Greetings, and welcome to the Select Energy Services First 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. Chris George, You may 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 first quarter results. With me today are John Schmitz, our Executive Chairman; 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 replay available until May 22nd, 2019. 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 8, 2019 and therefore time sensitive information may no longer be accurate as of the time of the replay 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 for the year ended December 31st, 2018, our subsequent quarterly report on Form 10-Q and our current reports on Form 8-K to understand those risks, uncertainties and contingencies. Also please refer to our first quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures. And now, I'd like to turn the call over to our President and CEO, Holli Ladhani.

Thanks Chris, and good morning, everyone. We appreciate you joining us today. It's been a solid start to the year with oil prices improving back to the 60s, a price range that's very supportive of our customers' capital programs. As such, we continue to be constructive on 2019 and beyond for U.S. shale development. And while capital discipline may restrain our customers from spending beyond their initial capital budgets, we're not expecting a repeat of the budget exhaustion industry dealt with at the end of 2018. Looking at the first quarter, market activities progressed as we expected. The first quarter had the inverse trajectory of Q4, with activity picking up in January off of December lows and increasing month over month through the quarter. After considering the sale of certain non-core operations, our revenues were up slightly in the first quarter. However, gross profit associated with our core businesses was up meaningfully on the back of a 250 basis point increase in margins. Looking forward, we believe we're uniquely positioned to help continue to lead the industry as it transitions toward increasingly complex, but efficient approaches to long-term field development. These trends, including the ongoing evolution and potential for closed loop water systems present opportunities for us to leverage the logistics expertise of our services business, the scale of our infrastructure capabilities and the intellectual capital of our chemical treatment and recycling businesses. To focus our efforts on these strategic objectives accordingly and with the intent of providing further transparency into our business, we've reorganized our management structure and we'll report in three operating segments going forward. Water Services, Water Infrastructure and Oilfield Chemicals. While we continue to see opportunity across all three of these segments, we're intensifying our efforts and allocation of growth capital toward developing water-related infrastructure that…

Thank you, Holli, and good morning, everyone. As Holli mentioned, the first quarter marked an acceleration of our strategic growth as a full cycle water company. We initiated the divestiture of certain Wellsite Services operations, while commencing another long-lived, high-return infrastructure investment opportunity in the Permian Basin. Beyond the first quarter realization of $16 million of proceeds from Wellsite Services divestitures, we concluded the sale of the majority of our remaining Canadian assets in April for roughly $2.5 million. We expect to receive roughly another $11 million to $15 million in proceeds from divesting the remaining Wellsite Services operations later in the second quarter. We plan to redeploy the proceeds from these divestitures and infrastructure opportunities that uniquely complement our existing footprint. We funded $33 million of net CapEx during the quarter, about $10 million of which was tied to Phase 1 of the Northern Delaware fixed infrastructure project with no associated revenue during the quarter. With today's announcement, we expect to commit a total of approximately $40 million to this project overall in 2019. During the quarter, we repaid another $20 million on our credit facility, leaving us with just $10 million of net debt as of quarter-end. Continuing to generate strong cash flow is our overriding priority regardless of market conditions. After realizing $83 million of cash inflow from accounts receivable in the fourth quarter, our working capital improvement took a pause in Q1 in part due to the improving revenue trajectory through the quarter as well as seasonal factors. We believe there is continued opportunity for working capital improvement to support our cash flow goals however, and our cash flow objective remains intact after adjusting for the incremental Northern Delaware project announcement. We continue to target $65 million to $80 million of free cash flow again after…

Thanks Nick. In conclusion, we're navigating the current environment with a capital discipline that has enabled us to simultaneously reduce net debt for multiple quarters in a row, while committing to unique large scale infrastructure projects supported by client contracts. We're positioning the Company for growth that leverages our legacy of leadership in water sourcing, the strength of our services franchise, and the entrepreneurial culture of the Company. The water landscape is changing rapidly and we believe we're well positioned to lead the industry through this transition, and in doing so, deliver shareholder returns. With our free cash flow generation and clean balance sheet, we expect our financial strength and flexibility to continue to improve. Our priority remains taking advantage of our market scale and leadership to grow and strengthen our position, while generating free cash flow with the goal of producing best-in-class shareholder returns. With that, I'll turn it back over to the operator and we'll take your questions. Operator?

