ARIS WATER SOLUTIONS, INC. You should read the following discussion of our historical performance, financial condition and prospects in conjunction with our unaudited condensed consolidated financial statements, and notes thereto, as of and for the three months endedMarch 31, 2023 , included elsewhere in this report, as well as our 2022 Annual Report, which includes disclosures regarding our critical accounting policies as part of "Management's Discussion and Analysis of Financial Condition and Results of Operations." The information provided below supplements, but does not form part of, our historical financial statements. This discussion includes forward-looking statements that are based on the views and beliefs of our management, as well as assumptions and estimates made by our management. Actual results could differ materially from such forward-looking statements because of various risk factors, including those that may not be in the control of management. See Cautionary Note Regarding Forward-Looking Statements.
Business Overview
We are a leading, growth-oriented environmental infrastructure and solutions company that directly helps our customers reduce their water and carbon footprints. We deliver full-cycle water handling and recycling solutions that increase the sustainability of energy company operations. Our integrated pipelines and related infrastructure create long-term value by delivering high-capacity, comprehensive produced water management, recycling and supply solutions to operators in the core areas of thePermian Basin .
First Quarter 2023 Results
Significant financial and operating highlights for the three months ended
? Total water volumes handled or sold of 1,376 thousand barrels of water per day
("kbwpd"), an increase of 18% as compared with the first quarter of 2022
Recycled produced water volumes sold of 258 kbwpd, a decrease of 5% as compared
? with the first quarter of 2022 and groundwater volumes sold of 147 kbwpd, an
increase of 123% as compared with the first quarter of 2022.
? Total revenue of
quarter of 2022
? Net income of
first quarter of 2022
? Adjusted EBITDA (non-GAAP financial measure) of
6% as compared with the first quarter of 2022
Dividend paid on our Class A common stock for the first quarter of 2023 of
?
holders of
For additional information regarding our non-GAAP financial measures, see Non-GAAP Financial Measures below.
Beneficial Reuse Strategic Agreement
InJanuary 2023 , Exxon Mobil Corporation ("ExxonMobil") joined our strategic agreement withChevron U.S.A. Inc. ("Chevron U.S.A. ") and ConocoPhillips to develop and pilot technologies and processes to treat produced water for potential beneficial reuse opportunities. Our goal under the strategic agreement is to develop cost effective and scalable methods of treating produced water to create a potential water source for industrial, commercial, and non-consumptive agricultural purposes. Aris is leading the engineering, construction, and 22
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execution of the testing protocols and pilot projects while leveraging the combined technical expertise ofChevron U.S.A. , ConocoPhillips, and ExxonMobil. The treated water will then be reused in a variety of ongoing research projects, including non-consumptive agriculture, low emission hydrogen production, and the direct air capture of atmospheric carbon dioxide. Aris,Chevron U.S.A. , ConocoPhillips, and ExxonMobil are working with appropriate regulators, with a goal to complete testing and performance evaluation of pilot technologies by the end of 2023. General Trends and Outlook Market Dynamics The current conflict betweenRussia andUkraine continues to have significant global economic implications and impacts on financial markets and the energy industry. The extent of these impacts will depend on the length of the conflict and whether the conflict spreads beyondUkraine's borders. In addition, commodity prices are being impacted by multiple factors such as supply disruptions and current recessionary concerns. During the three months endedMarch 31, 2023 , the average West Texas Intermediate ("WTI") crude oil spot price was$75.93 as compared with$95.18 for the three months endedMarch 31, 2022 .
Commodity prices will also continue to depend on the responses of the
We believe there are several industry trends that continue to provide meaningful support for future growth. Our key customers' capital allocation to thePermian Basin remains consistent and significant, including on acreage where the water sourcing and production is dedicated to us. Additionally, operators continue to average longer horizontal lateral lengths which corresponds to increased water sourcing and produced water handling volumes. Many industry trends such as simultaneous multi-well operations and reuse applications of produced water, particularly in the areas of thePermian Basin where we operate, are improving efficiencies and returns and provide us with significant opportunities for both our Produced Water Handling and Water Solutions businesses.
