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Select Energy Services, Inc. (NYSE:WTTR)
Q3 2020 Earnings Call
Nov 4, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Select Energy Services Third Quarter Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce your host Chris George. Please go ahead.

Chris George -- Vice President, Investor Relations and Treasurer

Thank you, operator, and good morning, everyone. We appreciate you joining us for the Select Energy Services conference call and webcast to review our financial and operational results for the third quarter of 2020. With me today are Holli Ladhani, our President and Chief Executive Officer and Nick Swyka, Senior Vice President and Chief Financial Officer.

Before I turn the call over, I have a few housekeeping items to cover. A replay of today's call will be available by webcast and accessible from our website at selectenergy.com. There will also be a recorded telephonic replay available until November 18th, 2020. The access information for this replay was also included in yesterday's earnings release. Please note that the information reported on this call speaks only as of today, November 4th, 2020, and therefore time-sensitive information may no longer be accurate as of the time of the replay listening or transcript reading.

In addition, the comments made by management during this conference call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of Select management. However, various risks, uncertainties and contingencies could cause our actual results, performance or achievements to differ materially from those expressed in the statements made by management. The listener is encouraged to read our annual report on Form 10-K for the year ended December 31st, 2019, our subsequent quarterly reports on Form 10-Q and our current reports on Form 8-K, to understand those risks, uncertainties and contingencies. Also, please refer to our third quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures.

And now, I would like to turn the call over to our President and CEO, Holli Ladhani.

Holli C. Ladhani -- Chief Executive Officer and President

Thanks, Chris. Good morning everyone and thanks for joining us today. 2020 continues to have its challenges, but we've made good progress since the market bottomed in the second quarter. Over the course of the third quarter most economies began the slow path to reopening resulting in increasing oil demand and steadying oil prices, which put our customers back to work.

Given the steep downward trajectory in Q2 and the notable month-over-month improvements in the third quarter, traditional quarterly activity comparisons are less meaningful this quarter, which has led to an unusually wide range of reported sequential activity metrics across various industry sources, including some data showing frac crew counts being up, while others reported a decline in well completions. What is clear is that month-over-month demand for our services increased over the course of the quarter, resulting in solid 10% revenue growth during Q3.

If we look at our segment results, activity steadily increased over the course of the third quarter for our Water Services segment. This improvement, however, wasn't quite enough to overcome the slope of Q2 declines, particularly when combined with continued pricing pressures resulting in relatively flat revenues. We believe that current pricing dislocations are being driven by significant distress across the competitive landscape and we expect market dynamics to stabilize over the next few quarters as the market turns out, particularly if recent federal support programs are exhausted.

On a brighter note, a recovery in activity in our Bakken Pipelines drove increased Water Infrastructure segment revenues and our Oilfield Chemicals segment delivered significant growth with revenues increasing by 45%. Importantly, the operating leverage of these businesses, combined with the cost savings measures we've implemented across the Company allowed us to deliver 58% incremental gross margins in Q3. We also continue to strengthen our balance sheet, generating $19 million of free cash flow during the third quarter and this takes our total year-to-date free cash flow to $117 million, increasing our total cash position to $185 million at the end of the third quarter.

As we look forward, it's always a challenge to predict the impact of potential Q4 seasonality but we're continuing to see activity increase in October and early November before an anticipated slowdown around the holidays in late November, December. As we look further toward 2021, we currently anticipate continued activity improvements and growth in the average frac counts next year off of Q3 levels. While there certainly remains a fair amount of near-term uncertainty from COVID-19 pandemic risk, at this early stage many third-party forecasts appear to be indicating a flattish US production outlook in 2021 relative to current levels, which is fairly consistent with our overall customer conversations today. By our estimates this outlook would likely require crude oil around $40 to $45 and would require somewhere between 150 to 175 frac crews on average during 2021. These activity levels would support modest improvements in revenues for us on a year-over-year basis even after consideration of the pre-downturn strength of Q1 of this year. Additionally, given the cost savings measures we've implemented over the course of the last six months, we're well positioned to deliver solid incremental margins in 2021 as well. All in all, even in a flat production environment next year we're confident our business can steadily grow revenues and margins over the next 12 months.

