Greetings and welcome to the Select Energy Services Third Quarter 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, Senior Vice President, Corporate Development, Investor Relations and Sustainability. Thank you, Chris. You may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us for the Select Energy conference call and webcast to review our financial and operating results for the third quarter of 2022. With me today are John Schmitz, our Founder, Chairman, President and CEO; 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 selectenergy.com. There will also be a recorded telephonic replay available until November 17, 2022. 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, November 3, 2022, 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, our current reports on Form 8-K, as well as our quarterly reports on Form 10-Q to understand those risks, uncertainties and contingencies. Also, please refer to our earnings announcement released yesterday for reconciliations of non-GAAP financial measures. With that, 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 excited to be discussing Select Energy again with you today. The third quarter's results combined with our recent acquisitions display our continued ability to execute on our core strategies of improving and bolstering our base business, advancing our technology, sustainability and diversification efforts and executing on strategic M&A. The third quarter saw strong sequential revenue growth, increasing 12% quarter-over-quarter with all segments showing solid improvements during the quarter. Our Water Service segment saw quarterly revenues approach pre-pandemic peak levels with gross margins increasing to 23%. Meanwhile, our Infrastructure segment achieved record quarterly revenues and our Chemical segment achieved record high margins. Reinforced by steady activity levels, a challenging labor market and a tight equipment supply environment, we continue to capture market share and see pricing improvements across each of our segments. Combined, these factors led to a strong 70% growth in net income and 32% growth in adjusted EBITDA. On the back of these strong financial improvements, I'm also pleased to have announced the acquisitions of Breakwater Energy Partners and the strategic infrastructure assets from Cypress Environmental Services, both of which closed this week. Select has a long and successful track record in M&A, and I continue to believe that consolidation remains an important way to drive efficiencies and further create value within our industry and more importantly, for the Select shareholders. Both of these acquisitions fit us extremely well and provide strategic growth opportunities at very attractive entry points. With these acquisitions, we are also bringing on skilled and experienced leadership and their strong operating teams who we are excited to partner with going forward. With Breakwater, we are acquiring one of the market leaders in advanced water recycling infrastructure, disposal and logistics solutions. Breakwater has broad capabilities…

Thank you, John, and good morning, everyone. The third quarter exceeded our expectations from both a revenue and margin perspective. And with the acquisition of Breakwater along with the Cypress infrastructure assets, we're poised to continue this momentum. Revenue of $375 million grew by 12%, or $39 million and 59% of this revenue increase fell through to higher gross profits. All three of our segments increased their gross margins from second to third quarter, resulting in our highest quarterly net income and adjusted EBITDA since the third quarter of 2018. Net income increased by 70% to $24.7 million and adjusted EBITDA by 32% to $62.8 million. Site volatility in commodity markets and in the daily headlines, our customers are in the strongest financial position they've been in years, and demand for secure and dependable oil and gas production from the United States continues to grow. As we partnered with our customers to produce natural resources in a safe, cost efficient, and environmentally friendly manner. We've also demonstrated the value of total flex -- unique ability to connect chemistry with full lifecycle water management and share in the value this partnership creates. Produced water recycling is a prime example of this value creation, and the Breakwater acquisition brings a substantial growth opportunity with a large footprint of new fixed recycling infrastructure in the Midland Basin. Along with consolidating certain Texas and New Mexico Water Logistics Services, this infrastructure network furthers our goal to increase contracted and production levered revenue streams and enhances our established commitment to growing our recycled produced water volumes. While we were already well on pace this year to exceed our 2022 target of 31 million barrels of recycled produced water through our six facilities, the Breakwater acquisition with its current 600,000 barrel per day recycling capacity provides…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first questions come from the line of John Daniel with Daniel Energy Partners. Please proceed with your questions.

Hey, guys. Congrats on the two deals. Probably it might be a silly question, but when you look at Breakwater with the 600.6 (ph) million barrels a day of capacity today, and you note the permits for another 1.4. Can you just walk me through the process to develop that capacity, the time required to develop it and the cost? Just incremental color would be helpful.

Sure, John. So this is Michael Skarke. So the permitting process, Breakwater has been very diligent and to permit commercial recycling facilities, once you have kind of a track record in the permitting process and you do it the right way, it can be done in short as three or four months. But initially, permits could easily take six months or more to just get them permitted. The construction is really going to depend on the size and the type of treatment being applied. But you're -- if I'm booking it on the low end, you're going to be -- if everything goes smoothly, you have the equipment, you're moving quickly. You could get it done in four or five months. And on the longer end, I would say it's going to be not 12, but probably close to nine months. One of the big problems is just commercializing it. So you're not going to put forth typically a large amount of capital for a project that's not underwritten and at least partially commercialized with the ability to expand beyond that. And so that's where the additional lead time could come into play. One thing I would note is I think Breakwater did a great job of going ahead and permitting this and setting up recycling facilities and storage, but they really didn't have the capital. And this was true with the other transactions that we've closed in the last 18 months that there was asset -- the assets were underutilized and they didn't have the growth capital to expand. And so we're really looking forward to working with them, understanding their pipeline, comparing it with our backlog and key customer relationships to see how we can develop out these systems and really fully commercialize it.

Okay. All right. Got it. And then just the transactions here, largely Permian, Bakken, can we talk about what are some of the other M&A opportunities might be in other basins? Is that how -- are you actively looking today or is this keeping you pretty busy with these two deals?

