Select Energy Services, Inc. — Q2 2019 Form 10-Q
Business context and reporting period
Filed August 7, 2019, for the quarter and six months ended June 30, 2019. The filing registrant is Select Energy Services, Inc. (NYSE: WTTR), a provider of water-management services and infrastructure and oilfield chemical products for the U.S. oil and gas industry. The filing reorganized reporting into Water Services, Water Infrastructure and Oilfield Chemicals; prior-period segment data was restated.
Financial performance and liquidity
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $323.9 | $393.2 | $686.5 | $769.6 |
| Gross profit / margin | $39.9 / 12.3% | $56.7 / 14.4% | $85.9 / 12.5% | $104.7 / 13.6% |
| Operating income | $11.2 | $24.8 | $17.8 | $43.4 |
| Net income | $8.1 | $25.0 | $9.5 | $41.2 |
| Net income attributable to Select Energy Services, Inc. | $6.2 | $17.0 | $7.3 | $27.1 |
| Adjusted EBITDA (non-GAAP) | $51.6 | $68.2 | $105.0 | $127.9 |
- Q2 revenue by segment: Water Services $202.0 million; Water Infrastructure $51.7 million; Oilfield Chemicals $63.0 million; Other $7.2 million.
- First-half operating cash flow was $74.7 million, investing cash outflow $21.1 million, and financing cash outflow $47.2 million. Property and equipment purchases were $57.5 million; operating cash flow less these purchases was approximately $17.2 million.
- Cash was $23.8 million at June 30. The company had no bank borrowings, a $256.4 million borrowing base, $16.4 million of letters of credit and $240.0 million of available capacity. It repaid $50.0 million of debt and borrowed $5.0 million during the first half; it reported compliance with debt covenants.
- Current assets were $421.2 million and current liabilities $164.2 million. Operating lease liabilities totaled $94.7 million ($19.6 million current); the filing adopted the new lease standard in 2019.
Material changes versus the prior comparable period
- Q2 revenue fell 17.6%, gross profit fell 29.6%, and net income fell 67.8% year over year. Lower Water Services activity and pricing, weaker Water Infrastructure revenue and the exit from certain businesses contributed to the decline.
- For the first half, revenue declined 10.8% and net income 77.0%. Adjusted EBITDA decreased to $105.0 million from $127.9 million.
- Water Services revenue declined 13.7% in Q2, primarily from reduced water-transfer activity and pricing pressure. Water Infrastructure revenue fell 7.2%, partly due to lower activity on the Bakken pipeline system. Oilfield Chemicals revenue decreased 2.8% in Q2, although first-half revenue increased 1.1%, supported by friction-reducer sales and Midland plant capacity.
- Affirm, Canadian and sand-hauling operations were sold or wound down during the period. Management said these businesses generated approximately $144.5 million of combined 2018 revenue; no regular recurring revenue from them was expected going forward. Divestitures and fixed-asset sales generated $30.1 million of proceeds during the first half.
- Unusual items included a $4.4 million goodwill impairment, $0.9 million property-and-equipment impairment, and $6.2 million net losses on sales of property and equipment for the first half. First-half SG&A rose 13.6% to $59.7 million, driven in part by equity compensation and divestiture-related severance.
Outlook, commentary, risks and contingencies
- No numerical financial guidance was provided. Management said it saw limited potential for activity to rise above Q2 levels in the second half of 2019, citing customer focus on cash flow and capital budgets set amid lower prices. It viewed current prices as supportive of longer-term investment, but did not expect substantial incremental capital to enter the market during 2019.
- Management emphasized cost controls, positive free cash flow, a strong balance sheet, selective investment in long-lived water infrastructure and technology, and potential growth from produced-water treatment and reuse. It also cited Midland friction-reducer production as a source of freight savings.
- Key business risks include oil and gas prices and customer spending, service pricing and demand, pipeline and regional constraints, competition, labor availability, regulation and permitting, environmental and safety performance, and access to capital. Completion efficiencies may reduce time on location and service revenue.
- The company is cooperating with a U.S. Department of Justice and EPA investigation concerning alleged vehicle emissions-control modifications at subsidiaries acquired in the Rockwater merger. It identified 31 vehicles in Pennsylvania and approximately 30 additional vehicles elsewhere; the modified vehicles were less than 5% of the approximately 1,400-vehicle U.S. fleet at the investigation’s outset. No charges had been brought, and the company could not estimate potential penalties. The filing notes that fines of up to $7,200 per altered vehicle have been imposed in similar cases; this is not an estimate of the company’s exposure.
- Management reported disclosure controls were effective at June 30. Previously identified material weaknesses in internal controls related to Rockwater purchase accounting and fixed-asset reconciliations were being addressed with new controls, whose operating effectiveness was still being tested.
Important facts for investors to verify
- Whether underlying activity and pricing stabilize, particularly in Water Services and the Bakken infrastructure business, after the reported declines.
- How much of the year-over-year revenue and earnings decline reflects discontinued operations versus changes in continuing segments.
- Whether the divestitures, asset-sale losses, impairment charges and severance costs are substantially complete, and how recurring cash generation compares with capital spending.
- Actual available revolver capacity and covenant headroom as the borrowing base and letters of credit change; the filing reported $236.4 million available at August 2, 2019.
- Developments and potential financial exposure from the emissions investigation, and completion of testing to remediate the previously identified internal-control weaknesses.