As I referenced earlier, pricing in some of our service lines, particularly in our Water Services segment, remains challenged today, but we believe we will benefit from an improving competitive landscape in the quarters ahead. We've already seen and expect to continue to see many of our smaller competitors struggle to survive with a number of key regional and even multi-regional players having shuttered in recent months. The timing of the improvement in the competitive landscape could be impacted by supplemental federal support programs, but we're fairly confident the landscape looks much clearer over the course of 2021, which should support improved pricing.

Looking at our customers, we think consolidation in the upstream space continue with a number of multi-billion dollar mergers and acquisitions already announced. This has been consistent with our expectations and we expect this trend to continue as these consolidators will be able to drive the industry toward a more efficient, sustainable and scalable shale development model. Ultimately this will have an effect on the services industry as consolidation has historically led to near-term capex reductions. We believe this capital efficiency is what the industry needs and we're positioned well with the right customers that will likely be the consolidators. Our initiatives around technology and full lifecycle water and chemicals management will not only provide more efficient, safer and cost-effective solutions for our customers, but will also help support them in the pursuit of their long-term ESG goals and initiatives.

Our core strategy remains centered on continuing to provide premier solutions to our customers, protecting our strong balance sheet and liquidity and maintaining the flexibility to capitalize on the significant opportunities we expect will be available to us. And I appreciate my team's continued focus on all of these areas thus far through this downturn. We'll continue to assess opportunities to grow organically, evaluate investments in technology and pursue accretive acquisitions that support our strategy. While we remain committed to disciplined and patient growth, I'm optimistic that we'll find and execute on attractive opportunities.

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

Nick Swyka -- Senior Vice President and Chief Financial Officer

Thank you, Holli and good morning everyone. The third quarter was no doubt a difficult one though our relentless focus on efficiency and customer service led to improving fundamentals despite these headwinds. The strong 58% incremental gross margins Holli referenced contrast well with the 20% decrementals we realized in the second quarter with especially robust operating leverage seen in the Water Infrastructure and Chemicals segments. We generated our 11th consecutive quarter of positive free cash flow and have built a solid war chest of $185 million in cash on hand.

Even with an improving environment, we continue to progress on our cost savings targets. Our SG&A declined another $1.7 million quarter-over-quarter to just under $16 million. However, I would note that this includes $1.1 million of non-ordinary course bad debt accruals and $0.5 million of other costs primarily related to the settlement of legacy legal claims related to previously acquired businesses. We expect to push SG&A lower to under $15 million in the fourth quarter, while we maintain tight reins on expenses even as business returns.

Our $117 million of year-to-date free cash flow has exceeded the full-year target we provided at the beginning of the year before the emergence of COVID-19 generated the sharp downturn. While much of this has, of course, been driven by rapidly throttling back spending, I believe it demonstrates our ability to effectively run a capex light business, be nimble and decisive on our cost cuts and stay disciplined in a difficult collections environment. Cash flow and liquidity are core to our financial philosophy and a key differentiator in today's environment.

Turning to our results in more detail. Select generated total revenue $101 million in the third quarter, up 10% from $92 million in the second quarter with September as the highest month. Gross margins before depreciation and amortization increased to 6.9% in the third quarter from 1.9% in the second due to the high operating leverage of our Bakken Pipelines system and chemicals manufacturing capacity, as well as the non-recurrence of severance and yard closure costs in the second quarter.

Adjusted EBITDA improved by $3.7 million to negative $4.7 million in the third quarter. Adjusted EBITDA during the quarter included adjustments for $2.2 million of non-cash compensation expense, $1.6 million of tax audit accruals relating to previously acquired businesses, $1.4 million of non-cash loss on sale of assets and $1.2 million of other non-recurring costs. I'd note, however, that the third quarter was also impacted by $1.5 million of sales tax audit accruals for periods dating back to 2015 and $1.1 million of non-ordinary course bad debt expense that were not included in these adjustments. We had a net loss for the third quarter of $36 million versus a net loss of $53 million in the second quarter due to improved margins, lower SG&A and lack of impairments during the third quarter.

