Aris Water Solutions Q4 2023 Earnings Call Transcript

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Provided by Quartr
February 29, 2024

There are 11 speakers on the call.

Operator

Greetings and welcome to the ARRIS Water Solutions Q4 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Turf, Senior Vice President of Finance and Investor Relations.

Operator

Thank you, David. You may begin.

Speaker 1

Good morning, and welcome to the ARRIS Water Solutions 4th quarter 2023 earnings conference call. I am joined today by our President and CEO, Amanda Brock our Founder and Executive Chairman, Bill Zartler and our CFO, Stephen Thompson. Before we begin, I'd like to remind you that in this call and the related presentation, we will make forward looking statements regarding our current beliefs, plans and expectations, which are not guarantees of future performance

Speaker 2

and are subject to a number

Speaker 1

of known and unknown risks and uncertainties and other factors that could cause actual results to differ materially from results and events contemplated by such forward looking statements. You are cautioned not to place undue reliance on forward looking statements. Please refer to the risk factors and other cautionary statements included in our filings made from time to time with the Securities and Exchange Commission. I would also like to point out that our investor presentation and today's conference call will contain discussion of non GAAP financial measures, which we believe are useful in evaluating our performance. These supplemental measures should not be considered in isolation or as a substitute for financial measures prepared in accordance with U.

Speaker 1

S. GAAP. Reconciliations to the most directly comparable GAAP measures are included in our earnings release and the appendix of today's accompanying presentation. I'll now turn the call over to our Founder and Executive Chairman, Bill Zartler.

Speaker 3

Thank you, David. 2023 was a fantastic year for the Harris business. We focused on fundamental execution, which improved profitability, reduced working capital and improved our operational flexibility while continuing to grow the business. Volumes were up 16% for the year and we recaptured margins which had been eroded by inflation and cost challenges driven by our rapid growth in late 2022. Strategically, we have remained disciplined in our approach to capital allocation, growing organically under long term contractual agreements while selectively evaluating and closing new agreements in an improving pricing environment.

Speaker 3

There is greater demand for water infrastructure in the Northern Delaware Basin than there are existing assets, and we have the opportunity to participate in further growth at attractive rates of return. Inorganically, we've maintained similar discipline with a continued focus on strategic fit and accretion across all metrics in both the short and long term. Our conservative balance sheet and ample liquidity give us the flexibility to invest when the timing and economics are most compelling. Looking to 2024, we're excited about the business and our opportunity set. We will benefit from our prior capital investments and anticipate being able to better leverage the system to improve capital efficiency going forward.

Speaker 3

Combined with continued operational and commercial improvements, we anticipate sustained positive free cash flow for the year, which will improve our options for capital allocation, which can include increasing our shareholder returns. Our team is focused on continuing execution we demonstrated in 2023, operating safely and reliably for our employees and customers while enhancing water sustainability in the Permian Basin. With that, I'll turn it over to Amanda.

Speaker 4

Thank you, Bill. I'd like to start off by echoing Bill's comments. We had an outstanding year delivering great results quarter over quarter and we entered 2024 with significant positive momentum. I want to recognize the tremendous efforts of the ARRIS team who worked extremely hard and performed consistently above expectations, I'm immensely proud of our collective achievements. At the outset of 2023, we said we would improve profitability while continuing our rapid pace of growth and infrastructure expansion.

Speaker 4

While there is still work to do, we exceeded our annual goal expanding margins by more than 10% and improving operational and financial efficiency. We maintained a strong rate of growth. We increased produced water volumes 19% and water solutions volumes 9% year over year, which combined with our expanded margins, culminated in adjusted EBITDA of $175,000,000 up 17% for the year and exceeding the upper end of our guidance range. In our produced water business, we averaged 1,100,000 barrels per day for the 4th quarter, ahead of our expectations and continued our sequential growth for the 9th consecutive quarter. As we've previously discussed, we have allocated additional resources to skim oil recovery and averaged approximately 13 60 barrels per day in the 4th quarter, ahead of expectations due primarily to higher volumes from flowbacks and operational improvements.

Speaker 4

Our large scale infrastructure and proven ability to deliver treated water in large quantities again allowed us to win additional spot business driving higher than anticipated water solutions volumes in the 4th quarter. As we've previously seen, the Water Solutions business can be lumpy and higher water volumes in the 4th quarter were also a function of a pull forward of activity originally scheduled for the Q1 of 2024. As operators limit their use of groundwater, the growth of produced water recycling in the Permian Basin has been unprecedented. Our water recycling and sourcing business sold 482,000 barrels of water per day or over 44,000,000 barrels in the 4th quarter alone, growing 5% sequentially and 32% year over year. We are extremely proud of this growth and our success in managing costs and logistics while optimizing the use of our infrastructure and enhancing water sustainability in the Permian Basin.