Cost Inflation
During 2021, theU.S. began experiencing increased wage and price inflation, as evidenced by increases in the Consumer Price Index ("CPI"). Although the current rate of consumer inflation has eased, core inflation remains high. The degree of inflation, and length of time it continues, will be impacted by any further steps theU.S. Federal Reserve Bank takes to combat inflationary pressures, such as by continuing to adjust interest rates. During the first quarter of 2023, as compared with the first quarter of 2022, our revenue growth was partially offset by inflationary pressure on costs. Our long-term, fee-based produced water handling contracts are generally subject to annual CPI based adjustments. However, many of our contractual CPI based adjustments are capped at a maximum annual increase and, therefore, our costs may increase more rapidly than the fees that we charge to customers pursuant to our contracts with them. If inflation in the CPI were to remain significantly higher than our contractually allowed fee increases, we could continue to experience negative impacts to our operating margins. 23 Table of Contents Seismicity We operate wells located in Seismic Response Areas ("SRA") inNew Mexico andTexas , one of which is partially curtailed. Due to the integrated nature of our pipeline network and our system-wide redundancy, we have been able to adapt to regulator responses to seismic activity, while continuing to provide service to our customers without significant disruption in our operations. In addition, although we cannot anticipate with any certainty future regulatory actions and the effect such actions could have on our business, our compliance with state regulator seismic response actions to date has not resulted in any significant volumetric, revenue or cash flow decreases.
Results of Operations
Results of operations were as follows for the periods indicated:
(in thousands) Three Months Ended March 31,
2023 2022 2023 vs. 2022
Revenue
Produced Water Handling $ 46,100 $ 35,100 $ 11,000 31%
Produced Water Handling-Affiliate 23,140 21,081 2,059 10%
Water Solutions 13,882 11,644 2,238 19%
Water Solutions-Affiliate 7,984 3,144 4,840 154%
Other Revenue 465 - 465 N/M
Total Revenue 91,571 70,969 20,602 29%
Cost of Revenue
Direct Operating Costs 43,845 26,671 17,174 64%
Depreciation, Amortization and Accretion 18,606 16,579 2,027 12%
Total Cost of Revenue 62,451 43,250 19,201 44%
Operating Costs and Expenses
General and Administrative 11,799 10,711 1,088 10%
Impairment of Long-Lived Assets - 15,597 (15,597) N/M
Research and Development Expense 408 19 389 2047%
Other Operating (Income) Expense 217 1,064 (847) (80)%
Total Operating Expenses 12,424 27,391 (14,967) (55)%
Operating Income 16,696 328 16,368 4990%
Interest Expense, Net 7,661 7,785 (124) (2)%
Income (Loss) Before Income Taxes 9,035 (7,457) 16,492 (221)%
Income Tax Expense (Benefit) 1,327 (840) 2,167 (258)%
Net Income (Loss) $ 7,708 $ (6,617) $ 14,325 (216)%
N/M Not Meaningful
Operating Metrics
The amount of revenue we generate primarily depends on the volumes of water which we handle for, sell to, or transfer for our customers.
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Our volumes were as follows for the periods indicated:
Three Months Ended
March 31,
2023 2022 2023 vs. 2022
(thousands of barrels of water per day)
Produced Water Handling Volumes 971 803 168 21%
Water Solutions Volumes
Recycled Produced Water Volumes Sold 258 273 (15) (5)%
Groundwater Volumes Sold 147 66 81 123%
Groundwater Volumes Transferred (1) - 25 (25) (100)%
Total Water Solutions Volumes 405 364 41 11%
Total Water Volumes 1,376 1,167 209 18%
Per Barrel Operating Metrics (2)
Produced Water Handling Revenue/Barrel $ 0.79 $ 0.78 $ 0.01 1%
Water Solutions Revenue/Barrel $ 0.60 $ 0.45 $ 0.15 33%
Revenue/Barrel of Total Volumes $ 0.74 $ 0.68 $ 0.06 9%
Direct Operating Costs/Barrel $ 0.35 $ 0.25 $ 0.10 40%
Gross Margin/Barrel $ 0.24 $ 0.26 $
(0.02) (8)%
Adjusted Operating Margin/Barrel (3)
(1) The groundwater transfer assets were sold in the first quarter of 2022.
(2) Per barrel operating metrics are calculated independently. Therefore, the sum
of individual amounts may not equal the total presented.
(3) See Non-GAAP Financial Measures below.
Our skim oil volumes recovered were as follows for the periods indicated:
Three Months Ended
March 31,
2023 2022 2023 vs. 2022
Skim Oil Volumes (bpd) 1,348 833 515 62%Skim Oil Volumes/Produced Water Handling Volumes 0.14% 0.10%
0.04% 40%
Skim Oil Sales Revenue/Barrel of Skim Oil (1)
(1) Skim oil price received from the purchaser is net of certain customary
deductions.