The Water Services segment's revenues decreased slightly to $55 million in the third quarter from $56 million in the second, tracking relatively closely to completions. The segment generated gross profit before depreciation and amortization of $1.7 million in the third quarter compared to $1.8 million in the second, with segment gross margins essentially flat sequentially at approximately 3%. This segment remains challenged by extremely competitive pricing as well as regional volatility and will likely face some seasonal pressures further into the fourth quarter. That said, we expect to hold revenue roughly flat on slightly higher margins in the fourth quarter.

The Water Infrastructure segment saw a modestly higher third quarter revenue of $16 million from $15 million in the second. Gross profit before D&A, however, greatly outperformed the revenue uptick, moving from $1.4 million in the second quarter to $3.3 million in the third.

Significantly benefited by the return of volumes through our Bakken Pipelines system, gross margin before D&A increased from 9.3% during the second quarter to 20.7% in the third. With pipeline volumes trending higher throughout the third quarter, we forecast this trend carrying into Q4 and anticipate segment revenues of more than $20 million with relatively stable low 20%s gross margins for the fourth quarter.

The Oilfield Chemicals segment made the strongest recovery of all three segments with revenue rebounding 45% quarter-over-quarter from $21 million in the second quarter to $31 million in the third. Gross margin before D&A improved from negative 6.8% in the second quarter to positive 6.6% in the third. Gross profit before D&A improved to $2 million from negative $1.4 million in the second quarter. The segment benefited from increased market share and activity in both our completions chemicals and WCS businesses. We expect modestly higher revenue and mid to high-single digit margins for the fourth quarter.

Below the line we accrued a slight tax benefit during the third quarter, while depreciation and amortization declined to $24 million. We expect to see D&A continue to decline modestly in the coming quarters giving meaningful reductions in capex spend this year. We continue to have zero bank debt and enjoy a net cash position of $185 million as of September 30th. Our success in generating free cash flow has exceeded expectations this year but we are likely to face a slight working capital headwind in the fourth quarter that could limit our ability to further improve on the $117 million of year-to-date free cash flow during Q4.

Despite the many challenges, we have a strong financial position at a time of considerable market dislocation. We believe this position provides us with unique opportunities and we will evaluate those while preserving the strength.

With that, I'll turn it over to the operator and we'll take your questions before Holli wraps up with some concluding remarks. Operator?

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from J.B. Lowe with Citi. Please go ahead.

J.B. Lowe -- Citi -- Analyst

Hi. Good morning, everyone.

Holli C. Ladhani -- Chief Executive Officer and President

Good morning, J.B.

J.B. Lowe -- Citi -- Analyst

A question on -- I mean I think the 4Q guide makes sense and hopefully we can get back to breakeven EBITDA next quarter. But I was more curious about what you guys were looking at into 2021. And the two questions I had were what do you consider to be decent incrementals for the activity increases you laid out in your prepared remarks? What do you think -- what do you think a reasonable incremental would be on that activity? And then two, given the activity increases that we expect, what do you think working capital can do in 2021?

Holli C. Ladhani -- Chief Executive Officer and President

Sure. I'll start maybe on the incrementals and Nick can weigh in on working capital. But as we think about some of the changes, obviously, that we've made across the business from a cost structure, I think earlier in the recovery we will see potentially higher incrementals than normal. But as you think about it in general across the course of next year, J.B., I think looking at our historical incrementals which is 30% to 40% depending on the service line, we have a little more torque, operational leverage in our chemicals business and our infrastructure business, particularly if we see some of the volumes across our pipelines that clearly will make a difference for that product mix concept on the infrastructure.

Water Services, that's really a little bit of the bogey in that pricing is going to be a fairly meaningful driver. On their incrementals, as we alluded to in the script and such, that's where we're seeing the most pricing pressure given the competitive landscape and depending on how long it takes for that to, I'll say, normalize and clear out so we get back to some more rational pricing. That one is a little bit harder to predict, but we are fairly confident with what we see happening in the competitive landscape that over the course of 2021 that does resolve itself.

So on working capital, Nick, why don't you hit on that?