Thank you [Operator Instructions]. Our first question comes from the line of Tommy Moll with Stephens. Please proceed with your question.

I wanted to start with the announcement to increase your throughput on the Northern Delaware project. If you just play this thing forward a little bit, are we likely headed for some more take-or-pay agreements or do you feel like you've got the one anchor deal and at this point you kind of want to preserve some spot exposure? Or how should we think about -- in the ideal case, how you develop that project going forward?

It's a good question, Tommy, because the extension really didn't follow our typical strategy of having it underwritten by a specific contract. But the way we looked at this opportunity is by increasing the acreage that we can access and by increasing the daily throughput capabilities of the system in an area that's clearly or debatably maybe the hottest area in the US there in the northern Delaware Basin. We think it'll generate attractive returns for us. And the basis for that, and this goes maybe a little more specifically to your question, is that given the location of the line and the delivered cost of water to that area it's going to make, we're just going to be a very economic solution for our customers regardless of whether or not we have contracts. And as we've talked about before, it's great to build a portfolio approach of having your take or pay, having your spot and then maybe having some shorter-term agreements to commercialize the line and that -- that's our objective is to have a mix of all three of those.

And as a follow up on infrastructure, I want to clarify something I heard you say with the agreements you have in place with your industrial source in New Mexico, as I do the math, there is a lot more you can draw even after you get to the 150,000 barrels per day. So if we're going to 150,000 barrels per day by the end of this year and you see good market demand going forward next year, I just want to make sure there's still, if my math is correct, that you still got a lot more capacity that you could draw from what's your existing sources. Is that right? And if yes, could you frame up what the opportunity might look like?

Yes, that's correct, Tommy. Given the sources that we have lined up and when you think about New Mexico, not only do we have our industrial sources, but we also have access to water wells and surface sources that clearly the industrial are the largest source we have. It gives us that high rate movement. Our first objective is let's get that 150,000 barrels a day of capacity utilized and then through what I would consider smaller incremental investments probably largely around storage and some things like that. That would allow us to increase the utilization of this system over time, with some incremental investments to be able to get more of our water sources to the end market.

Our next question comes from the line of Jud Bailey with Wells Fargo. Please proceed with your question.

A question regarding margins from Water Services. The margin performance in 1Q was quite good. Could you maybe give us I guess Number 1, a little bit of color on the improvement there? You touched on it a little bit in your prepared remarks, but maybe help us get a lot more insight as to what drove the margins there and then helping us think about expectations moving forward as you continue with the automation initiative, maybe helping us think about back half of the year where those margins, where you would expect those to be as if the macro picture kind of holds up.

Sure. Jud, one thing that you have to keep in mind is that Q4 was actually a lower point for us and when you think about just the typical seasonality that happens. And so, we always expect Q4 margins to be a little lower and it's because of labor cost and holidays and you end up having sometimes higher operating costs. But that said, the 26% gross margin is more in line of what we expect from this business. And it does include the benefits of continuing to drive out cost from our system because we think about there is starting to be a little bit of pricing pressure. And we did have some of that in Q1, but we were able to offset that with these other efficiencies. And so, consistent with how we've talked about it in the past, I think the high-20s is the right gross margin for you to continue to hold us accountable for that certainly what we're driving toward and think that's a spot that we should be able to get to this year.

And then moving over to Water Infrastructure. With that segment, there's a lot of different pieces in there. I was wondering if there's any way you could help us size up maybe the revenue contribution whether it's giving us any type of numbers you can read of the Bakken or GRR or you also have gathering and disposal wells. There's a lot of different I'm sure big margin picks in there as well. Is there any way you can help us think about sizing up kind of the different components there and maybe the difference in profitability?

