Select Water Solutions, Inc. (WTTR) Q4 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the Select Energy Services' Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris George. Thank you. You may begin.

Thank you, operator and good morning, everyone. We appreciate you joining us for the Select Energy Services' conference call and webcast to review our 2018 fourth quarter and full year Results. With me today are John Schmitz, our Executive Chairman; 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 selectenergyservices.com. There will also be a recorded replay available until March 6, 2019. 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, February 27, 2019. And, therefore, time-sensitive information may no longer be accurate as of the time of the replay 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 Energy's 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 31, 2017, our subsequent quarterly reports on Form 10-Q, our current reports on Form 8-K, and our annual report on Form 10-K for the year ended December 31, 2018 which we expect to file in the coming days to understand those risks, uncertainties and contingencies. Also, please refer to our fourth quarter earnings announcement released yesterday for reconciliations of non-GAAP financial measures. And now, I would like to turn the call over to our Founder and Executive Chairman, John Schmitz.

Thank you, Chris. And I would like to welcome everyone to the Select Energy Services' 2018 fourth quarter conference call. Before I hand the call over to Holli and Nick to review the recent quarter's performance and outlook, I wanted to start by taking a few minutes to look back at 2018 and what we have accomplished. While the fourth quarter was a soft period for the industry, 2018 overall was a very good year. Since we originally set out to combine Rockwater and Select back in 2017, our focus has been to create the clear-cut leader in the industry for comprehensive water solutions. And we believe we have done that. On a combined basis, accounting for the Rockwater merger, we have grown revenues by 22% and adjusted EBITDA by 50% year-over-year and generated over $80 million of free cash flow during 2018. We have expanded our scope of services, executed on acquisitions, and strategically returned capital to the shareholders, all while reducing our outstanding debt and strengthening our balance sheet to support our future strategic endeavors such as our recently announced Northern Delaware water infrastructure project. It is clear that the market environment has changed recently and our industry is undergoing an active transformation. And with that, our customer's business models and priorities have changed away from a cyclical growth towards a capital discipline and free cash flow generation. We believe this is healthy for our industry and that Select's business model and balance sheet are built to thrive in this involving landscape. Our customers trust and value the expertise, scale, efficiency, and safety that we are able to provide them across a wide range of solutions. The oil prices have been gradually climbing since year-end. Recent volatility has created some uncertainty around near-term activity levels. That said, we believe the broader market supply, demand fundamentals, and the secular trends behind the growing demand for water solution in the coming year remain intact. We remain focused on improving operations efficiencies and providing the value add solutions that our blue chip customers need to continue to lead the US as the center of global supply growth for the years to come. With that, let me turn it over to Holli to walk you through some of our recent accomplishments and our outlook before she hands the call over to Nick to cover the financials. Holli?