Nick Swyka -- Senior Vice President and Chief Financial Officer

Sure. J.B., we didn't give much of a view on 2021 like most of the industry as well. But to the extent that 2021 is better, paradoxically that's going to hold back our cash flow and working capital will build. But we'll certainly be reviewing our customers' budgets and commentary over the next few months and having discussions with them and try to understand that better before we can give kind of a concrete number there on working capital for 2021. But regardless with our $185 million cash on hand we certainly feel good about where we are and can handle any kind of upside that leads to a working capital drag there.

J.B. Lowe -- Citi -- Analyst

Okay. Great. My second question was just on -- specifically on your permanent infrastructure in the Permian. Just how those volumes or how you expect those volumes to trend in 4Q and into 2021, both on the New Mexico line and also the GRR acquisition. That would be great. Thanks.

Holli C. Ladhani -- Chief Executive Officer and President

Sure. We probably look at those somewhat together just because the GRR system feeds the new infrastructure that we've put in place. So it's a little hard to break them apart too much. But what I would say is our Q3 utilization was pretty similar to Q2 and we're expecting probably an uptick in that in the Permian in Q4 and then would -- when you look at just our outlook on 2021 and maintaining production flat and the activity that that would require we would expect to actually see some even continued improvement there on that system.

And clearly, it's one of those of -- having the customer base we have there will be the driver as we look forward.

J.B. Lowe -- Citi -- Analyst

All right. Thanks so much, guys.

Holli C. Ladhani -- Chief Executive Officer and President

Thanks.

Operator

Next question is Ian Macpherson with Simmons. Please go ahead.

Ian Macpherson -- Simmons Energy -- Analyst

Good morning, Holli and Nick.

Holli C. Ladhani -- Chief Executive Officer and President

Good morning.

Nick Swyka -- Senior Vice President and Chief Financial Officer

Good morning.

Ian Macpherson -- Simmons Energy -- Analyst

Your patience with capital allocation and just harvesting your free cash flow has been wise, obviously, until now as valuations have continued to be pressured. And I know you get it in both ears from all of your shareholders and analysts about redeploying capital into the business or how you are thinking about M&A. And your cash balance relative to your market cap has really been more definitive than it is now. So with your operator landscape consolidating and you said you think it probably takes some time, maybe a few quarters for your water services business to find a more rational footing as the smaller players clean up a little bit. Are you content to remain patient and sit on cash or do you think that there could be a narrowing window to do something transformational with your portfolio at this point in time?

Holli C. Ladhani -- Chief Executive Officer and President

Yeah. No -- and appreciate the fact that you highlighted that patience because it's hard at times when there is so much pressure. But you'll continue to hear that mantra from us. I would say, we look at ways to deploy that capital in at least a couple of buckets. There is, obviously, organic and then there is through acquisitions.

On the organic front, I think we continue to find multiple opportunities. Some of that is around technology where we can invest in technologies that help with emissions, help -- technologies that help with water reuse, frac efficiency. They're all pretty small, but we have several that we're looking at that I'm optimistic about that could be constructive for us. We've actually initiated a project in the Permian for a recycling reuse facility. Again, relatively small, but pretty strategic. It's with one of our key customers to help them on their recycling goals. It allows us to potentially serve some other operators in the area. This particular opportunity is underpinned by a contract. So there are a lot of singles out there that I think in the next quarter or two we'll find some success in delivering good projects that have the right return metrics.

When we think -- on the M&A front we still stay active and making sure we understand what the opportunities are. And again there the key is just going to be making sure we deliver something that's accretive and delivers value. So that will stay on the radar. But I would say, certainly that does -- it is not the only way we can create value. There are these smaller organic opportunities that we're continuing to execute on.

Nick Swyka -- Senior Vice President and Chief Financial Officer

I'd add that returning capital to shareholders remains a core priority for us. It's just with the current market and the dislocation we see we're pursuing a more comprehensive evaluation of what the opportunities are. But certainly shareholder returns remain core to our long-term vision.