Sure. When you think about the profitability, if you think about the sub-pieces being the starting going backwards from your question, the disposal, well, when you think about the pipeline infrastructure we've put in place and then the sourcing and the services around supporting that pipeline infrastructure. The pipelines are going to be your highest margin business. And that's because obviously you put the capital in upfront. Following that is going to be the disposal. Again, you have capital committed there. And then, your water sourcing will be of those three, the lower margin piece of the business. And keep in mind around the pipeline too, we do have support services that are around those and those are nice margin businesses as well. And when you think about the contribution, that's something that we haven't -- these are baby steps I would tell you and we're happy that we've gotten to the point that we can break out the infrastructure piece, but we hadn't planned on going into a lot of detail on the individual service lines within the segments. But just when you start to break it down between your sourcing and your pipelines and then the services to support those pipelines, that's fairly ratably divided and our disposal revenues are the smaller contributor our gathering disposal to the segment.

I appreciate that color and that's every bit of that is helpful. If I could sneak in one more just on your comment on the progression -- the margins within the buckets that you mentioned, is the disparity quite wide or is it tightly aligned around that 30% margin that you would hope to get to, like as one substantially above, one substantially below and it kind of averages out of that number, or are they all within a decent range from a basis point standpoint?

Pipelines are going to be a higher. Gross margin, again, as you've put the capital in the ground, and then the lower margin that then allows all that to average out to that 30-ish percent that we expect to get back to is going to be around your sourcing and that's just because we don't put a lot of capital to speak of upfront on that. So you get really nice returns, but it is a lower gross margin.

Our next question comes from the line of Tom Curran with FBR. Please proceed with your question.

For the Northern Delaware pipeline project, when it comes to the incremental $40 million of CapEx that will be required to expand the capacity and extend the reach, how do you expect to fund that additional CapEx? I know the first $25 million should be entirely covered by non-core assets sales. Are you also expecting perhaps greater total proceeds from those originally planned sales or perhaps divestiture of a few additional assets to also help cover a portion of that $40 million or just how should we think about the financing of that $40 million?

Sure. No material changes in our expectations with regards to the sales proceeds around the operations and Wellsite Services that we're divesting up. Still expect that to be around $30 million. To-date, we've already funded about 10 under the pipeline, so we have another 30-ish to go here. So, I think stepping back the way we look at it and obviously our cash flows are fairly fungible, but we're still in a position even after funding the entire $40 million of the project as well as the $100 million and $120 million that we've previously disclosed around maintaining our business and margin enhancement growth. That will generate free cash flow of $65 million to $80 million. So, I'd say it's sort of all in there, but we haven't specifically tagged any other meaningful asset sales other than just the ordinary course that we do throughout any year.

And Holli, would the incremental CapEx for this project be expected in any way to perhaps diminish your ongoing appetite for bolt-ons? Or should we think about the M&A effort continuing in parallel along with this incremental investment and perhaps additional future organic infrastructure investments?

Yes. On that front, since I guess maybe the best way to think about it Tom is we're economic animals. If there are good ways for us to invest the cash flow that our core businesses generate then we're going to be interested in those. And that could be organic projects like the one we announced today. It could be small bolt-on strategic fit for our organization. So we continue to look at all of those, but if it doesn't meet our investment thresholds, then we don't feel like we have to rush out. We have plenty of opportunities with our existing asset base to actually continue to grow, so that's essentially the way we're going to think about our M&A focus for the year.

And then, Nick, I'll squeeze in one more here on free cash flow. Would you update us on how much you expect working capital to contribute to this year's expected free cash flow range of at least $85 million to 100 million, and specifically remind us of what your goal or target ranges are for day sales outstanding DSOs and days payable respectively?

Sure. Tom, I think so that cash flow number you gave $85 million to $100 million was pre the second phase here that we announced today. So, I'd say let's bring that down by $15 million to $20 million, $65 million to $80 million all-in after the project announced today. So on DSOs, we did pull in $45 million in fourth quarter that was directly related to the improvement initiative out of that full number of $83 million in AR that we reduced in Q4. So this quarter, seasonally, it's a difficult quarter as you've seen for the industry. I think the monthly progression in revenue did obscure a bit of progress we made of reducing DSOs by three days on a monthly basis within our water group overall. And so, as we go forward here, so that $45 million is out of the $50 million to $75 million overall target. So I would tell you we probably have about $30 million left for this year within that full cash flow number that should come from DSO improvement, and when we talk about the DSO that's really AR reduction. Our payables we think pretty in line with peers and so it's a reduction of accounts receivable and that comes mostly from the water business.

Our next question comes from the line of Ian McPherson with Simmons. Please proceed with your question.