Thanks, John, and good morning, everyone. Looking back on the fourth quarter, the team delivered strong free cash flow and managed operations through the anticipated, but nonetheless challenging double-digit activity decline seen at year-end. We were able to generate more than $100 million in cash flow from operations which allowed us to execute on a number of our operational and strategic objectives. After funding net CapEx of roughly $50 million, we repurchased approximately $16 million of shares, closed $15 million of acquisitions, repaid $20 million of outstanding borrowings, and still modestly increased our cash balance. For the full-year, as John just mentioned, we generated $80 million of free cash flow. While the activity outlook for 2019 remains somewhat certain, we are still well-positioned to support our customers. And we expect to generate free cash flow during 2019 in excess of our 2018 levels. I am also pleased to talk about our recently announced Northern Delaware infrastructure project. We have begun construction on the system and expect to invest approximately $25 million to have the system operational in the third quarter of 2019. This investment is supported by a five-year take or pay contract with a major international integrated oil company for the purchase and delivery of 75 million barrels of water. We are pleased to have the opportunity to partner with an important customer to support the initial build out. And we will explore additional commercialization opportunities to provide other operators in the area with the services and solutions they need. This new system, which will be capable of delivering 100,000 barrels of water per day, complements our existing GRR infrastructure and operations in this highly dynamic area of developments. Overall, this project showcases the strength of the Select team in developing critical long-term value-added solutions for our customers. With the planned divestment of our non-core operations, including our Affirm and Canadian operations, we're focused on efficiently reallocating our capital from lower margin, more commoditized service offerings, towards more unique high margin and stable cash flow streams from investments such as infrastructure. We anticipate receiving proceeds of 30 million to 35 million for these two businesses, including working capital, with initial proceeds arriving in the first quarter. Gross profit before depreciation and amortization was approximately 3 million during the fourth quarter. Additionally to support our growth initiative, we also continue to strengthen our other service capabilities in New Mexico, as demonstrated by the acquisition of [Technical difficulty] Looking forward, there remain some market big challenges ahead of us, and while oil prices are improving from [Technical Difficulty] conversations with customers, we believe activity could decline by high single digits during 2019. As we look at the first quarter, many of our customers have gotten off to a slow start for the year. And we've seen some seasonal challenges such as cold weather conditions impacting operations, the sentiment is improving, we anticipate the first quarter will look much like the fourth quarter overall, I would also note that our results will likely be impacted by the timing of the planned divestitures I just mentioned. While we didn't see a material impact on the fourth quarter from pricing, we're having more pricing discussions with our customers today. We believe we have differentiated capabilities that our customers value and as these discussions occur, we will be focused on adding more stability to the revenue stream through longer term agreements exclusive and priority vendor status, service offering expansion and other arrangements to partner with our customers. Despite some uncertainty in the macro view, we believe our customers have an ability to generate good returns at current crude oil pricing levels and feel confident about our business and where we sit. While we can't control the number of wells being completed, we can't control our cost management and capital allocation strategy. We have an agile business model, which gives us flexibility to manage our cost and investments in a changing environment. We will continue to drive a disciplined approach to capital deployment in 2019, with a focus on return on assets and free cash flow. While the team continues to evaluate a number of additional infrastructure opportunities, the timing of such opportunities are difficult to predict. As such, we haven't incorporated any major infrastructure projects into our 2019 budget other than the recently announced northern Delaware system. We are budgeting a 2019 capital program of $125 million to $145 million, which again does include the $25 million for the Northern Delaware infrastructure project. To reiterate what John said, we believe we've built the franchise water company to serve the development of US shale. And looking back on 2018, we took a balanced approach in our capital allocation decisions as we invested to maintain our core business, invested growth capital organically and through acquisitions, executed a modest share repurchase, and preserved our financial flexibility by reducing our debt by 30 million over the course of the year. You can expect a similar approach from us in 2019. With that, I'd like to hand it over to Nick to walk through our financial performance in more details. Nick?