Ian Macpherson -- Simmons Energy -- Analyst

That's great. Thank you both for that. Just last one for me. On the Water Services side it sounds like averaging -- correct me if I misinterpret this, it sounds like pricing has more -- has closed to bottom, but it may be -- is a bleeding headwind still into Q4 that maybe will have stabilized by the time we get to Q1 so that if your outlook for total market activity and volumes next year proves accurate then you would expect your revenue for Water Services to be pretty well correlated with activity. Is that the right way to think about it?

Holli C. Ladhani -- Chief Executive Officer and President

I think that's fair. I guess the way I would think about it, Ian, is that you're right, we have found the bottom on pricing. We're just -- we're at a point that we're not willing to go lower and our customer base understands that. And there are people that can bid subsidized labor and they can do that for a bit longer, but that's going to go away. So I think the way to think about our services -- water services business is as you described it.

One nuance I would note is that our water services business had fairly strong representation in the second quarter and for a good part of the third quarter from some of the gassier basins. And we do expect those to slow down a bit more going into the fourth quarter just because they deploy their capital fairly ratably over the first part of the year. So the seasonality we will get in that basin will be, I'd say, more like historical levels versus being muted like we're expecting in some of the oilier basins. So that does change your starting point a bit for water services. But at least from a go-forward perspective, tying it to activity, frac crews in particular, is a good way to think about it.

Ian Macpherson -- Simmons Energy -- Analyst

Right. Thanks for the insights. Appreciate it.

Holli C. Ladhani -- Chief Executive Officer and President

Sure.

Operator

Next question, Kurt Hallead with RBC. Please go ahead.

Kurt Hallead -- RBC Capital -- Analyst

Hey. Good morning.

Holli C. Ladhani -- Chief Executive Officer and President

Good morning, Kurt.

Kurt Hallead -- RBC Capital -- Analyst

Hey. Thanks for all that great color and perspective on your views for not only next quarter but going into next year. So I guess, Holli, from where I sit, right, kind of look at the outlook that you provide gave us the context around production holding flat in US and what that could mean for potential average number of frac crews operating throughout the course of the year. And I guess what I could use maybe a little bit more context around would be you're still going to be down in terms of overall frac activity on a year-on-year basis for next year, right. So it's hard to kind of get my head around how water solutions -- water services could be up, let's say, '21 versus '20. So -- I know you're talking about how revenue should be up on a year-on-year basis. Just looking at a little bit more context around that, I would guess it would be more driven by chemicals, by infrastructure and would be by water services. So maybe you can help me calibrate that.

Holli C. Ladhani -- Chief Executive Officer and President

Sure. And part of it, Kurt, is that, I know we've struggled as we were in trying to compare second quarter to third quarter activity levels. It gets challenged as you have the volatility that we saw. But if you think about the average frac crew count in 2020, it's below 150, it's probably in the 130, 140 range. So when you look at 2021 and have a 150 to 175 average, then that's how you start to see that ability for water services revenues to grow. And then the other thing I would build in there is the pricing pressure started pretty heavily in Q2. It's running its way to Q4. And we're optimistic, I don't know if it's next summer, but certainly the back half of 2021 would expect pricing to be more normalized and that will also help the top line.

Kurt Hallead -- RBC Capital -- Analyst

Got it. That's helpful context. So, I appreciate that for sure. Okay. And then just for point of clarity here, to make sure that everybody comes out of the call with the correct message at least on the fourth quarter. So, Nick, do you expect EBITDA to be positive in the fourth quarter given your guide points?

Nick Swyka -- Senior Vice President and Chief Financial Officer

Yes, we do. And we can walk through those segments a little more. But I think if you take our guidance on a segment basis along with the SG&A that's likely where you'll end up.

Kurt Hallead -- RBC Capital -- Analyst

Okay. All right. That's great. That's it for me. Thank you.

Nick Swyka -- Senior Vice President and Chief Financial Officer

Thank you, Kurt. [Phonetic]

Operator

[Operator Instruction] Our next question comes from Thomas Curran with B. Riley. Please go ahead.

Tom Curran -- B. Riley FBR -- Analyst

Good morning.

Holli C. Ladhani -- Chief Executive Officer and President

Good morning, Tom.

Nick Swyka -- Senior Vice President and Chief Financial Officer

Good morning.