Thanks. Good morning. Holli, you might have answered this indirectly with Jud's question, but I wanted to maybe ask it more bluntly. I would have expected the first phase of investment with the Delaware pipeline and now the augmented scale of that to generally just be accretive to 30% target margins for infrastructure in the second half of this year. It is based on my prior notes from how you've described the take-or-pay portion. Is that too much of a leap to think that all this pipeline overall should be accretive to that 30% as we move into next year?

I think that's a fair assumption. And anytime we add these projects, they're going to have a higher -- certainly our expectation is to meet our return thresholds. They're going to have a higher gross margin than that 30%. And again, just to be clear, we expect to build out to take the better part through the third quarter. So, we'll start to get things online in the fourth quarter. So your assumption that this is a 2020 margin improvement and contribution is the right way to think about it.

And not to put the cart before the horse, but just looking at extrapolating free cash flow into next year, obviously you've made good use of capital reinvesting in the business and growing the business. But I wonder if the boardroom discussion has begun to look toward cash back optionality to shareholders as you move into next year? And if so, what those conversations have entailed with regard to the possibility maybe adding a dividend or other returns of cash?

Sure, Ian. We think about that as part of our overall portfolio of opportunity there. So the M&A, the new investments and then return of cash to shareholders, obviously we have our net debt down to a pretty low level here and we want to make sure we keep it that way. So anything we do returning cash to shareholders, we do want to have that come out of the free cash flow of the business and not something where we're really extending beyond the free cash flow. So that $16 million we did last quarter, we did a little bit this quarter but the focus obviously was more on the upcoming expansion of Northern Delaware infrastructure. But that overall option whether it's a continued share buyback or a dividend that will certainly continue to be part of the discussion. We think that's an important piece of our business and our strategy and we want to make sure that we are returning cash to shareholders as appropriate within our cash flows.

Our next question comes from the line of Martin Malloy with Johnson Rice. Please proceed with your question.

I want to ask if you could maybe talk a little bit about the post-frac initiatives that you've got ongoing, particularly around saltwater disposal wells and number that you have now and maybe comments about the permitting of saltwater disposal wells for the future.

Yes, Martin, this is John Schmitz. I'll take that one. With the re-segment, you can see that we've got to focus now on the infrastructure piece. We put a team around it. That focus both is still in pre-frac as well as post-frac. Our post frac is more organic than acquisition. We're using our knowledge base for our customers, their placement, their needs and our team to come up with the opportunity to whether to permitting new wells, putting in gathering systems, putting in agreements over the long term. Length and developing the post-frac side of the business through the infrastructure we got today. So more organic, but using the footprint, we we segmented to show that we can put a team around this asset and this effort and grow it from here.

And then on the Northern Delaware project, you mentioned it's coming online late this year. Can you talk about the ramp-up time associated with that? Does it take a quarter or two?

It does to some extent to get to the full efficiency. I mean obviously, the pipeline capacity will be there, but just the operations of a system of that size, you do have somewhat of a ramp up associated with it. So while we expect contributions in the fourth quarter, we don't expect sort of the more than full run rate type contribution until we get into 2020.

Ladies and gentlemen, this concludes our question-and-answer portion of the call. I will now turn the call back to Holli Ladhani for final comments.

Thanks. Just want to close with a couple of key takeaways, maybe first around cash flow. As Nick mentioned, even with the typical seasonality and the build and working capital that we saw, we did manage to generate a small amount of free cash flow and reduce our net debt to $10 million, so we're very happy with where our balance sheet sits. And then, I want to emphasize that we do expect our ongoing businesses to generate the cash flow of $65 million to $80 million, so that's before our proceeds from the sale of Wellsite Services and that's after funding the Northern Delaware project. So I feel very good about how the strategy and the business model and our ability to generate cash flow is playing out. And while 2019 is going to be -- continues to be fluid and we don't necessarily have a road map to the back half of the year, we do think we're well positioned. And so, we're going to continue to focus on essentially four things and that's operational execution. It's around identifying the right sort of growth investment opportunities that come with the right returns. It's around delivering that free cash flow and then just as Nick hit on making sure that we're disciplined about how we allocate that cash flow. So again, thanks for joining us today.

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