Select Energy Services, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results. The company is an oilfield-services provider focused on water management, oilfield chemicals and wellsite services for unconventional oil and gas operators in the United States and Western Canada.
Business context and significant transactions
The November 1, 2017 Rockwater merger substantially expanded the company’s water and chemical services, geographic reach and asset base. The merger consideration was approximately $620.2 million, primarily in equity. The company also completed the GRR Permian Basin acquisition in March and the Resource Water acquisition in September 2017. Because Rockwater’s results are included only from November 1, and other acquired businesses from their respective acquisition dates, reported year-over-year results are not directly comparable.
Financial highlights
| Metric | 2017 | 2016 |
|---|---|---|
| Revenue | $692.5 million | $302.4 million |
| Gross profit (loss) | $57.8 million; 8.3% margin | $(44.1) million |
| Operating loss | $(30.0) million | $(299.0) million |
| Net loss | $(35.1) million | $(313.9) million |
| Adjusted EBITDA | $117.3 million | $16.9 million |
| Cash from operating activities | $(2.9) million | $5.1 million |
| Capital expenditures | $108.3 million | $36.3 million |
| Cash and cash equivalents at year-end | $2.8 million | $40.0 million |
| Debt at year-end | $75.0 million | None |
All amounts are in U.S. dollars. Adjusted EBITDA is a non-GAAP measure; the company reported 2017 EBITDA of $74.1 million. Adjusted EBITDA includes adjustments such as transaction, severance, equity-compensation and other specified costs.
Fourth-quarter 2017 revenue was $304.2 million, compared with $86.7 million in fourth-quarter 2016. Fourth-quarter gross profit was $26.3 million (8.6% margin), while the company reported a net loss of $15.0 million, including a $9.7 million net loss attributable to Select Energy Services, Inc. The filing attributes the revenue increase mainly to higher completion activity and the Rockwater merger.
Water Solutions generated approximately 76% of 2017 revenue; Oilfield Chemicals contributed 6%, and Wellsite Services 18%. Water Solutions and Wellsite Services revenue rose with higher activity and acquisitions; chemicals revenue reflects Rockwater results from November onward.
Changes, liquidity and outlook
- Revenue rose 129% year over year, but the increase reflects both market recovery and acquisitions. Gross profit returned to positive territory from a 2016 loss; the 2016 results included approximately $198.7 million of impairment charges, compared with none in 2017.
- Operating cash flow was negative as accounts receivable and working capital increased with growth. Investing cash outflow was $156.7 million, including $65.5 million for acquisitions and higher capital spending. Financing activities provided $122.4 million, supported by IPO proceeds.
- At December 31, 2017, the company had a $300 million senior secured revolving facility, $75 million drawn and $167.3 million of available capacity. It reported compliance with debt covenants. The facility matures November 1, 2022; availability depends on a borrowing base. As of March 15, 2018, availability was $166.3 million.
- Management said operating cash flow and available credit were expected to fund operations for at least the next 12 months. The company expected customer spending to continue increasing in 2018, following a modest recovery in 2017; it did not provide quantified financial guidance.
- Management cited completion activity, oil and gas prices, customer capital spending and acquisition integration as important drivers. The business is seasonal, with holiday periods and winter weather typically reducing fourth-quarter activity; the filing’s reported fourth-quarter revenue nevertheless includes two months of Rockwater operations.
Risks, contingencies and unusual items
- Industry and execution: Demand and pricing depend on volatile oil and gas prices, drilling and completion spending, competition, labor availability and the successful integration of Rockwater. The company has substantial infrastructure and water-permit exposure in the Bakken.
- Regulatory and environmental: Water sourcing, hydraulic fracturing, wastewater disposal, induced seismicity, emissions and chemical regulation could increase costs, delay operations or reduce customer activity. The company operates permitted saltwater-disposal wells and is exposed to spill, safety and environmental liabilities.
- Emissions investigation: The U.S. Attorney’s Office and EPA were investigating altered emissions-control systems on vehicles associated with acquired Rockwater operations. The filing identified 31 vehicles in Pennsylvania and approximately 30 additional vehicles elsewhere that may have been modified. No charges had been brought as of the filing; the company was cooperating and had agreed to restore or remove affected vehicles. Potential fines and other outcomes were not estimable.
- Lease and insurance obligations: Abandoned-facility lease obligations totaled $22.6 million at year-end; non-cancelable lease payments extend through 2027. The company self-insures certain claims and recorded $14.9 million for workers’ compensation, employer and vehicle liabilities, plus $1.1 million in general liabilities.
- Tax and ownership structure: Tax Receivable Agreements generally require payment of 85% of specified tax savings. A hypothetical termination at December 31, 2017 was estimated at $98.9 million, based on assumptions; no related liability was recorded because associated tax savings were not considered probable. Rockwater’s NOL utilization may be limited following an ownership change.
- Other: The company recorded $12.5 million of phantom-equity and IPO-related compensation and $10.2 million of transaction costs among its 2017 Adjusted EBITDA adjustments. It reported no impairment charges in 2017. Class A-2 shares could generate additional share dilution if specified registration conditions were not met; a resale shelf registration statement was filed in January 2018.
Most important facts for investors to verify
- How much of 2017 and fourth-quarter revenue and earnings improvement came from organic activity versus acquisitions, and whether post-merger margins and cash conversion improve.
- Receivables collection and working-capital trends, given year-end trade receivables of $373.6 million and negative operating cash flow.
- Actual borrowing-base availability, covenant headroom and debt levels, alongside the company’s capital-expenditure and acquisition plans.
- The resolution and potential financial, operational or reputational consequences of the emissions-control investigation.
- Final purchase-price allocations for Rockwater and other acquisitions, goodwill and intangible-asset assumptions, and any resulting impairment risk.
- Potential dilution from Class A-2 conversion, equity awards and other registration-rights sales, as well as the timing and possible cash burden of Tax Receivable Agreement payments.