Thank you, John and Holli, and good morning, everyone. As Holli just mentioned, our operating cash flow for the quarter of $108 million marked an all-time high for the company and our total operating cash flow for 2018 totaled $232 million. Continuing to generate strong cash flow is our overriding priority regardless of market conditions. We are targeting $85 million to $100 million of free cash flow again after net CapEx for 2019. This is prior to the planned divestitures. Supporting this cash flow target, we are planning a modestly reduced $125 million to $145 million CapEx budget for 2019. We expect that roughly half of this budget will be related to maintenance CapEx. Our forecast utilizes a conservative approach following the capital - the CapEx forecast provided today by our customers. While we believe current oil prices still provide our clients with an attractive return on their investment, E&P capital forecasts are generally expected to be down year-over-year and we've crafted our budget accordingly. The share buyback we executed in the fourth quarter while limited in scope is indicative of the importance we place on returning value to shareholders, while operating under a disciplined capital allocation mindset. We still see attractive investment opportunities such as the recently announced fixed infrastructure project and we are committed to maintaining our strong balance sheet. With an expectation of 2019 free cash flow generation in excess of 2018 levels, we will continue to evaluate additional opportunities to return capital to shareholders during the year. We reported total revenues of $362 million for the fourth quarter of 2018, down 9% sequentially from the third quarter. We believe this revenue decline is generally consistent with the industry completions activity decline quarter-on-quarter. Adjusted EBITDA of 56 million declined from 74 million in the third quarter, driven by both the decline in revenue and by segment specific factors I'll detail shortly. Annually, revenue as reported increased from $692 million in 2017 to $1.5 billion in 2018. Much of this impact was driven by the merger with Rockwater that activity growth drove a substantial effect as well. Similarly, as reported, adjusted EBITDA for the year grew from 117 million to 258 million in 2018. While there is no perfect macro indicator for our business, we do look to the completions count as a relevant and readily available metric even if it is frequently subject to later revision. Fourth quarter is typically a seasonally difficult time for completions activity and this year the sharp decline in oil prices during the quarter exacerbated this trend. We see completions activity improving in the first quarter from its Q4 low, but expect relatively flat quarter-over-quarter levels with limited visibility beyond that at this time. Turning to our segment results, water solutions revenues decreased 12% sequentially to $248 million in the fourth quarter from $281 million in the third quarter. The segment generated gross profit before depreciation and amortization of $56 million compared to $73 million in the third quarter. Gross margin declined from 25.9% to 22.7%. We did see modestly lower than expected margins during the fourth quarter impacting our bottom-line, driven largely by customer related job mix as well as a lag in calibrating expenses with the rapid activity declines as we continued to focus on retaining employees through the period. For Q1, we expect water solutions revenue to stabilize in line with the completions trend. Margins should rebound somewhat as we better align resources with our customers' activity levels, although pricing pressure is a factor in certain areas. While the oil field chemical segment revenues increased 5% to $67 million from $64 million, the segment generated gross profit before depreciation and amortization of $6 million during the fourth quarter, down from just under $8 million in the third quarter. Margins were challenged by higher raw materials costs, driven partly by tariff in positions. While we expect to see flat revenue in this segment over the first quarter, we expect the gross margin percentage to recover to the low teens as seen in the third quarter, as we recapture the higher raw materials costs. Our Wellsite Services segment which will see considerable exchanges going forward with the upcoming divestitures saw revenues decline in Q4 to $47 million as compared to just under $52 million in Q3. While the to-be divested Affirm and Canada businesses declined, we saw continued strength in our rental service line. This business, known as peak oilfield services, will be staying with the company going forward. We've seen continued growth alongside higher returns on this business, even though the recent market challenges and are excited to expand its potential. Turning to our balance sheet, we repaid another $20 million of borrowings during the fourth quarter, while also executing on several strategic uses of cash. Our net CapEx for the quarter totaled $51 million. We ended the quarter with $45 million of borrowings on a revolver and cash on the balance sheet of $17 million for net debt of less than $30 million. There were a number of special items that drove adjustments to our consolidated adjusted EBITDA during the quarter. I encourage you to review the reconciliation tables in our press release for additional detail. This measure includes adjustments for certain non-recurring and non-cash items, including $23 million of impairments. This total is made up of 18 million of goodwill impairment within our Affirm and oilfield chemicals businesses driven primarily by the decline in external market conditions at year-end and $4 million of asset impairments relating to our Canadian operations, reflecting the continued deterioration of this market. Other adjustments included $4 million of non-recurring costs, resulting from sales tax audits for prior years dating back to 2011, including for previously acquired businesses, a $3 million non-cash, non-recurring charge related to a change in vacation policy and other smaller items. Finally, as we transitioned it year-end from emerging growth company status in to SOX 404 compliance, we identified a material weakness in the effectiveness of our internal controls related to the identification and substantiation of fixed assets purchase, specifically related to the purchase price allocation between goodwill and property and equipment in connection with the Rockwater merger. We will be correcting this purchase price allocation of approximately $16 million transferring from property, plant and equipment to goodwill in our upcoming 10-K, which will be filed in the coming days with no adjustment to our prior financials. Looking forward, we expect depreciation and amortization to remain relatively flat in 2019 versus 2018 based on our current capital expenditure budget. We do not expect to be a significant cash taxpayer in 2019 and expect to incur a low to mid single-digit percentage of tax expense, primarily consisting of state obligations, as we continue to benefit from our remaining NOL carry forwards and other tax attributes. Additionally, we do not expect to have material cash related obligations related to either our taxable income or our tax receivable agreement. With that, I'll hand it back to Holli for some concluding remarks.

Thanks, Nick. In conclusion, we're very proud of the strength of our cash flow generation in the fourth quarter and for the year and we are well positioned to capitalize on opportunities in what will be a dynamic market in 2019. We'll continue to remain disciplined with our capital, seeking good long-term high return growth investments while prioritizing cash flow and we'll measure these opportunities against returning capital to shareholders just as we did in 2018. With that, I'll turn it back over to the operator and we'll take the questions.

Thank you. [Operator Instructions] Our first question is from the line of Thomas Curran with B. Riley FBR.

Good morning.

Good morning.

