Select Water Solutions, Inc. annual report, FY2018

Business context and reporting period

This is Select Energy Services, Inc.’s Form 10-K for the fiscal year ended December 31, 2018, filed March 1, 2019—not a standalone Q4 filing. Although the request metadata names Select Water Solutions, the filing identifies the registrant as Select Energy Services, Inc. The company provides oilfield water-management services, specialty chemicals, and wellsite services across North America. Results include the Rockwater business for all of 2018 but only from November 1 in 2017, limiting comparability.

Financial performance and liquidity

FY 2018 Adjusted EBITDA, a non-GAAP measure, was $257.6 million, versus $117.3 million in 2017. Cash used in investing activities was $168.4 million; cash used in financing activities was $49.3 million. At December 31, 2018, the company reported $204.7 million of available borrowing capacity under its revolving credit facility and compliance with debt covenants. Its $300 million facility matures November 1, 2022.

Q4 2018 revenue was $362.3 million, gross profit $34.4 million, operating loss $14.0 million, and net loss $18.1 million. Q4 2017 revenue was $304.2 million, gross profit $26.3 million, operating loss $8.0 million, and net loss $15.0 million.

Material changes versus prior periods

• Revenue increased 120.8% year over year, reflecting stronger completion activity and full-year contributions from 2017 acquisitions, particularly Rockwater. Water Solutions generated $1,060.2 million of segment revenue; Oilfield Chemicals $259.8 million; and Wellsite Services $209.0 million.
• Gross margin rose to 13.0% from 8.3%, which management attributed to greater asset utilization, revised useful-life and salvage-value estimates, and integration synergies, partly offset by the larger share of lower-margin chemical revenue.
• Operating cash flow improved substantially, while debt was reduced by $30 million. Capital spending rose to $165.4 million as the company expanded its operating capacity.
• The company recorded $17.9 million of goodwill impairment, $6.7 million of property-and-equipment impairment, and $2.0 million of cost-method investment impairment. It also recorded $3.9 million of lease-abandonment costs.
• Changes to estimated useful lives and salvage values of certain assets reduced 2018 depreciation and increased net income by $10.9 million, including noncontrolling interests; management reported a $0.15 increase in basic and diluted EPS attributable to stockholders.

Outlook, risks, contingencies, and unusual items

Management said operating cash flow and available revolver capacity were expected to fund operations for at least the next 12 months, while cautioning that this was not assured. No specific revenue, earnings, or capital-spending guidance was provided. In February 2019, the company announced an approximately $25 million northern Delaware Basin pipeline project, expected to begin operating in Q3 2019, supported by a five-year take-or-pay contract for 75 million barrels of water.

Management described a customer spending pullback in Q4 2018 amid lower oil prices and seasonal factors. Key risks include commodity-price volatility and customer capital spending, water access and permitting, disposal-well restrictions and induced seismicity, environmental and chemical regulation, labor and equipment availability, competition, and the ability to pass through chemical raw-material and fuel costs.

The company disclosed material weaknesses in controls over Rockwater acquisition fixed-asset accounting and physical-inventory reconciliation. Management said these did not cause a material misstatement in 2018, but could result in future misstatements; remediation was underway. Management found disclosure controls ineffective, and the auditor issued an adverse opinion on internal control over financial reporting while giving an unqualified opinion on the financial statements.

A U.S. government investigation concerns alleged emissions-control modifications to a limited number of company vehicles. The company was cooperating and had begun resolution discussions; possible penalties were not estimable. The filing also disclosed ordinary-course lawsuits and claims, which management did not expect to have a material adverse effect.

After year-end, the company decided to sell or wind down certain Wellsite Services operations, including Affirm, Canadian operations, and sand hauling. It reported a February 26, 2019 sale of part of Affirm for $11.2 million, with $11.0 million of proceeds received and a gain expected.

Most important facts for investors to verify

• Whether 2018 growth and margin improvement persist without the full-year acquisition comparison effect, and how the Q4 operating loss informs that assessment.
• Whether operating cash flow can sustain planned capital investment and debt service, given year-end cash of $17.2 million and the borrowing-base nature of revolver availability.
• Progress and testing of remediation for the fixed-asset control material weaknesses and whether future filings report effective controls.
• Final costs or penalties, if any, from the emissions-control investigation and the status of other contingencies.
• Execution, contracted economics, and capital requirements for the New Mexico pipeline project, plus proceeds and gains from the Wellsite Services divestitures.
• Potential effects of impairment assumptions, revised asset lives and salvage values, and future lease-accounting adoption, which management expected to add $100–$120 million of right-of-use assets and lease liabilities.