Greetings, and welcome to Select Energy Services fourth quarter earnings conference call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris George, Vice President, Investor Relations and Treasurer. Thank you, Mr. George. You may now begin..

Thank you, Operator, and good morning, everyone. We appreciate you joining us for the Select Energy Services conference call and webcast to review our 2019 fourth quarter results. With me today are Holli Ladhani, our President and Chief Executive Officer; and Nick Swyka, Senior Vice President and Chief Financial Officer.

Before I turn the call over, 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 selectenergyservices.com. There will also be a recorded telephonic replay available until March 10, 2020.

The access information for this replay was also included in yesterday's earnings release. Please note that the information reported on this call speaks only as of today, February 25, 2020, 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 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 for the year ended December 31, 2018, our subsequent quarterly reports on Form 10-Q and our current reports on Form 8-K as well as our annual report on Form 10-K for the year ended December 31, 2019, which we expect to file this week to understand those risks, uncertainties and contingencies.

Also, please refer to our fourth quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures. And now I would like to turn the call over to our President and CEO, Holli Ladhani..

Thanks, Chris. Good morning, everyone, and thanks for joining us today. Looking back on 2019, we continue to execute on our strategy to strengthen and differentiate our position as the market leader in integrated water and chemical solutions while also delivering meaningful free cash flow.

The fourth quarter was a tough quarter for the industry from an activity standpoint, but we were able to end the year with another very strong cash flow quarter, generating over $60 million of operating cash flow and over $40 million of free cash flow. This strong finish took our free cash flow to more than $105 million for the year.

Over the course of the year, the team accomplished a tremendous amount across a number of key objectives. Before diving into the quarter, I want to take a minute to thank the team for their efforts and to recognize their accomplishments.

Specifically, during 2019, we repaid the remaining $45 million of our outstanding debt; completed our new Mexico water pipeline system, added incremental chemicals manufacturing capacity in the Permian Basin; and continued to take market share with our high-margin friction reducer products.

We divested our noncore well site services businesses for about $30 million; acquired a strategic water treatment business from Baker Hughes for $10 million; continue to invest in automation technology that differentiates our services and reduces our costs; and finally, we continue to return cash to shareholders through roughly $18 million of targeted share repurchases, all while continuing to generate and build cash on the balance sheet.

For this, I'd like to say thanks to all of our employees. Shifting to the fourth quarter. While the end of the year certainly had its challenges, we believe the intensity of these challenges was largely seasonal in nature.

Budget exhaustion began earlier for many of our customers and activity levels declined sharply over the course of the fourth quarter. Looking at third-party data on activity levels for the fourth quarter as well as our own internal tracking of pressure pumping fleet, our estimate is that completions activity was down 18% to 20%.

This clearly impacted our revenues, which declined by about 16%, with most of the decline in our water services and water infrastructure segments. The activity drop off was more pronounced with the smaller operators that have more commodity price sensitivity and generally less flexibility in regards to their capital programs.

Notably, our revenue with our top 15 customers actually remained flat quarter-over-quarter. Revenue for our Oilfield Chemical segment modestly increased, benefiting from a full quarter's contribution from the WCS acquisition.

We're still in the early stages, but we're excited about realizing the full benefits of the WCS business, both financially and strategically as it furthers our full water life cycle solutions capabilities.

Looking forward, while full year activity is expected to decline year-over-year in 2020, we've already seen activity pick up in the early part of the year, and we expect improvements across all 3 segments in the first quarter relative to the fourth quarter.

I can't say we have full visibility into 2020, but E&P CapEx forecast indicate a year-over-year percentage decline in the low teens.

The major seem to be generally indicating modestly flat to up forecast with the larger cap operators flat to down and smaller public and private operators pointing to materially lower activity levels than the average for the industry. Clearly, our industry has undergone a transformation over the last 18 months or so.

Our customers' business models and priorities have shifted away from growth towards capital discipline and free cash flow generation. This has resulted in more restrained E&P spending, but we believe it's healthy for our industry over the long term.

Select business model and balance sheet are built to adapt in this evolving landscape as our customers trust and value the expertise, the scale, the efficiency, the technology and the safety culture we deliver. There remain a number of global influences and geopolitical unknowns that could impact near-term activity levels.