Speaker 4

Over the course of 2023, we reduced rental equipment and diesel fuel expenses by converting facilities to permanent electrified infrastructure. We reduced these costs by approximately $7,600,000 on an annualized basis, exceeding the target we set at the beginning of the year. We have additional facilities identified for conversion and believe that we can capture further electrification savings in 2024. In terms of revenue, the largest of our annual CPI escalations took effect at the beginning of Q3 and combined with the success of our electrification projects and rental expense reductions drove significant margin expansion of $0.05 per barrel since our cost peaked in the middle of 2022. We've also made a lot of progress in the field piloting technologies for the treatment of produced water for beneficial reuse.

Speaker 4

The results have been promising and a lot of lessons learned as we focus on costs and treatment technologies that can operate consistently at scale. Working with our industry partners, ConocoPhillips, Chevron and ExxonMobil, we will be piloting and evaluating 2 additional desalination technologies and will also be evaluating the commercial viability of mineral extraction from our produced water. We look forward to updating you next quarter. Looking ahead to 2024, we continue to work closely with our customers to be their partner of choice delivering safe, reliable and sustainable water infrastructure solutions. Volumetrically, as the basin matures and our customers' pace of growth moderates, we anticipate our own water volume growth will more closely growth in the Northern Delaware Basin, with year over year volumes expected to be up approximately 2% to 5% after adjusting for prior asset divestitures.

Speaker 4

In addition to the sustainable growth rate, we expect to benefit from improved profitability from the positive momentum on margins coming out of last year, additional operating cost reductions in chemicals, filtration and waste disposal, as well as further contractual revenue escalation. With considerable investment to date in our infrastructure and greater operational visibility and flexibility through our control room and automation efficiencies, we also anticipate being able to more fully leverage our existing assets this year, which should allow us to bring our capital spending down by approximately 40% versus 2023. Steve will expand on the details, but sustainable volume growth, our anticipated continued expansion of operating margins and significantly reduced capital spending sets up 2024 as a pivotal year for ARRIS as we anticipate sustained positive free cash flow. Our compelling outlook for this year is a testament to our keen focus on margins and the hard work and consistent results of our team delivered in 'twenty three, and we're excited by our continued momentum into the Q1 of 2024. With that, I'll turn it over to Steve to discuss our financial results for the quarter and detail on our outlook for 2024.

Speaker 5

Thank you, Amanda. We recorded adjusted EBITDA for the 4th quarter of $49,300,000 up 37% from the Q4 of 2022 and up 10% sequentially from the Q3 of 2023, again exceeding expectations for the quarter. The sequential increase was largely due to additional short cycle commercial wins and some pull forward of activity in water solutions, higher than anticipated skim oil recoveries and lower G and A costs. For the full year, adjusted EBITDA of $175,000,000 was above the high end of our original guidance. For capital expenditures, we incurred approximately $20,000,000 in the quarter, bringing us to $156,000,000 for the year, and improvements delivered an almost 41% decrease in net working capital and a period which saw revenue grow more than 22%, driving a $43,000,000 working capital benefit.

Speaker 5

Taken together, our operational performance, lower capital investment and working capital improvements delivered $14,000,000 in positive free cash flow in 2023. Looking ahead for the year 2024, we expect produced water volume to be between 1.020000001.07000000 barrels of water per day, up approximately 2% to 5% year over year when adjusted for the impact of our Martin County asset sale completed in the Q3 of last year. We're forecasting skim oil recoveries of approximately 1300 barrels of oil per day at an average WTI price of $76 per barrel and as a reminder, each $1 change in oil price relative to expectations would correspond to a change of $475,000 in EBITDA per year. For the Water Solutions business, we expect 1st quarter volumes to average 325,000 to 345,000 barrels per day and expect full year volumes of between 430,000,470,000 barrels per day, approximately flat year over year, which corresponds with currently forecasted Permian Basin rig and frac crew counts. As we've seen in the past couple of years, Water Solutions volumes generally ramp up throughout the year as operator capital budgets are refreshed and wells are drilled in the first half of the year with flowback activity rate escalations, we forecast margins between 40 inflation based rate escalations, we forecast margins between $0.42 $0.44 per barrel for the year, which represents a 10% increase at the midpoint relative to 2023.