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Revenues
An analysis of revenues is as follows:
Produced Water Handling Revenues
Total produced water handling revenues and produced water handling revenues per barrel are as follows:
Three Months Ended
(in thousands, except per unit amounts)
2023 2022
Produced Water Handling Fees $ 60,924 $ 49,894
Skim Oil Sales Revenue 8,316 6,287
Total Produced Water Handling Revenue
Produced Water Handling Fees/Bbl
0.09 0.09
Total Produced Water Handling Revenue/Bbl
Produced water handling revenues for the three months ended
? an increase of
activity associated with our long-term acreage dedication agreements, and
an increase of
? on the system and higher skim oil recoveries per barrel of produced water
received, offset by a reduction in average crude oil prices.
Water Solutions Revenue
Water solutions revenues for the three months ended
an increase of
? groundwater volumes sold, offset by a 25 kbwpd decrease in groundwater volumes
transferred, and
? an increase of
volumes sold constituting a larger portion of overall water solutions volumes.
Expenses
An analysis of expenses is as follows:
Direct Operating Costs
Direct operating costs for the three months endedMarch 31, 2023 as compared with the three months endedMarch 31, 2022 increased due to higher volumes as well as cost inflation in labor, chemical treatment, rental equipment and fuel expenses. On a per barrel basis, direct operating costs increased for the three months endedMarch 31, 2023 as compared with the three months endedMarch 31, 2022 due to cost inflation in labor, chemical treatment, rental equipment and fuel expenses. 26 Table of Contents
Depreciation, Amortization and Accretion Expenses
Depreciation, amortization and accretion expense for the three months endedMarch 31, 2023 as compared with the three months endedMarch 31, 2022 increased due primarily to higher amortization expense related to a previously acquired customer contract recorded as an intangible asset, as well as depreciation expense related to new assets placed in service.
General and Administrative Expenses
General and administrative ("G&A") expenses for the three months ended
Impairment Expense
See Item 1. Financial Statements - Note 4. Property, Plant and Equipment.
Loss on Asset Disposal and Other
See Item 1. Financial Statements - Note 4. Property, Plant and Equipment.
Interest Expense, Net
Components of interest expense, net are as follows for the periods indicated:
Three Months Ended
(in thousands) March 31,
2023 2022
Interest on Debt Instruments $ 8,561 $ 7,812
Amortization of Debt Issuance Costs 610 610
Total Interest Expense 9,171 8,422
Less: Amounts Capitalized (1,510) (637)
Interest Expense, Net $ 7,661 $ 7,785
Interest expense, net for the three months ended March 31, 2023 remained flat as
compared with the three months ended March 31, 2022 . An increase in total
interest expense due to Credit Facility borrowings was offset by an increase in
capitalized interest related primarily to the increase in assets under
construction.
The average outstanding debt balance for the three months ended March 31, 2023
was $446 million compared with $400 million for the thee months ended March
31,
2022.
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Non-GAAP Financial Measures
Adjusted EBITDA, Adjusted Operating Margin and Adjusted Operating Margin Per
Barrel are supplemental non-GAAP measures that we use to evaluate current, past
and expected future performance. Although these non-GAAP financial measures are
important factors in assessing our operating results and cash flows, they should
not be considered in isolation or as a substitute for net income or gross margin
or any other measures prepared under GAAP.
We believe this presentation is used by investors and professional research
analysts for the valuation, comparison, rating, and investment recommendations
of companies within our industry. Additionally, we use this information for
comparative purposes within our industry. Adjusted EBITDA, Adjusted Operating
Margin and Adjusted Operating Margin per Barrel are not measures of financial
performance under GAAP and should not be considered as measures of liquidity or
as alternatives to net income or gross margin. Adjusted EBITDA, Adjusted
Operating Margin and Adjusted Operating Margin per Barrel as defined by us may
not be comparable to similarly titled measures used by other companies and
should be considered in conjunction with net income and other measures prepared
in accordance with GAAP, such as gross margin, operating income or cash flows
from operating activities.
Adjusted EBITDA
We use Adjusted EBITDA as a performance measure to assess the ability of our assets to generate sufficient cash to pay interest costs, support indebtedness and, at the discretion of our Board of Directors, return capital to equity holders. We also use Adjusted EBITDA as a performance measure under our short-term incentive plan. We define Adjusted EBITDA as net income (loss) plus: interest expense? income taxes? depreciation, amortization and accretion expense? abandoned well costs, asset impairment and abandoned project charges? losses on the sale of assets? transaction costs; research and development expense; loss on debt modification; stock-based compensation expense; and other non-recurring or unusual expenses or charges (such as temporary power costs and severance costs), less any gains on sale of assets. For the fourth quarter of 2022, we began including research and development expense in our calculation of Adjusted EBITDA due to our new beneficial reuse pilot projects, which are discreet, non-revenue initiatives.