And oil prices have certainly been volatile recently. But we believe that broader market supply and demand fundamentals and the secular trends behind the growing demand for water and chemical solutions in the coming years remain intact.

Even at the current forecasted levels of activity, we expect to generate meaningful cash flow, targeting $80 million to $100 million of free cash flow for 2020. Absent signals of further increases in activity levels, we'll continue to invest our capital judiciously, targeting $55 million to $70 million of net CapEx in 2020.

Having ended the year with no debt and nearly $80 million in cash on the balance sheet, we remain well positioned to navigate the potentially volatile market ahead of us.

We continue to believe we'll have opportunities to invest incremental capital and opportunistic acquisitions or growth projects, but we'll be responsive to market conditions over the course of the year and maintain capital discipline and manage our cost as market activity levels dictate.

With that, I'll hand it over to Nick to walk through our fourth quarter financial performance in more detail..

Thank you, Holli, and good morning, everyone. I'm pleased to announce that with $41 million of free cash flow in the fourth quarter, we generated $106 million of free cash flow in the year, meaningfully exceeding our target of $65 million to $80 million.

While over half of our operating cash flow during Q4 came from continued working capital improvements, for the full year 2019, only about 20% of our operating cash flow was from working capital, with the majority coming from our strong operating results.

With this operating cash flow, during Q4, we invested $21 million in net CapEx and returned nearly $5 million of capital to shareholders via buybacks and still increased our cash on hand by $36 million. Our full year net CapEx of $97 million came in modestly below our latest guidance of $100 million to $110 million and well below our initial target.

Through the year, we dynamically adjusted our spending to a changing market, focusing on opportunities we are confident could still deliver shareholders a return on investment in excess of our cost of capital. The New Mexico pipeline is a good example of this strategy. We also kept our maintenance CapEx below the 1/3 of EBITDA we generally target.

As Holli mentioned, we expect to continue to generate solid free cash flow in 2020, and believe a CapEx program of $55 million to $70 million should allow us to generate free cash flow of $80 million to $100 million in 2020. Looking at the fourth quarter, Select generated total revenue of $276 million, a decrease of 16% quarter-over-quarter.

While our Oilfield Chemicals segment demonstrated resilience in growing both revenues and margins during what was a challenging quarter for the industry, our water services and water infrastructure segments faced meaningful declines due to the significant reduction in activity levels during the quarter.

Adjusted EBITDA was impacted by the revenue decline, decreasing to $29 million, down $20 million from the third quarter, leading to a net loss of $12 million. Our focus on real-time cost reductions [indiscernible] sufficiently impact of the activity and revenue reductions.

With activity levels beginning to decline by late Q3 and the full quarter impact of previous pricing pressures being felt in Q4, the water services segment's revenues decreased 22% sequentially to $153 million in the fourth quarter from $197 million in the third.

The segment generated gross profit before depreciation and amortization of $27 million in the fourth quarter compared to $43 million in the third, reflecting a decline in segment gross margins from 22% to 17%.

While the severity of the activity drop off Q4 challenge the segment's revenue modestly more than expected, our operational leadership quickly took decisive action that when combined with our improved efficiencies from our investments in technology kept Q4 decremental margins to 38%, in line with expected levels of 35% to 40%.

We expect this segment to see improved revenues from a low to mid single-digit percentage increase in activity levels in Q1, with margins improving due to typical incrementals closer to 30%. The water infrastructure segment saw revenues decline by 18% to $52 million in the fourth quarter from $64 million in the third quarter.

Gross profit before D&A decreased from $17 million to $12 million quarter-on-quarter and gross margin before D&A decreased from 27% during the third quarter to 23% in the fourth quarter.

While this segment certainly is an immune to macro volatility, we are disappointed in the overall results during Q4 as the New Mexico pipeline starting up in late Q4 did not overcome the revenue declines we saw during the quarter from traditional water sourcing volumes.

[Technical Difficulty] we saw material increase in costs associated with our legacy GRR sourcing and logistics operations and the start-up of the New Mexico pipeline. These cost inefficiencies should be resolved over the course of the first quarter.

Looking forward, we expect this segment to improve both revenues and margins in Q1 as we get a full quarter contribution from the New Mexico pipeline and see the seasonal impacts of Q4 recover.