Speaker 5

Given the outlook from our customers and continued operational improvements, we are forecasting adjusted EBITDA of $180,000,000 to $200,000,000 for 2024 increasing 9% versus 2023 at the midpoint. Alongside a moderating growth outlook from our customers and our ability to drive further capital efficiencies, we anticipate capital expenditures to total between $85,000,000 $105,000,000 for the year, including $12,000,000 to $16,000,000 of maintenance and system optimization capital, an approximately 40% reduction versus 2023. The higher end of the range includes potential business development projects under evaluation, which could deliver incremental earnings in 2025 and beyond. For the Q1, we anticipate $30,000,000 to $35,000,000 of capital expenditures as our spending is expected to be weighted towards the first half of the year. With continued earnings growth and significantly reduced capital expenditures, we anticipate 2024 to deliver a clear and sustained free cash flow inflection point for ARRIS.

Speaker 5

We anticipate generating free cash flow of $45,000,000 to $65,000,000 for the year, which will give us the optionality to evaluate greater shareholder returns through either dividend growth or share repurchases. Turning to our balance sheet, we ended the quarter with a healthy debt to adjusted EBITDA of 2.4 times, below the low end of our long term leverage target and $330,000,000 of available liquidity, which provides us with significant financial flexibility. Finally, for the Q1 of 2024, we declared our 10th consecutive dividend of $0.09 per share to be paid March 21 to shareholders of record as of March 7. With that, I'll turn it over to Amanda to wrap up.

Speaker 4

Thanks, Steve. To close, I want to again highlight the success of 2023, our consistent execution across the year and the momentum it provides us looking forward into 2024. We've made great progress and our business today is more efficient, more profitable and more predictable, which is evident in our 2020 3 results. We are not done. In 2024, we will continue to identify new opportunities for growth, execute on additional cost reductions and margin expansion and further leverage our existing assets to deliver increased value from our business.

Speaker 4

Our reduced capital spending will allow us to achieve greater free cash flow and provide us the opportunity to increase shareholder returns. With that, we are happy to take questions.

Operator

Thank you. We will now be conducting a question and answer session. Thank you. Our first question comes from the line of Spiro Yonis with Citi. Please proceed with your question.

Speaker 2

Pat on for Spiro. Just starting off, how would you stack the priority for excess cash flow here given your under your leverage target and where would M and A fall on that?

Speaker 4

Good morning, Spiro, and thanks for the questions. In terms of priorities, we're thinking about everything. So in terms of sort of responding as to what we're going to do, I think it's early. We have those conversations all the time. Obviously, there's the buybacks, there's the dividend, there's the paying down debt.

Speaker 4

We are going to continue to evaluate that and just expect to be talking to everybody about that later in the quarter sorry, later in the year.

Speaker 2

Okay, makes sense. And I guess just kind of thinking about 'twenty three was a year of execution for you and you've largely met those goals. How are you thinking about what the focus will be for 2024?

Speaker 4

We're going to continue to be very focused, Biro, on execution. We still see opportunity for margin expansion in our core business, working with our customers and also looking at other opportunities that may be there as it relates to our beneficial reuse, mineral extraction. But I think we're just going to continue to have our heads down and execute and feel very optimistic about 2024.

Speaker 2

Okay, makes sense. Thanks for the time.

Speaker 4

Thanks, Biro.

Speaker 6

Sequentially, but with upside to be better. Is that upside, could that come from a carry forward from a better 4th quarter? And understanding that there is a seasonality factor here, it seems as though the Q1 is higher than the full year guide. Could you give us your thoughts on how volume trend throughout the year?

Speaker 4

Thanks, Jackie, and thanks for the question. Great question. I'm going to let Steve take that and to explain how we see this as back end weighted.

Speaker 5

Yes. And Jackie, I think when you look at some of the public commentary from some of our larger customers, they've indicated some of the volume profile they expect throughout the year. And so a lot of that flows into our own internal forecasts. When we provide our outlooks here, we do get about 6 month notice from our customers. We have very good line of sight in the first half of the year and we do start working further out beyond that.

Speaker 5

But when we're providing guidance around the volumetric outlook, we're very deliberate around what we put out based on what we know and what we're confident in. So as we move through the year, we'll see where our customers come out with refined volumes. There could be upside from greater activity as we get to the back half of the year.

Speaker 6

Great. That makes sense. And then just on margins, you mentioned further margin improvement for 2024. And you mentioned that there may be further efficiency initiatives on the cost side. What specifically are those initiatives for 2024?

Speaker 6

And in that context, when you look at better margin guidance for the year, is that what's driving the higher outlook here or fees also doing some of that work?