Adjusted Operating Margin and Adjusted Operating Margin per Barrel
Our Adjusted Operating Margin and Adjusted Operating Margin per Barrel are
dependent upon the volume of produced water we gather and handle, the volume of
recycled water and groundwater we sell and transfer, the fees we charge for such
services, and the recurring operating expenses we incur to perform such
services. We define Adjusted Operating Margin as Gross Margin plus depreciation,
amortization and accretion. We define Adjusted Operating Margin per Barrel as
Adjusted Operating Margin divided by total volumes handled, sold or transferred.
Adjusted Operating Margin and Adjusted Operating Margin per Barrel are non-GAAP
financial measures.
We seek to maximize our Adjusted Operating Margin in part by minimizing, to the
extent appropriate, expenses directly tied to operating our assets. Landowner
royalties, utilities, direct labor costs, chemical costs, workover and repair
and maintenance costs, and contract services comprise the most significant
portion of our expenses. Our operating expenses are largely variable and as
such, generally fluctuate in correlation with throughput volumes.
Our Adjusted Operating Margin is incrementally benefited from increased Water
Solutions recycled water sales. When produced water is recycled, we recognize
cost savings from reduced landowner royalties, reduced pumping costs, lower
chemical treatment and filtration costs, and reduced power consumption.
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The following table sets forth a reconciliation of net income (loss) as determined in accordance with GAAP to Adjusted EBITDA and Adjusted Operating Margin for the periods indicated:
Three Months Ended
(in thousands) March 31,
2023 2022
Net Income (Loss) $ 7,708 $ (6,617)
Interest Expense, Net 7,661 7,785
Income Tax Expense (Benefit) 1,327 (840)Depreciation, Amortization and Accretion 18,606 16,579 Impairment of Long-Lived Assets
- 15,597
Stock-Based Compensation 2,468 2,337
(Gain) Loss on Disposal of Asset, Net (13) 554
Transaction Costs 45 508
Research and Development Expense 408 19
Other (104) 2
Adjusted EBITDA $ 38,106 $ 35,924
Total Revenue $ 91,571 $ 70,969
Cost of Revenue (62,451) (43,250)
Gross Margin 29,120 27,719Depreciation, Amortization and Accretion 18,606 16,579 Adjusted Operating Margin
$ 47,726 $ 44,298 Total Volumes (Thousands of BBLs) 123,815 105,006 Adjusted Operating Margin/BBL$ 0.39 $ 0.42
Liquidity and Capital Resources
Overview
Our primary needs for cash are permitting, development and construction of water handling and recycling assets to meet customers' needs, payment of contractual obligations including debt, and working capital obligations. When appropriate, we enhance shareholder returns by returning capital to shareholders, such as through dividend payments and share buybacks (to the extent determined by our Board of Directors). Funding for these cash needs may be provided by any combination of internally generated cash flow, borrowings under the Credit Facility, or accessing the capital markets. We believe that our cash flows, undrawn Credit Facility and leverage profile provide us with the financial flexibility to fund attractive growth opportunities in the future. As ofMarch 31, 2023 , we had a cash balance of$25.5 million and working capital, defined as current assets less current liabilities, of$30.3 million . We had$400.0 million face value of Notes outstanding and$41.0 million outstanding under our Credit Facility, with$158.85 million of availability under the Credit Facility. As ofMarch 31, 2023 , we were in compliance with all the covenants under our Credit Facility and the indenture governing the Notes. See Item 1. Financial Statements - Note 6. Long-Term Debt.
On
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In 2023, we entered into an agreement with an unaffiliated water disposal company to dispose of a minimum volume of produced water over a term of 7 years, for a total financial commitment of approximately$28.0 million , undiscounted. As ofMarch 31, 2023 , we have short-term purchase obligations for products and services of approximately$40.8 million due in the next twelve months. See Item 1. Financial Statements - Note 10. Commitments and Contingencies.
