very pleased with the team's execution and performance in the first quarter against the plan we laid out. And with that, I'll turn it over to Steve to discuss our financial results for the quarter.

Thank you, Amanda. We recorded adjusted EBITDA for the first quarter of $38.1 million, up 6% from both the first quarter of 2022 and sequentially from the fourth quarter of 2022. The sequential increase was largely due to our produced water and Water Solutions volume growth as well as approximately $2 million of skim oil revenue above expectations. We also realized $675,000 of lower G&A expense relative to our plan as some spending was reduced or delayed until later in the year. For capital expenditures, we incurred approximately $48 million for the quarter, in line with our expectations and guidance. Looking ahead to the second quarter, we expect produced water volumes to average approximately one million barrels per day, reflecting continued growth consistent with our outlook for the year. We are also forecasting skim oil recoveries of 0.10% of produced water inlet volumes at an average realized price of $68 per barrel. For the Water Solutions business, we expect volumes of 365,000 to 375,000 barrels of water per day for the quarter and expect to recycle approximately 25% of inlet produced water volumes. On the cost side, well maintenance expense is forecasted to be approximately $1.5 million higher relative to the first quarter, which is part of the annual increase we highlighted on our last earnings call. We also expect G&A expense to be approximately $500,000 higher than the first quarter, largely due to ongoing accounting improvements and increased headcount. Taken together, we are forecasting adjusted EBITDA of $35 million to $37 million for the second quarter as compared to first quarter guidance of $33 million to $35 million, which would imply a 6% increase at the midpoint, excluding one-time benefits we saw in the first quarter. We also forecast capital expenditures to total between $55 million and $65 million, consistent with our full-year capital plan of $140 million to $155 million, which, as we noted last quarter, is weighted towards the first half of the year. Turning to our balance sheet. We ended the quarter with a debt to adjusted EBITDA ratio of 2.7x and approximately $159 million available under our credit facility. We have increased our focus on improving working capital and have made meaningful progress in reducing our accounts receivable balance by $27 million or 21% from year-end 2022, while growing revenue 11% sequentially. Finally, we recently announced our seventh consecutive dividend of $0.09 per share, which will be paid June 29th to shareholders of record as of June 16th. Now looking forward, we recognized the importance of free cash flow and return of capital to shareholders. We continue to grow our business volumes and see additional opportunities for expansion. While it is still too early to provide a formal outlook for 2024, based on our current outlook, we are focused on achieving a free cash flow inflection point in 2024 and providing an update to our shareholder return framework to supplement our high-return organic growth opportunities. With that, I'll turn it over to Amanda to wrap up.

Thanks, Steve. We are proud of the Aris team's performance in the first quarter. We are optimistic for the rest of the year. But notwithstanding the first quarter's improvement, we still have work to do, and we are going to remain focused on reducing our operating costs, enhancing capital efficiency and selectively pursuing additional growth opportunities where we feel we can invest capital at attractive returns. We are also going to continue to work towards improving our operating margins and where possible, increased pricing in our shorter revenue cycle businesses. While it's premature to make changes to our full-year guidance, our successful start to the year gives us further confidence in meeting our financial targets. With that, we'll take questions.

Thank you. We will now conduct a question-and-answer session. [Operator Instructions] Our first question comes from Spiro Dounis with Citi. Please proceed.

Thanks, operator. Good morning, team.

Good morning.

Good morning. So Amanda, you had mentioned trying to find some new initiatives to reduce costs beyond what you've laid out so far. Just wondering can you maybe provide some examples of what you're evaluating there? And if you think these – maybe this next tranche of cost savings could be as large as what you're doing this year?

We see the next tranche of – sorry, good morning, Spiro. Thanks for your question. But launching right into the answer, we see the next sort of tranche of cost savings being more incremental. As we've indicated, the electrification process and the cost savings associated with that initiative and with reducing rentals gives us a much larger impact to margins. We are still looking at chemicals. We are still looking at our personnel costs. We are still looking at the construction of our facilities and how we change some of the materials that we use to lower cost, but all of those are going to be incremental and will continue over time to just bring in incremental savings.