Revenue should increase by roughly mid single-digit percentages in the first quarter, though margins likely will not recover to the high-20s until later in the year.

Oilfield Chemicals segment continues to improve its profitability, with revenues increasing $3 million to $71 million in the fourth quarter and gross margin before D&A of 16%, a modest improvement of 40 basis points versus third quarter.

This combination of higher revenue and margins led to a gross profit before D&A of more than $11 million for the quarter, up nearly $1 million relative to the third quarter. The primary driver of the revenue growth was the full quarter contribution of the WCS business, which attributed more than $7 million in revenue during the quarter.

The WCS business was impacted by seasonality and integration and relocation costs during Q4. And we anticipate its contribution in 2020 to meaningfully exceed its Q4 run rate.

In addition to the benefit of WCS, the continued effectiveness of our proprietary products and favorable logistics with our in-basin manufacturing continues to win new customers, and we saw our legacy operations materially outperform the overall market during the quarter.

Heading into Q1, we anticipate modest single-digit percentage growth in revenue with margins holding relatively consistent to Q4. Looking at our other corporate costs. We saw a $1.3 million tax benefit during Q4.

Depreciation remained relatively flat, while SG&A decreased about 10% or $2.6 million during the quarter, meaningfully exceeding our $1 million target for the quarter.

Looking ahead into 2020, with the progress we were able to make in Q4, we anticipate that SG&A will stay relatively flat to current levels, equating to a roughly 5% decline year-over-year. That said, we will continue to evaluate further cost savings measures as market conditions necessitate.

We expect to see depreciation reduce modestly year-over-year and an effective tax rate in the low teens range. We continue to have 0 bank debt and enjoy a net cash position of $79 million as of December 31.

While Q1 is often a challenging quarter for working capital as the trajectory of revenue inverts relative to Q4, we still anticipate being able to generate solid free cash flow during the first quarter.

We continue to deploy free cash flow towards share repurchases, buying back approximately $5 million worth of shares during Q4, bringing our total capital return to shareholders via buybacks over the course of 2019 to roughly $18 million and more than $33 million over the last 5 quarters since initiating our buyback program.

We will continue to review additional shareholder return options as an ongoing part of our capital allocation strategy.

The solid cash flow generating potential of our franchise has manifested itself through positive free cash flow for 8 consecutive quarters since the Rockwater merger, and we expect that to continue through a challenging stretch in oilfield services.

While remaining opportunistic in our pursuit of high return investments, we will continue to safeguard the balance sheet and prioritize cash flow and returns on capital above all other financial metrics. With that, I'll turn it over to the operator, and we'll take your questions before Holli wraps up with some concluding remarks.

Operator?.

[Operator Instructions]. Our first question is from the line of Sean Meakim with JPMorgan..

So Holli, maybe to start, can we just talk a little bit about how you think about the operating leverage between the services segment versus infrastructure? Maybe a little of how the context of 4Q and your expectations for 1Q filter into that? I'm trying to get a sense for how we should think about that business as we see changes in volumes, how that should flow through into EBITDA margins for each of those two segments?.

Yes. I think if you step back and think about the services business, it's going to be fairly -- it's going to have a high correlation to completions activity. And once you dig beyond that, it matters which customers you're working with and what their spend levels were, so that may or may not track exactly to overall activity levels.

But as we talked about in prepared remarks, we essentially -- on the services business, we're able to protect the decrementals on that business in Q4 by managing our cost and we would expect the typical incrementals on that as we look forward into the Q1 and increased activity levels that we're seeing there. Infrastructure, it is different.

But I would say we had an odd quarter on it for Q4. And while we had solid performance in the Bakken, we frankly, underperformed in the Permian. We had some specific water sourcing customers that took a pause in Q4, and that hurt the top line. And then we just -- we didn't manage some costs well. They got the better of us on our existing operations.

Then -- and that actually impacted the margins as well. On that front, I do think the team, they understand the issues, and I think we're getting them fixed. And I'm confident we'll have that back on track. It may give a little bit of a drag in Q1.

But by Q2, I expect that to be more in line with what you would expect and not have the same level of volatility necessarily that the services business would have..

Got it. Okay. I think that feedback is helpful. I appreciate that. So given the macro environment is challenging, focusing on the things that you can control, still looks that you can generate a good amount of cash this year. M&A has always been a central part of the thesis.