Dividends and Distributions
OnMarch 3, 2023 , we announced that our Board of Directors had declared a dividend on our Class A common stock for the first quarter of 2023 of$0.09 per share. In conjunction with the dividend payment, a distribution of$0.09 per unit was paid to unit holders ofSolaris LLC . OnMay 8, 2023 , we announced that our Board of Directors had declared a quarterly dividend of$0.09 per share for the second quarter of 2023 on our Class A common stock. The dividend will be paid onJune 29, 2023 , to holders of record of our Class A common stock as of the close of business onJune 16, 2023 . In conjunction with the dividend payment, a distribution of$0.09 per unit will be paid to unit holders ofSolaris LLC subject to the same payment and record dates.
Cash Flows from Operating Activities
For the three months endedMarch 31, 2023 , net cash provided by operating activities totaled$59.7 million as compared with$26.4 million for the three months endedMarch 31, 2022 . The net increase is primarily due to the$20.6 million increase in total revenues offset by increases in direct operating costs and general and administrative expenses. Net cash provided by operating activities also included a net increase (decrease) of$28.9 million and($2.0) million for the three months endedMarch 31, 2023 and 2022, respectively, associated with changes in working capital items. Changes in working capital items adjust for the timing of receipts and payment of actual cash. The increase in cash provided from changes in working capital was primarily due to lower receivable balances associated with improved collections timing.
Cash Flows from Investing Activities
For the three months endedMarch 31, 2023 , net cash used in investing activities totaled$35.3 million as compared with$9.8 million for the three months endedMarch 31, 2022 . Expenditures for property, plant and equipment were higher in 2023 as compared with 2022 due primarily to increased capital activity to support our growing operations, including our management agreement with Chevron Corporation.
Cash Flows from Financing Activities
For the three months endedMarch 31, 2023 , net cash provided by financing activities consisted of$6.0 million net Credit Facility borrowings, offset by$5.4 million dividends and distributions paid and$0.6 million treasury stock repurchases related to tax withholding on stock awards that vested. For the three months endedMarch 31, 2022 , net cash used in financing activities totaled$8.9 million which consisted of dividends and distributions paid.
Capital Requirements
For 2023, we expect our capital expenditures will be between approximately$140.0 million to$155.0 million which is based on our currently contracted customers' latest outlooks on our dedicated acreage. We intend to fund capital requirements through our primary sources of liquidity, which include cash on hand and cash flows from operations and, if needed, our borrowing capacity
under
the Credit Facility.
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Critical Accounting Estimate -
As further described in Critical Accounting Policies and Estimates - Impairment ofGoodwill included in our 2022 Annual Report, we assess goodwill for impairment annually as of the fourth quarter of our fiscal year and more frequently when circumstances warrant. During the quarter endedMarch 31, 2023 , we conducted a quantitative interim test of goodwill due to a decline in the price of our Class A common stock during the period. Based on the interim assessment, we determined no impairment was necessary as the fair value of our reporting unit exceeded its carrying value. Our impairment analysis contains inherent estimates and assumptions, many of which are outside the control of management including interest rates, cost of capital, tax rates, market multiples and credit ratings, which could positively or negatively impact the anticipated future economic and operating conditions. The assumptions and estimates used in determining fair value require considerable judgement and these assumptions can change in future periods as a result of overall economic conditions, including the impacts of inflationary pressures, increased interest and discount rates and global supply chain constraints, among others. As a result, there can be no assurance that estimates and assumptions made for the purpose of assessing impairment will prove to be an accurate prediction of the future. Potential circumstances that could have a negative effect on the fair value of our reporting unit include, but are not limited to, lower than forecasted revenue growth rates, higher operating or capital costs, lower operating margins, changes in discount rates and changes in income tax rates. A reduction in the estimated fair value of the reporting unit could trigger an impairment in the future. We cannot predict the occurrence of certain events or changes in circumstances that might adversely affect the carrying value of our goodwill. A goodwill impairment would have no effect on our liquidity or capital resources. However, it could result in a material non-cash charge and could materially adversely affect our financial results in the period recognized.
Emerging Growth Company Status
We are an "emerging growth company," as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies." We may take advantage of these exemptions until we are no longer an "emerging growth company." Section 107 of the JOBS Act provides that an "emerging growth company" can take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. We have elected to use the extended transition period for complying with new or revised accounting standards and as a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates. We may take advantage of these exemptions up until the last day of the fiscal year following the fifth anniversary of our initial public offering or such earlier time that we are no longer an emerging growth company. We would cease to be an emerging growth company if we have more than$1.235 billion in annual revenue, we have more than$700.0 million in market value of our stock held by non-affiliates or we issue more than$1.0 billion of non-convertible debt securities over a three-year period.
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