Speaker 4

So when we look at our operations, we are constantly looking to places that we can drive costs down. So when I think about 2024 working with the team, we're going to be very focused on the reuse area, chemicals across the system, labor productivity, also very focused on waste and filtration and what we can do to reduce costs in those areas. We will have some continued electrification, which will continue to drive costs down. So Jackie, it's really a combination of things looking across our entire portfolio and being very deliberate as we sort of manage our costs and identify opportunities for efficiency. In terms of margins but we from those

Speaker 2

set rates, as you

Speaker 4

know from but we from those set rates, as you know from our contracts, we have the revenue reset with CPI. And we have CPI really that comes across the year with 2 big adjustments at the end of March, at the end of Q2 actually Q3 and then in January. So it's a function of rates and margin.

Speaker 6

Great. Thank you so much and congrats again.

Speaker 4

Thank you.

Operator

Thank you. Our next question comes from the line of Eli Housum with JPMorgan. Please proceed with your question.

Speaker 7

Hey, good morning, everyone. So just wanted to circle back to the free cash flow deployment. So you alluded to potentially increasing shareholder returns. Should we expect a dividend raise in 2024? Otherwise, what color can you add for those potential to increase shareholder returns?

Speaker 7

Thanks.

Speaker 5

Yes. Good morning. Thanks for joining us. As you saw in the press release and in our financial statements, our leverage is very low relative to our target. So no need to allocate capital to further debt reduction at this time.

Speaker 5

So that leads you to either dividends or share repurchases. Now repurchases would exacerbate some of the issues we see from the low float that's out there. But when you step back, we're a far cry from where we think the intrinsic value of our stock is. So there's some compelling value when we look at potential repurchases. So dividends, repurchases or a combination of both are on the table.

Speaker 5

We're working through that. And as Amanda said, we'll be back to you guys here later in the year.

Speaker 7

Okay. I look forward to that. And then maybe just as a follow-up. In the release, you also touched on your recent divestiture of non core assets that kind of allows for a capital redeployment into higher return organic projects. Maybe just a little bit more color on what those types of projects might look like?

Speaker 4

Certainly. I mean, we're seeing a lot of projects right now, particularly in our core salmon and Northern Lee County area. These are just going to be additional projects working with our customers where we expand our system to capture additional volumes at very attractive

Speaker 8

rates. Okay. Thanks again, guys.

Speaker 4

Thank you.

Operator

Thank you. Our next question comes from the line of Don Crist with Johnson Rice. Please proceed with your question.

Speaker 9

Good morning, Amanda and team. You made big strides on connecting your facilities to the grid last year. Can you remind us where you are in that process? Are you over halfway in connecting everything to the grid now? And what kind of savings do you expect this year from those efforts?

Speaker 4

Good morning, Don. We are more than halfway. And as we told you, Steve is going to have the exact numbers for you. Yes.

Speaker 5

Hey, Don. When we originally announced that we had 19 locations we were going to connect, at this point we've got 16 of those done. But we do have 2 additional facilities we've added to the list. So there's 5 remaining out of that 21. And at this point, we're mostly waiting on Xcel, the regulated utility to get there.

Speaker 5

So we're in the queue, but we're at their mercy a little bit when we've made significant progress. On the recycling facilities, we do have another 2 locations there. So well over the halfway mark, but we'll see some incremental margin improvement this year from those.

Speaker 4

As you know, Don, we indicated that we hope to achieve 7 point 5 savings by actually connecting all of those systems and we finished the year with more to go and actually $7,600,000 in savings.

Speaker 9

Yes, it's great progress. And Amanda, if you'll indulge me just a little bit, from where I sit, I'm asked a lot about OFS consolidation and M and A in the light of E and P consolidation. And my answer to investors are the water industry in general, especially in the Permian is kind of right for M and A given the large amount of private equity on that side of the business. From where you sit, not saying that you're going to do a lot of M and A, but from where do you sit, do you see that industry as right for consolidation as we kind of move through 'twenty four and into 'twenty five?

Speaker 4

Great question, Don. I'm going to let Bill answer that because we're having this conversation all the time.

Speaker 3

Yes. I mean, Don, the market is fairly fragmented. There's a couple of us larger players out there. But the fragmented players do and will need to be consolidated. I think that our focus has really been on making sure that what we do is truly accretive to our business.

Speaker 3

We have such great long term contracts and customers that it's hard to evaluate those in light of where we're valued today and using our equity The challenges around the Delaware Basin versus the Midland Basin and landowners and their ability to extract value in these complex systems or at least integrated systems makes it more challenging. But we are in the middle and constantly evaluating all of the opportunities

Speaker 9

Thanks, Don.