Got it. That's great. Second one, just around CapEx. I think as we look for the remainder of the year, it implies a pretty sizable step down in the second half of 2023. And I guess I'm just curious, is that a good run rate as we think about 2024, it sounds like you're obviously still evaluating growth initiatives here? And so I'm just trying to get a good sense for what's the more normalized sort of growth CapEx level.

Well, we said before on CapEx is that throughout the year, high yield CapEx, comes in quarter-to-quarter is very lumpy. This year, we've been very clear that it is front-end loaded, which will result in revenue in 2024. Obviously, it is too early. We are looking at 2024. Our hope is that, that CapEx obviously continues to come down, and we are evaluating additional growth opportunities. We are growing with our customers. But last year, it was back-end loaded this year it is front-end loaded. Steve, would you like to add anything to that?

No, I think you're right, Amanda, that we're going to grow alongside the industry. So while we see sustained levels of completion activity from our customers, we're going to see the capital program play out the way it is this year. It is too early to say where we're going to land next year. But we did see the deceleration going into the second half of the year playing out based on the current outlook.

Got it. That makes sense. That's all I had today guys. Thanks for your time.

Thank you.

Thank you.

[Operator Instructions] Our next question comes from Samantha Hoh with Evercore. Please proceed.

Hey guys. Thanks for taking my question and congrats on a really nice quarter. You know, I wanted to maybe spend a little bit of time on this awards that you won in – or that you’re a finalist for in Berlin. I don't realize that, that would be an opportunity in terms of like water reuse in Europe, especially since most of your work here is using produced water, but I was just wondering if there's an opportunity there then to apply the process or technologies that you're developing in the Permian to maybe applications in Europe?

Good morning, Samantha. Thanks for the question. The Global Water awards are pretty much the premier awards in the world, and they have their ceremony actually tonight where they choose between the four. We were very surprised that we were chosen, particularly that this has produced water in the energy industry. And this was an award that is in Europe. We believe it gives us a lot of exposure to people who may have technologies that we want to see whether or not we can apply them for the cost-effective treatment of produced water for beneficial reuse. But in terms of, do we have technologies that we can apply international, yes, we believe we do, but that is not anything that we are looking at, at this time. We are very focused domestically. We've got a lot of work to do here. But it's a great complement. I mean we – I shouldn't say we don't expect to win, but when you're up against a wildlife park in Singapore and a massive project in Australia, we're just happy out of hundreds of applicants to be on that list.

Yes. No, congratulations. It's really nice to see water have more of a global solution sort of being applied here. I guess my other question has to do with just how you're able to keep growing at such a low like people intensity. I think we spoke offline about just how you're just not as intensive in terms of like headcount weighted basis. Is there a level at which like you will need to scale up more on the people side? Or how do you think about having like training for appeal hands and just sort of like what your needs are here based on like what your outlook for growth is and how you're managing through the whole labor shortage, inflationary like all those very strong macro fundamentals that are going on in the U.S. here?

Samantha, good question. As Steve said in his comments, you will see in Q2 that we will have some additional head count. We are looking at this all the time. We run very lean. We have also talked in past quarters about our automation efforts – and those efforts are to reduce labor across a large geographic area with lots of driving and with facilities that are not necessarily co-located. So we continue to look at the allocation of labor. We are very focused on training, but we do understand the cost associated with that, but we are going to operate efficiently. So as we increase the number of facilities as we continue to add volumes, you will see us add labor, but it will be a very managed process.

Yes. We've spent a lot of capital on automation. And remember, this is a big infrastructure business. So it's – we're putting capital in rather than adding headcount in a lot of places and that we will see the benefits of some of that as we grow spreading that – those fixed costs layer greater volumes.

Excellent. That’s it for me. Thank guys.

Thank you.

Thank you. Our next question comes from Wade Suki with Capital One. Please proceed.