Any read in terms of how the shopping list looks today in terms of the bid-ask spread for certain assets that is more attractive in the current environment? Or given how the view in North America has maybe changed for folks in about 6 to 12 months, does that give you any pause in terms of pursuing further M&A? Just curious how you think about best uses of that cash.

Nick highlighted share buybacks being a portion of it, but probably not going to be the entire amount? Just curious how you think about deploying some of that capital potentially in 2020..

Sure. I think this team has done a pretty good job over the last several years. When we think about acquisitions and it's a strength to be able to identify and then integrate these, and to your point, we have a balance sheet that positions us in a way to look at various opportunities that others probably won't. I would tell you on the services side.

And that's where organic and acquisition sort of valuations are getting relatively close versus the infrastructure side where acquisition multiples, or is there still a pretty good spread there versus what we can do organically.

So I think we're more focused on organic on that front than acquisitions, but we're certainly very aware of the opportunities. And if we find the right returns, we could be inclined to take action there. And then chemicals is probably somewhere in between.

But I think maybe the key message is we're going to be patient, and we're going to be disciplined in terms of valuation. And we'll just stay focused on the types of growth that we are going to add, help differentiate what we have to offer or can leverage our platform, frankly.

So I would say, we will absolutely be inquisitive, but at the same time, remain patient and disciplined..

Our next question comes from the line of Kurt Hallead with RBC..

Holli, I just wondered if maybe we could just delve a little bit deeper into the dynamics related to the water infrastructure and particularly, the New Mexico pipeline. I know you indicated that the management team has kind of identified the challenges and you're confident that they'll be overcome.

But in that context, what were the most specific challenges related to the cost dynamics that you think you've identified and should be able to overcome?.

I'm glad you asked the question because I maybe didn't describe that well, Kurt. The issues we had in the Permian or in our infrastructure segment were largely on our sourcing business, and they were not necessarily related to the new pipeline that we've just brought on.

On the sourcing side, what the team is laser-focused on are things around potentially some opportunities to restructure some of our supply contracts that give us a little more flexibility. We think that there are ways to improve on the logistics and the costs associated with those off of some of our water sources.

Automation being one of those potential benefits that we think can help us drive some cost out of the system. But when step back and think about the New Mexico system, we did get that online in the sort of middlish of Q4, and we're moving volumes across it. And we were obviously building off of that now in Q1.

And we're -- while we're not necessarily finding the opportunities to ink up long-term contracts, kind of a tough market to get people to sit down and think about their 3 and 5 year development programs. But we are moving volumes across that system with customers that are outside of the take-or-pay.

And given sort of the outlook for the area around our pipeline for 2020, we still feel quite good about that providing the kind of returns that we expected..

Okay. That's good color. And maybe just staying in -- on that New Mexico infrastructure and pipeline dynamics.

Just wondering if you can give us a general update on how you would -- how much volume you think you could potentially fill as the year progresses, given the fact that you mentioned as a number of customers are not really all that excited about signing long-term deals?.

Yes. And so, again, long-term is nice. You do take pricing concessions when you do long term. So right now, we are focused on 2020. And it's -- the capacity of the line, 150,000 barrels a day as we had initially scoped that out. And at this stage, in 2020, if we're half -- 50% utilization is probably a fair expectation.

And as you'll remember, the take-or-pay is -- was a 25-ish percent utilization. So that's meaning we do believe we'll be able to add meaningful third-party volumes to the pipeline..

Our next question is from the line of Tommy Moll with Stephens..

I wanted to ask 1 follow-up on the Northern Delaware pipeline progression for this year. You've kind of cleared up some of the margin noise on the legacy business.

But specifically, as you start up operations on the new pipeline, how much residual start-up costs should hit this quarter and maybe even in the second quarter? Or should we think about it as for the full year 2020, we're already kind of at the run rate in terms of the margin contribution there?.

On the pipeline itself, there's some opportunity to improve on that in the back half of the year, and it may be even sort of fourth quarter as we get some of the larger electrified pumps on to the system. Right now, we're using diesel fire, which isn't as efficient, but there are very long lead times on the electric pumps.