Tom Curran -- B. Riley FBR -- Analyst

On pricing, for water services across your offerings, how much is average pricing down from its 2019 high? And then of that division's six segments where is pricing proving the most resilient and fragile respectively?

Holli C. Ladhani -- Chief Executive Officer and President

Yeah. It definitely does range across the service lines. But I think the 20% to 30% is probably the right perspective when you think about the degradation that we've seen. I would say it does become a little bit regional after that as we think about what held in better than others. Clearly, things like our -- you find -- our chemicals business, our infrastructure business, our margins aren't as impacted by pricing adjustments just because our cost structure, water sources, raw materials tend to move with it. But obviously on the services side, our cost structure, labor and some of the fixed costs that we have make that a little more challenging to manage through to the margin line. But I think as you're looking at the world, a 20% to 30% reduction is the right lens to view it from.

Nick Swyka -- Senior Vice President and Chief Financial Officer

And as far as the --

Tom Curran -- B. Riley FBR -- Analyst

Okay. Good ahead.

Nick Swyka -- Senior Vice President and Chief Financial Officer

Yeah, I think the kind of the services element that we hit on have been more challenged in the chemicals and infrastructure.

Tom Curran -- B. Riley FBR -- Analyst

And within it which segments would you highlight as having been hit the most and the least?

Holli C. Ladhani -- Chief Executive Officer and President

I would say it's been fairly non-discriminatory. With certain of our service lines we do find ourselves you still have some smaller regional competitors that we're up against. And unfortunately when activity levels fall to the level that they have, it allows that layer essentially of service provider to set the price. And with federal funding programs and the like, it has just lead to something that frankly we've not seen before. And there is plenty of work that we walk away from in the sense that we aren't even close. But then we find our core customers who know that we're going to be here. We're going to provide the level of service that they require and they're essentially, I'll say, paying a premium to these predatory type pricing levels. And that's where, again, while it's impacted pretty much all of our service lines, it's not something we suspect or expect to sustain.

Tom Curran -- B. Riley FBR -- Analyst

Okay. And then following up on Ian's question about your capital allocation priorities and decision-making process, when it comes to how your acquisition opportunity set is evolving, would you be open to and already expecting to participate in auctions or liquidations when some of these struggling smaller private players start to go under? Is that a means of picking up assets that you're interested in and anticipating? And then what are your criteria moving forward from here with the cash war chest where it is for deciding to become more aggressive with share repurchases?

Holli C. Ladhani -- Chief Executive Officer and President

Sure. I'll start with looking at auctions and things like that. Just stepping back, Tom, oftentimes the first companies to go are those that have older worn-out equipment. So certainly our hope is most of that finds its way out of the market. It scrapped because that will help manage the supply demand dynamics.

I'd say we are aware when these auctions do occur just to make sure we take a review. The guys in the field will look at these, but also thinking through our needs. Our equipment fleet today as we look forward, while there'll be some small investments that are required along the way, we're pretty well equipped to manage and meet the needs of 150 frac crew market. 175 starts to put a little more strain on our fleet. But we're not looking at needing to add a tremendous amount of capital for next year. So with that, we'll be very selective. And again a lot of the assets that are coming to market are probably not the assets that are going to be needed to serve sort of the future needs of customers.

As we think more broadly on the capital allocation, as Nick said, returning value to our shareholders and we have multiple ways clearly of doing that, is investing to accretive value-additive growth, it's buybacks, it's dividends. All of these things are on the table that we continue to assess and try to determine the best means of being able to deliver that value to shareholders.

Tom Curran -- B. Riley FBR -- Analyst

Thanks for fielding my questions.

Holli C. Ladhani -- Chief Executive Officer and President

Happy to.

Operator

Next question comes from Sean Meakim with JP Morgan. Please go ahead.

Sean Meakim -- JP Morgan -- Analyst

Thank you. Hey. Good morning.

Holli C. Ladhani -- Chief Executive Officer and President

Good morning.