Good morning, everyone and thank you for taking my question. I wanted to see if you all might be able to give us a little bit more color on working capital. You had a nice release there. Accounts receivable did decline quarter-to-quarter. And really more in the context, second half guidance outlook and really in the context of free cash, I mean could we see free cash inflection points, maybe a little earlier than expected? Thank you.

Thanks, Wade. And Steve is very happy you asked that question. So I'm going to defer Steve.

Thanks. Good morning, Wade. I think as you just heard Bill talk about the automation and investments that we've made on the operations side. What we have on the back office side is ripe for automation and so that's some of the expense that you see this year and evaluating our accounting systems, and we have added some resources to drive a greater focus on efficiency of working capital. So we're very pleased with what we saw this quarter. We expect to see incremental improvements over the course of the year. And then we are looking to replace our accounting ERP package over the next six to 12 months, which is going to drive further automation. So I don't expect a step change similar to what we saw in Q1 to repeat itself, but we will expect to see further incremental improvements quarter-over-quarter.

Wonderful. Thank you. And just switching gears a little bit. You all spent some time last quarter talking about the M&A market. I'm wondering if you could maybe give us an update on what you're seeing out here right now. That's all I've got. Thank you.

Wade we did – obviously, we see a lot of opportunities out there. But as we previously indicated, we're always going to be disciplined. We're not going to put the balance sheet at risk. If we see something that we like, it's got to be accretive. It's also going to make sense to us strategically and geographically where we think we bring synergies to a particular opportunity. So that being said, if we see something that fits all those criteria will take a hard look, but I'll let Bill add to this because he has pretty strong opinions on this. And as you've seen our track record, we have been very disciplined.

Well, I think – I mean, we continue to believe that accretive growth makes sense, and we will do it opportunistically where we find a fit and Amanda hit really our key criteria, which is we are going to protect our balance sheet. We need to see a really strong strategic fit to the business with some synergies going forward, and it needs to be accretive. And obviously, our stock hasn't performed as well as we like and the relative valuations. The private sellers are struggling a little bit with what they think their businesses are worth. And hopefully, there's a meeting of the minds over the course of the next year, and we find opportunities that make sense for us to take advantage of. If not, we're happy and we can continue to grow organically at the same time.

Wonderful. Thank again, and great quarter guys.

Thank you.

The next question comes from Selman Akyol with Stifel. Please proceed.

Thank you. Good morning. I guess following up on that last question. Is there any update on the integration of Delaware Energy Services? And then I have one more after that as well. Thank you.

Good morning, Selman. We're on track with the Delaware upgrade. And as we indicated last quarter, workovers and repairing some of those assets, all of those initiatives are on track. So we expect to be able to achieve our targeted incremental run rate EBITDA in the second half of 2023.

Got it. And then also, you talked several times about accretive growth, looking at new contracts. I'm wondering maybe could you just talk a little bit about the activity you're seeing in and around your assets as well as what the pricing is out there right now? What the pricing environment is? And that does it for me. Thanks.

Certainly. And yes, accretive growth is obviously very, very important, particularly in this environment. And we are seeing steady activity. As Bill said in his opening comments, notwithstanding sort of price fluctuations. What we are seeing is steady growth from our primary customers, our primary customers being Chevron, Mewbourne, Conoco, Oxy, everybody with more of a long-term view. And we've been looking at the forecast and relooking at our forecast, and we are just seeing growth that is consistent with what we laid out for 2024. Mewbourne has had some accelerated growth. They obviously got a lot of rigs out there. So we are seeing consistent growth from our customers in and around our assets. We are also seeing activity in new areas that are proving to be very promising for operators adjacent to our assets. So I think you will just continue to see this growth in 2023 and beyond.

Thank you.

Thank you. At this time, there are no further questions in queue. I would like to turn the call back over to management for closing comments.

Thank you. So thank you very much for joining us today. We've had a strong quarter. We look forward to coming back and talking again at the end of second quarter. We also want to thank all of our shareholders and stakeholders, including our customers and most importantly, our sort of dedicated employees who have been working very hard to continue to make the improvements that we talked about today. So thank you very much and talk to you at the end of second quarter.