Holli, for the 1Q guidance you gave, when you say 1Q is likely to look like 4Q, if I understood correctly, that's inclusive of the pending divestitures. And if so, when does it assume the divestitures occur within 1Q?

Good question, Tom, and maybe one thing I would clarify, when I say Q1 will look similar to Q4, that's in sort of a total number. Certainly from a trajectory perspective, Q1 looks better. We're in an upward slope versus Q4, it was obviously going down as we exited the year, but there will be some impact, Tom, in Q1 because for example, we actually closed a portion of the sale of the Affirm business yesterday and brought in about 11 million of proceeds. So, over the course of March, we will probably have other opportunities to go ahead and execute there. So activity level-wise, I would say Q1 with a different trajectory, but looks like Q4 with a slight impact from the asset sales that we're going through.

Great. And then just based on the visibility you have now, the latest customer indications, should we assume given the ramp you already have experienced coming out of 1Q that 2Q would then be higher and you'd expect a continued trajectory from there?

I think that's fair that we would expect Q2 to be an improvement on Q1, not only from an activity level, but just also some additional internal focus that we have on some efficiencies. So beyond that, calling the second half of the year is maybe a little early. I do think our customers are going to abide by their commitments to live within cash flow. So I think part of the Q1 challenges, we did have weather in a few regions that maybe completions were down, so that still leaves activity that'll get caught up, but I think from your perspective as you think about Q2 relative to Q1, your assumption is good.

Great. And then turning to the 2019 CapEx budget, taking that total of 125 million to 145 million, extracting the 25 million for the new Delaware pipeline system, could you give us an idea of how the remaining 100 million to 120 million is expected to breakdown in terms of allocations?

Sure. We will say that of that 125 million to 145 million, about half of it is maintenance. So obviously once you pull out the Northern Delaware, that gives you a sense of that 60 million to 70 million for maintaining our current asset base. And beyond that, the types of other investments that we're looking at would be around continuing investment in technology. So adding things like automated proportioning systems, we are taking a fresh water stream and a produced water stream, given the shift in the space that require that. Certainly things like automated manifolds, where we're able to assist our customers at the well pad, and certainly that is going to continue to be something that we invest in, because it makes us more sticky with our customers and it helps us hang on to pricing. And then there'll be other opportunities where we add a water source, a water well or reservoirs to help supplement the systems that we have. So when you think about that additional growth CapEx, that's where you should expect us to put it.

Thank you. And our next question is coming from the line of Tommy Moll with Stephens.

Good morning. Thanks for taking my questions.

Good morning, Tommy.

Wanted to start with the positives news on the infrastructure project in the Northern Delaware, can you give us some background just on how long that had been in the works, how it came together, is it a new customer, is it an existing customer that just wanted to deepen the relationship, what are the milestones that you need to achieve in order to be ready to start in 3Q? And then also you flagged some supply agreements with industrial sources. I wonder if you could give us any details on those.

Sure. So, first of all, if you just look at the history, when we acquired the GRR back in early 2017, that really solidified our presence in New Mexico. So that team has very deep relationships and that stands not only from the customer base but also that ties into your last part of the question on the industrial sources that they were able to secure. So this is a project that's been ongoing and it was active over the course of 2018. And this one was particularly interesting. As I've always described, you have to start with getting the right source at a high rate. You have to have the right-aways to be able to then forward deploy that into a region where your customer needs it. Interestingly enough, the water source was probably the larger challenge here because you don't find high rate water sources in New Mexico very often. So, while we can't really disclose the details of our commitments there, we have long-term commitments on high rates of water that we'll be able to move over our system. And then what the team was able to do was leverage the right-aways, many of which already existed as part of that GRR system. And as you can imagine, while it's never easy finding a customer in [indiscernible] County with an active development program for the next several years was easier than the other things the team had to do, none of which was easy but hopefully that gives you a little more context.

Yes, absolutely, and thank you. As a follow-up, I just want to hit a couple of the modeling points again. You've mentioned a few of these budgets. I just want to make sure I'm following you here. So for 1Q, I think in terms of the as reported financials; we ought to expect revenue to roughly approximate 4Q and by that I mean there will be some headwind due to the divestitures, but in terms of the numbers that you'll report, they ought to look similar. And then as a follow-on to that, is the same true in terms of margin quarter-to-quarter and then below the line, are there any non-cash items that you anticipate may impact the quarter in terms of earnings per share?