So that is some upside, but I think it won't have a material impact on 2020, but there would be some uplift when you start to compare 2021 back to 2020..

Okay.

But for Q1 specifically, we shouldn't expect any kind of big drag on the margin from the pipeline just due to a start up?.

No, that's correct..

Okay. Okay. And then following up on CapEx, could you break apart the budget for us into how much is maintenance versus growth? What some of the growth initiatives are? And then I just wanted to make sure we are correctly understanding when you're referencing net CapEx.

Is that range that you gave us a net CapEx range or a gross? And just to clarify the difference in those two..

Sure, Tommy. So that range is a net CapEx range, but we don't expect material divestitures or asset sales. It's just all part of an ongoing normal course of business, turning back in obsolete or equipment that we've used the lease term. As far as breaking down the CapEx, roughly half of that is going to be maintenance CapEx there.

We do have a couple of infrastructure projects in that number. Some of that is within the flexibility of the $55 million to $70 million range, but those are not on the same scale of the $40 million New Mexico pipeline.

The rest, we have an expansion of our Midland Chemicals facility and some other smaller initiatives, but I think that gives you a high level picture there..

Yes, indeed..

[Operator Instructions]. Our next question is from the line of J.B. Lowe with Citi. .

So just to clarify on the -- Holli, I think your comment that you felt 2020 on the Northern Delaware pipe you can get up to 50% utilization of the 150.

Is that something that you think you can average for the year? Or is that kind of a later back half run rate?.

I think when you get the average for the year, we should be able to achieve that..

Okay. That was easy. And then my other question was on the chemicals side. You guys have been doing really well on the FRS.

I'm just wondering, are there any kind of new products that you guys have been introducing lately or plan to introduce in 2020 that you can expand your sales look pretty good further?.

It's a good question because, frankly, the frac fluid systems evolve rapidly. And even just within our friction reducer product line, we have continued to add new products. Just depending on the water that you're dealing with, you need a different chemistry.

And frankly, that's one of the things that really does make us a better partner for a lot of folks in the basin.

In that, especially when you look at the Permian, the amount of produced water that's being used, our ability to, I'll say, customize solutions for the varying types of water that's being pumped has been a big driver in the market share gains that we've seen.

So not only does it help us from a cost perspective, but it helps us, I'll say, better service to customers and be able to take a larger share of wallet and add customers. And frankly, our manufacturing capacity, we were so highly utilized in the last 3 or 4 months of the year.

We just recently approved an expansion of our capacity in Midland on the FRS, and it will be low single-digit kind of capital that's part of what Nick was describing earlier. But it will increase our capacity by over 25%, and we expect that to be online in early Q3.

So I'm excited about the opportunities to continue to deliver new products, solve problems and grow our market share. And then the other benefit we have is WCS contributed to the top line a little bit in Q4, but obviously, integration can be a distraction. And as we expected, the -- with integration costs, we didn't see a margin improvement or impact.

But we do expect Q1 that, that business will -- new service line, essentially in business, will also add to opportunities in the chemicals segment..

Okay, great. That's good feedback. Last one for me was just the kind of the longer-term margin target on infrastructure was kind of, I think, 30%, basically more or less.

Is that something that you think you can still eventually hit? Or is there something structurally about the business that you think it's going to be capped in kind of the high-20s that you hope to get through by the end of this year?.

Yes, I think that it's certainly possible to still get to that 30s-type number. As Nick said, high-20s this year. One of the things to keep in mind is that as we continue to grow the volumes on the New Mexico system, that certainly does help us. But we'll need volumes in excess of 50% utilization to start to get to that sort of 30% mark.

But again, I think with some of the improvements and the focus that the team has, well, we do expect to still get to the high-20s as we get to the end of this year..

That concludes the question-and-answer portion of the call. I'll now turn the call back to management for any final remarks..

Sure. I'll be brief, guys. I know you all are covering a lot more at the end of the earnings season, but really the message I'd like to leave with you is that, clearly 2020, it's going to present both challenges and opportunities. But frankly, I really like the way that Select is positioned to take advantage of all the 2020 is going to have to offer.

So thanks for joining us today, and we'll talk to you again in a quarter..

Thank you. Ladies and gentlemen, thank you for your participation. This does conclude today's conference, and you may now disconnect your lines, and have a wonderful day..