Nick Swyka -- Senior Vice President and Chief Financial Officer

Good morning

Sean Meakim -- JP Morgan -- Analyst

So, Holli, on water services and the volume question into next year, we've seen pressure pumpers experience much lower revenue per fleet in 3Q and into 4Q as E&Ps are taking advantage of lower sand cost to self-source. Thanks to cheap spot pricing in the sand market. Obviously, water and sand sourcing, two different markets. But are you seeing shifts in behavior among your customers in terms of how they're sourcing water? Is that impacting how you're performing in terms of volumes versus the broader completions market?

Holli C. Ladhani -- Chief Executive Officer and President

Not really, Sean. What I would say on the water sourcing side what did change in Q3 and will probably start to shift back in Q4 is that our customers, because their activity levels went down as much as they did, they weren't using as much produced water. They were using other brackish sources that we typically would provide. So in some ways as the market fell, our water sourcing volumes weren't impacted as much. Keep in mind that's the smaller and lower margin piece of what we do. But what did change is the type of water being used. So that's the trend we expect to go back the other way.

So higher volumes of produced water, which again I think lends itself to our level of service, our treatment capabilities, the more complex chemistry, we can apply to that. I think that's probably the trend more to watch.

Sean Meakim -- JP Morgan -- Analyst

Okay. Thank you for that. And then coming back to the margin question for services. I appreciate that's the area that experienced most pricing pressure. It's also historically the lower operating leverage business, labors, the biggest component of COGS and that's more of a variable cost for you. You're working to take cost out. But if we're looking ahead and you're troughing at a low single digit gross margin for the business, you previously peaked, say, mid 20%s [Phonetic] in 2018. How do you think about normalized gross margins for the business? And if you look at the past from where we are here to there, how much of that is volume driven versus pricing?

Holli C. Ladhani -- Chief Executive Officer and President

Yeah, great question. And I wish we had a more, I'll say, precise quantitative answer to it, but it's absolutely both. So I think in the near term to your point, when we add business, yes, we need to add labor. But we don't have to add another yard. So there is operating leverage across our -- across that business, not as strong, obviously, as chemicals and infrastructure, but it does exist. But the pricing will be the bigger lever likely as we work our way through 2021.

Sean Meakim -- JP Morgan -- Analyst

And if you wouldn't mind just to follow up on that. If we think about fixed versus variable costs, are you able to maybe give us a rough breakdown across the business segments, the relative scale, it could be helpful for people?

Holli C. Ladhani -- Chief Executive Officer and President

Maybe the easier way to answer that, Sean, is more back to the incrementals that you find on the water services. Those incrementals are probably in that range of 30% to 40%. The water services it's going to be at the low end of that range whereas our infrastructure and our chemicals are at the higher end of that range.

Sean Meakim -- JP Morgan -- Analyst

Got it. Very good. Thank you.

Holli C. Ladhani -- Chief Executive Officer and President

Sure.

Operator

I would like to turn the floor over to management for closing comments.

Holli C. Ladhani -- Chief Executive Officer and President

Thanks. And first I want to start with a thank you to the group for taking time to listen in this morning. Recognize that it was a pretty chaotic morning and a lot of information for people to digest, maybe no conclusions, but certainly information and that makes all our jobs a little bit harder. So maybe I would just close with this that as we indicated, nobody is immune to what's going on in the oilfield right now. But what I remain confident about is that oil and gas is going to play a critical role in powering economies around the world. And to do that we will see an improvement in activity from where we sit today.

And while I wish I had more visibility on the timing and the cadence of that improvement, what I can say is that Select continues to be unique in the terms of when you think about our market-leading position, our full fluids lifecycle offering and the fact that this has proven to be a cash flow generating business and that's what led to the debt-free balance sheet that we have today. And all of that's going to position us well as activity levels do improve. So, again, thanks for joining us today and have a good day.

Operator

[Operator Closing Remarks]

Duration: 38 minutes

Call participants:

Chris George -- Vice President, Investor Relations and Treasurer

Holli C. Ladhani -- Chief Executive Officer and President

Nick Swyka -- Senior Vice President and Chief Financial Officer

J.B. Lowe -- Citi -- Analyst

Ian Macpherson -- Simmons Energy -- Analyst

Kurt Hallead -- RBC Capital -- Analyst

Tom Curran -- B. Riley FBR -- Analyst

Sean Meakim -- JP Morgan -- Analyst

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