Speaker 4

Thanks,

Operator

Don. Thank you. Our next question comes from the line of Selman Alkove with Stifel. Please proceed with your question.

Speaker 10

Thank you. Good morning all. So I just want to start with in your opening comments, you talked about how higher spot volumes were helpful. And so maybe you could just talk about what really drove that? And then as well as we're 2 months into the Q1, how you saw that cadence progress as we moved into the New Year?

Speaker 4

Yes. So, we mentioned the higher spot volumes. We were able to bring those in. And what we've talked about is when there is availability on our system going out to our customers and bringing volumes in on an interruptible basis, that's as it relates to disposal. What we were really referring to is bringing in additional water solutions business.

Speaker 4

That's a much shorter cycle business. And you're looking constantly for opportunities where somebody may need additional water for completions. And so in Q4, we mentioned bringing in some volumes from Q1 'twenty four and also being able to sort of win additional business. It's just very fluid and we are well positioned with geographic reach and the number of recycling locations we have to actually win additional spot business.

Speaker 10

Understood. Thank you for that. And then also I think you referenced sort of 1360 barrels of skim oil and then your guidance is 1300. And so is that just conservatism because if you expect volumes to ramp across your system, wouldn't we naturally expect that to move higher as well?

Speaker 4

So, it's a level of looking at what we tend to get over time. When we mentioned the 10 36 skim oil barrels, we also indicated that it seemed to be higher as a consequence of flow back. We also had some benefit of price. And so we do see some lumpiness in those skim volumes. So we are just estimating that over the year, we will sort of have steady state at that 1300 barrels a day.

Speaker 10

Got it. Thank you so much.

Operator

Thank you. Our next question comes from the line of John Daniel with Daniel Energy. Please proceed with your question.

Speaker 8

Thank you. Good morning, guys. Amanda, this might be a rookie question and it is a bit of a long term one. But when you think about how important water recycling is to your customers, their ESG goals and perhaps high switching costs, I'm not sure if that's right or not, but I would think so. How will that ultimately influence pricing strategy as contracts mature years down the road?

Speaker 8

It seems like pricing could have a bias higher over time.

Speaker 4

John, I don't think you've ever had a rookie question, but good question. So yes, the relationships we have with our customers and as a consequence of the physical infrastructure we have and the volumes we aggregate in order to deliver these large quantities of water to our customers as they need more and more with these multiple fracs, the relationships are very sticky. I think as contracts roll off and as there is more demand in the basin for reuse versus groundwater, for example, I do think that there will be pricing power. We will also see some pricing power and rate increase over time in our disposal business as volumes just over the basin continue to increase.

Speaker 8

Got it. Okay. Thank you. And then when I look at the customer list you guys have, which is a very good one, And many of those are the people that are viewed as the likely consolidators. I know in some of the dumb iron oil service businesses, and that's a term of endearment, but those types of companies will switch to their incumbent providers pretty quickly because of service and reliability.

Speaker 8

I'm curious like what happens when a big company A bus, big company B, your customer, they've got a different water infrastructure partner? How quickly do they want change? Do they change? Just any thoughts on that would be helpful to me.

Speaker 4

Let me answer sort of from a legal perspective first. Our contracts, which are long term contracts with our customers, are sort of covenants running with the land. So what that means is even if they sell or consolidate, they will still have that contract in effect. So, we have contractual support. But Bill, why don't you respond to that?

Speaker 4

We've seen that

Speaker 3

happen with Concho rolling into Conoco. And relationship already and continue to get more business from Conoco along the way. And so the takeaway piece of this and the infrastructure required is this is a midstream business. These are long term contracts. But in order to facilitate the oilfield service part of this, if you will, the water recycling that's in high demand, you have to have the infrastructure in place to be able to deliver and control those volumes, which we do under those contracts.

Speaker 3

And so the stickiness is around the infrastructure and its ability to perform more than it is the relationship per se. And so I think that the buffer ponds are there, the pumps are there, the massive amounts of their water plus other people's water that we can blend and treat and redeliver for these big fracs is just impossible to replicate.

Speaker 8

Fair enough. Okay. Thank you for indulging me again, guys. I appreciate it.

Operator

Thank you. There are no further questions at this time. I'd like to pass the floor back over to Amanda Brock for closing remarks.

Speaker 4

Thank you very much. First of all, I want to thank everybody who called in and our customers who we continue to work with very closely and appreciate. We had a great year in 2023 and we are continuing to push hard into 20 24 because our work is not done. So with that, I want to especially thank our employees who worked so hard to deliver the great year we had in 'twenty three and provided us with this positive momentum into 2024. So we look forward to talking to you all again later in the year.

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