Sure. So I think you're correct on thinking about the top line, very similar with the caveat of the divested businesses and knowing exactly when those fallout. From a margin perspective in Q4, we were just above 23% gross margin on our water solutions business. And while - we're certainly having more conversations today on pricing than we were in Q4, we think there's a lot of that that will not come to bear or will be able to mitigate. So I think the right way to think about their margins is low to mid-20s for water solutions makes sense and for chemicals, I think low teens is the right way to think about their gross margins for the first half of the year with hopefully some opportunities to improve that going forward. So hopefully that gives you some context.

Yes, absolutely, and I appreciate it, thank you.

Sure.

Our next question is from the line of Martin Malloy with Johnson Rice.

Good morning.

Good morning, Marty

I was hoping maybe you could talk a little bit about initiatives that you have to grow in the post frac produced water area and how you see that developing?

Sure. So you have a couple of things going on. First, you have to where your operators are trying to live within free cash flow. So whether or not, they want to continue to invest in water infrastructure. I think a lot of those conversations are ongoing today and that's an opportunity for us, given our relationships. And the key there is to be able to take an underutilized single user system and convert that into a multi-user system. If we can identify opportunities to do that, then the economics tend to make sense. But also on that front, what I'll tell you is we're focused on organic development and we're probably more focused there just because we already have the relationships with the customers. We have the surface use agreements, so it's really about designing a complete solution for a particular customer. So it's definitely something that we're focused on and have a few alternatives or options in the queue that the team is working on. And my comments largely relate to the Permian just to be clear because that's where you're seeing high water cuts associated with the increase in production there.

Okay. And then just in terms of the trend towards using more recycled water in frac operations, can you talk about how you see that impacting Select's going forward, I guess, the positives and negatives?

Sure. Relatively speaking, I would say on the balance, it's positive for us. Certainly, one of the things that we've been seeing is that while we haven't seen a reduction in our demand for our services on freshwater, what we have seen is that we're moving more produced water in our water transfer. So in the Permian, 20% to 30% of our water transfer jobs are actually moving that impaired water. And then the demand for things like our automated proportioning systems is going up. Again, that's where you're taking a produced water stream and a freshwater stream and we can then essentially design an output and the system will fall to that. Also things like demand for our automated pumps become more important in a produced water world just because it helps mitigate some of the risks associated with spills. And we've been very active with our customers as it relates to, not only on the pre-frac disinfection of the water stream, but also on the treatment of the produced water, so they can reuse that. So - and I guess finally, I'd note that on the chemical side, as you have changing water quality that actually provides opportunities to be able to develop more customized [indiscernible] systems to help support the customer. So generally speaking, you're absolutely seeing more of a focus on that again in the Permian not so much in other basins, but it's created more opportunities for us that we're seeing today.

Thank you.

Sure.

And our next question is from the line of Mike Urban with Seaport.

Thanks. Good morning.

Good morning.

Great job on the free cash flow this quarter, and love to hear the outlook for 2019. I did wanted to get to that a little bit more and just to be completely clear. The CapEx includes the 25 million for the new project, but the free cash flow number excludes any proceeds that you're getting, is that correct?

That's right, the way we're thinking about it Mike is that essentially maybe stepping back just a little bit as you think about our business model, about a third of our EBITDA or less should be going to maintenance CapEx. Then that leaves us two-thirds to be able to allocate. And as we look forward into '19, what we're saying is after you consider some of the growth opportunities around technology I mentioned, after you consider the Northern Delaware system, we still have at least 80 million that has been, they will say is unallocated. And then if you add sales of wellsite services proceeds on that becomes a larger number that we have yet to allocate to either you think about additional growth opportunities around infrastructure, debt reduction is probably lower on our list, but certainly it wouldn't be completely out of question that we could pay that down just to have drypowder to fund future investments, but then returning value to our shareholders is certainly part of our capital allocation strategy as well.

Great, thanks. And you've also done good job in kind of pulling back in some of the working capital and really good result there in the fourth quarter. How much more do you have to go there, is there more to harvest there and how should we think about the working capital element of that free cash flow guidance?