Yeah, John. This is John Schmitz. I would tell you that we know the market. I mean, we're actively in the market at all times. We try to stay as in tuned to the market as we can. As you've seen in the past, we remain open to business in this kind of transactions. And we believe there is still more opportunity across the United States in these unconventionals to do water and chemical solutions in these kind of transactions where we're adding asset base that really fits with our asset base, assets that need capital to really commercialize them. We're in a position that you can put contracts and long term relationships around them, efficiencies and value to the customer. So we're active, still John, and we believe there's more.

Fair enough. Okay. And then the last one, just a housekeeping. Nick, I think you said the net CapEx for '22 is $45 million to $50 million.

That's correct.

I heard that correctly. I mean just a framework for next year, just given that your growth through acquisition, what that might look like potentially?

Yes. Obviously, we'll have more detail on our next call with the whole budget, but I think we can go into some of the factors here. So as we acquire more assets as activity increases, that's going to naturally take your maintenance CapEx up a little bit. So right now, we're seeing $40 million to $50 million as a ballpark range for next year. We'll be adding to that some targeted growth opportunities not only around the previously announced acquisitions, but as we get our hands around the Breakwater and Cypress yields and understand the great opportunities there. You will have fewer asset sales than we had in the year-to-date period so far. But as far as the growth investment, really, our third quarter infrastructure performance reflected putting a lot of money or the money to work on our previous acquisitions. And I think the infrastructure group has a healthy trajectory in front of it, not just from those, but on an ongoing targeted capital light basis here.

Okay. That's a good starting point. Thank you very much for letting me asking questions.

Thank you, John.

Thank you. Our next questions come from the line of Tom Curran with Seaport Research Partners. Please proceed with your questions.

Good morning. Nick, I think this quarter's big working capital build that consumed $54 million as CFO and then the related step down in cash on the balance sheet to just $13 million has spurred some consternation following on the heels of your regular dividend introduction. Obviously, as usual, at this point, in an OFS up-cycle, Select's need to build working capital is a very high quality positive challenge. But could you expound on how exactly you expect to reverse working capital flow in 4Q? What specific levers are you planning to pull for it to become a source of CFO in 4Q? And then how do you expect to constrain it as you move through 2023?

Sure, Tom. So these are high quality customers. We work for the biggest majors, large independents and very high quality, smaller independent and private equity backed customers as well. So as you're well aware, we've had a number of integrations recently. I'm going to try not to get too deep into the weeds here, but we're also upgrading various ERP systems into one consistent ERP across the whole company. Right now, we have three. So each of those, you're operating separate groups, billing customers from different historical accounts, and that just provides a little bit of confusion and need to integrate teams and processes and accounts going forward. So we're disappointed by the working capital build in the third quarter, but we do see great opportunity not just in the fourth quarter to turn that around. But in 2023 to deliver substantial positive free cash flow. We've been focused on these recent acquisitions to a large extent recently. We will have some working capital needs as it relates to that revenue that we're bringing on. However, we think for the entire company, we have a large opportunity here going forward to unlock that. You saw in our liquidity number that was up $25 million that we are very well capitalized. We are still net cash positive, no bank debt. And so all those things provide us with a lot of opportunity here.

And as your team has had the chance to dig into the receivables that you've inherited via the acquisitions, are there any that have seen an increase in the risk profile where you've seen an increase in the possibility of not being able to collect to the extent you thought or potentially having to create a reserve?

No, Tom, no surprises. Our reserve is very conservative or it is appropriate for our ongoing business and our ongoing revenue. There are no surprises in any of these acquisitions. It's just getting everything connected on the same wire and pulling those in.

Got it. And then exiting 2Q of your seven existing recycling facilities, I believe six were still at utilization levels of less than 50%, could you update us on how those six progress over 3Q and where their utilization rates stand now?

Sure. So Tom, this is Michael. When we look at the fixed facility recycling facilities we have, all of them, this was the first quarter where we had all of them contributing for a full quarter. So we're certainly trending in the right direction from that standpoint. And as I look at Q4, I think we're going to continue to commercialize, particularly the newer facilities and see utilization continue. As I think about kind of your more specific question, I'd say about a third of the utilization for Q3 was higher across the board than it was for Q2, but half of our facilities are still really new and emerging and underutilized. So we have the ability to continue to commercialize really all of them, but at least half, I would consider only utilized today.

Thanks for that, Michael. And then last one for me. Could you just clarify, did you enter into the negotiations with the Cypress creditors while it was still going through Chapter 11 restructuring? And did you close -- I just don't know if it's actually emerged yet. So could you just share a bit of color on how you actually pursued and seize on that opportunity?

Yeah, Tom. This is John Schmitz. We did have conversations prior to the transaction that did happen, which I believe was an out-of-court restructuring, but we actually did the transaction with the group that bought the whole Cypress, they were wanting the pipe inspection business out of it, and we were wanting the disposal assets that we ended up getting. So we actually bought it from party that participated in restructuring the company.

Got it. Thanks for that additional color, John. I’ll turn it back.

Thank you.

Mr. Schmitz, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

You bet. Thanks, everybody for talking about Select today and look forward to the next quarter. And again, welcome all the employees of the transaction as the team members. Thank you.

Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation and have a great day.