Sure, Mike. So we pulled in about 40 million to 45 million of accounts receivable purely through days sales outstanding, reducing that total there. We have given a total in our last call of between $50 million and $75 million expectation between fourth quarter through the first half of this year. So I'd say, we're pretty well on our way to reaching that and it probably moves towards the high-end of that expectation versus the low-end. So we do believe there is a little bit more value there. I would say we had $108 million of operating cash flow. This effort delivered about 40 to 45 of it. So there's a significant chunk there that's coming from the business, the majority. And so we don't want to obscure that with the success that we're having on the working capital front.

Okay, so a little bit more to do there, but most of that improvement for cash flow is operating is the way to interpret that?

That's right.

Okay, that's all from me. I'll come back if I have any other questions. Thank you.

Thanks.

Our next question is from the line of Kurt Hallead with RBC.

Hey, good morning.

Good morning, Kurt.

So Holli, just wanted to get general sense as you think about this new pipeline contract that you have take-or-pay contract. Can you give us some general sense on what we can anticipate as may be kind of annualized revenue generation from that and how should we think about the payback period of that investment?

Sure. So as I mentioned that it will come online sometime in the third quarter, it always takes a little bit of time to get those things operating efficiently. But maybe the right way to think about it is on an annualized basis, should add 6 million to 7 million of gross margin. And when - we'll refer oftentimes to as we think about our capital allocation, being capital discipline, it has to meet a particular return threshold for us. And just for you all's benefit, the way we think about that is our internal hurdle rate is 2 to 3 times, times return. So we start, also as we've said in the past, we look at paybacks and say, this system, we want to have an anchored tenant that gets us a four year payback. And then we can commercialize the system further to bring that in, but we also balance that with the times return of that two to three that I mentioned.

Got you. And then I think my general understanding is that the take-or-pay deal I think only accounts for about 40% of the total pipeline capacity, and so, when you think about how should we think about the potential aggregate annualized say gross margin for this pipeline, given the fact that you have 60% incremental capacity to use?

I think the right way to think about it is you'll seldom get to 100% utilization because you can't fill the pipe to its full extent every day, but I think it's not unreasonable to think that we could double that sort of gross margin contribution once we have the system fully commercialized.

Okay. And is that fully commercialized, meaning once you step into 2020 or does it take longer than that?

I would say we're working on it today and I'll have more feedback for you probably on the next call.

Okay. Great, thanks. And then follow-up I had was, as you divest the Affirm business, when you extract that, what's the annualized kind of revenue run rate for the remaining businesses within wellsite?

So I think the way that we thought about it, sorry and I am going to let Nick clean me up here a little bit is that, as we describe, we'll divest of the Affirm, which is our construction - wellsite construction business, we'll divest of Canada. We'll be getting out of the sand hauling business, so what that leaves is the rental business peak and that's something that actually fits quite well into our water solutions offering. And it's been a business, it's performed well through, actually even through the fourth quarter. And so I think we'll have more information to give you on the total impact. But we did indicate that the gross margin for the businesses that we're divesting was about 3 million in the fourth quarter. But Nick, I don't know what else you would add.

Yeah. That's right, Holli. And Kurt, to give you an idea going forward, peak accounts for under half of the revenues of that segment there, but on a gross profit basis, it's about two-thirds of that segment. So it's really the core performer there and we're excited about getting to invest in it a bit more and hopefully expand its contribution to the whole company.

Okay. And that's great color. Appreciate that. Thank you.

Our next question is from the line of Jud Bailey with Wells Fargo.

Thanks. Good morning.

Good morning.

Hey, Holli, a question on water solutions margins, you talked about the first quarter expectation. How would you help us maybe directionally think about year-over-year for 2019, given the headwinds for completions, but you guys have done a nice job of maintaining margins, is keeping margins at the same level year-on-year broadly speaking achievable in your mind or is there a scenario where there could be higher or is the bias lower and maybe help us think about kind of full-year versus '18?

Sure. It will obviously be somewhat dependent on activity levels, but we're baking in some activity level declines in 2019, just given where operators' capital budgets are and we do think that there'll be some headwinds around pricing, but we have line of sight to some improvements we can continue to make in our business and as we continue to invest in things like technology, I think that will continue to drive costs out of the system. So to maintain the 2018 margins, which if you think about that in total for the businesses that we're retaining, is just over 22%. I think that's probably the right way plus or minus that there's probably more downward pressure than there is uplift on that number. But I don't think, we expect it to be materially different.

Okay. I appreciate the color on that. And then my follow-up is after this latest New Mexico pipeline project, how would you assess the outlook for future opportunities in that kind of same opportunity set. Are you more likely to do something like that do you think or is there anything on the chemicals side that is of interest from a growth opportunity standpoint, maybe give us your thoughts on that?

Sure. I think on the chemicals side, it's more of an inwardly focused operational efficiency, getting our volumes up to capture that operating leverage. So we're more focused there, less capital going into that business and more process and volume oriented and technology oriented and adding new product lines to service our customers. When we think about the other water solutions and the growth opportunities around infrastructure, we think that again we have a queue of projects that we're continuing to work on and we're focused there. We're looking at pre-frac and post-frac, but we're focused on the Permian and in the Bakken, the Permian because it's a natural, when you think about our footprint that our ability to be able to build off of that is good. And then in the Bakken, we have - we still have opportunities as it relates to our unique water source up there and our Thomson [ph] Intake. So we're still, I think optimistic about being able to bring good options forward for us to then consider as we think about how to allocate that additional cash flow that the business is going to generate.

Okay. I appreciate that. I'll turn it back. Thanks.

Thanks.

And our next question is from the line of J.B. Lowe with Citi.

Hi, good morning everyone.

Good morning.

It sounds like as produced water transfer is - sounds like it's becoming a pretty sizable chunk of your transfer business. Is there any margin differential between moving freshwater versus moving produced water, is one higher cost than the other and do you make up for it on revenue side. Just what's kind of rule of thumb there?

Excuse me, yes. What you will tend to find is there are fewer people that operators will trust to move produced water, just because of the implications of, if you have an issue and the fact that we have things like the automated pumps and that help mitigate some of those risks. That certainly distinguishes us and it does allow you to think about how you're going to price that sort of activity. Our cost is really not different in the sense of you don't have a different set of tools we are using to execute that, but again, it's more of a benefit to us in a sense of there are fewer people that are capable or maybe I should say that operators choose to use to assist them as they're moving an impaired water.

I guess would maintenance costs be higher like if you have to replace your lay flat more often given the [indiscernible] anything like that?

We haven't seen that yet. I think to anticipate some of that over the life of the hose is probably not unreasonable, but then as you can imagine, it absolutely depends on the different varying quality of the water, right, sometimes an impaired water is actually not going to be any more or very much more corrosive than another water stream, we're using a brackish water or something but it is something that we will continue to monitor over time.

Okay, thanks. And then just on the Oilfield Chemicals, the tariff cost that you guys saw in 4Q. It sounds like you're going to get margins back up in 1Q. How are you mitigating the higher raw materials cost and where did those tariffs, were you sourcing material from China or what was the tariff impact there?

Sure. And maybe due to stepping back, what you find on your raw material costs in the chemicals is it usually has a sort of a quarter lag and then it's going to depend on is the product that we're manufacturing, an oil based product or [indiscernible]. So, what you'll find is that it seems sort of odd that our raw material costs will go up in Q4, as oil prices were falling, but that's because that was based on more Q3 pricing. And then the tariffs were something that came in to impact us in Q4 and it was certain materials that we import from China and the way you get that back is generally speaking, again, the pressure pumper is our customer for these products and we are able to pass through changes in raw material costs like that to them, but you can't do it immediately. So that's why we believe that we will be able to improve our margins, part of that in Q1 is due to being able to pass that - those additional costs through.

All right, thanks, and last one for me. At the beginning of the year, there was probably a better opportunity to buy back some of your own stock? Did you guys do any repurchases early in the quarter?

I think maybe the best answer there is that you may be familiar or aware of it, we're going to blackout period and that starts for us 15 days before a year or quarter end that we have to abide by.

Okay. Thank you. This concludes today's question-and-answer session. I would like to turn the floor back to Holli Ladhani for closing comments.

Yes, just a couple of key thoughts guys that I want to make sure we leave you with. Certainly, we were proud of the free cash flow that the team generated in 2018 and that's what we absolutely will hold ourselves accountable to is to generate at least that much again in 2019. And then, again, there's some uncertainty around '19 and we're just going have to be nimble, and I do think we're positioned well, but what you're going see us focused on is really four things in '19 and that's around our operational execution, it's going to be around identifying additional high return growth opportunities, delivering free cash flow and then just ensuring that we have a disciplined approach to how we allocate that free cash flow. So that's what you all should expect from us in 2019, but thanks for joining us today.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.