Flotek Industries, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Flotek develops and supplies oilfield chemicals, drilling and artificial-lift technologies, and related services. Its May 10 acquisition of Florida Chemical added non-energy chemicals for flavor, fragrance, food, beverage, and industrial markets. Florida Chemical results are included from the acquisition date.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $93.6 million | $78.3 million | $171.8 million | $157.5 million |
| Gross margin | $37.6 million (40.2%) | $33.0 million (42.2%) | $70.2 million (40.9%) | $66.5 million (42.2%) |
| Operating income | $13.5 million | $15.6 million | $26.1 million | $32.3 million |
| Net income | $8.4 million | $13.2 million | $16.2 million | $16.8 million |
| Diluted EPS | $0.16 | $0.25 | $0.31 | $0.33 |
Q2 revenue rose 19.5% and first-half revenue rose 9.1%. Management said Florida Chemical contributed $14.5 million of revenue in the periods; excluding the acquisition, Q2 revenue increased 1.0%, while first-half revenue was essentially flat. Higher SG&A and depreciation and amortization more than offset the gross-margin increase: operating income declined 13.2% in Q2 and 19.4% for the first half. Reported gross margin percentages contracted year over year. The filing attributes underlying margin pressure mainly to product mix in Chemical Technologies.
First-half operating cash flow was $11.5 million, down from $22.1 million. Investing used $59.5 million, including $53.4 million net cash for Florida Chemical and $9.1 million of capital expenditures. Financing provided $51.0 million. Cash increased $2.8 million from year-end to $5.5 million.
Liquidity, debt, and balance sheet
At June 30, cash was $5.5 million, current assets $143.0 million, and current liabilities $89.3 million; reported figures imply working capital of approximately $53.6 million. Total debt was approximately $88.8 million: $37.6 million drawn on a $75 million revolver, $49.4 million on the term loan, and $1.8 million in capital leases. The filing classifies revolver borrowings as current. The term loan is due May 2018, with monthly principal payments. The company reported compliance with its debt covenants at quarter-end; the facility includes leverage covenants and restricts cash dividends.
Total assets increased to $383.1 million from $219.9 million at year-end, largely reflecting the acquisition, including $39.3 million of newly recorded goodwill and acquired intangible assets. The company repurchased the remaining $5.2 million of convertible notes in February 2013 and had no convertible senior notes outstanding at June 30.
Material changes and management commentary
- Florida Chemical was acquired for total consideration of $106.4 million: $49.5 million cash, $52.7 million in Flotek shares, and $4.2 million repayment of debt. It contributed $2.7 million of operating income from May 10 through June 30. Acquisition costs of $1.1 million were expensed.
- Q2 and first-half oilfield activity faced a weaker backdrop: average North American rig counts declined about 11% year over year, with natural-gas rigs down approximately 35% in Q2. Management cited pricing pressure, tight customer budgets, and competitive markets. Oil prices were comparatively stable and natural-gas prices improved, but remained well below 2008 levels.
- Chemical Technologies revenue decreased 1.4% for the first half, while operating income fell 13.2%; the company cited lower demand, international sales declines, lower-margin product mix, and higher costs. Drilling Technologies revenue was broadly flat, with reduced motor rentals offset by product and service growth. Artificial Lift revenue increased, supported by pump and international valve sales.
- Management emphasized R&D, product differentiation, capacity and geographic expansion, and organic and acquisition-led growth. The 2013 plan anticipated stable industry conditions and approximately $10.2 million of remaining capital expenditures; no specific earnings or revenue guidance was provided.
Risks, contingencies, and unusual items
- Results remain exposed to oilfield activity, commodity prices, customer spending, pricing competition, and product and raw-material availability. Revenue is concentrated in oil and gas customers; one customer accounted for 17.2% of first-half revenue, predominantly in Chemical Technologies.
- Operating cash flow was reduced by approximately $14.1 million of working-capital use, including inventory growth and lower accounts payable. Variable-rate debt creates interest-rate exposure.
- A $10.0 million escrow fund, split equally between cash and company stock, was established for Florida Chemical seller indemnification obligations. Management said routine litigation was not expected to materially affect the company.
- In July, Flotek entered a non-binding letter of intent to acquire Eclipse IOR Services for expected consideration of approximately $6.5 million, subject to due diligence.
- Management reported disclosure controls effective at June 30 and said previously reported weaknesses related to ERP implementation and monthly close had been remediated. Florida Chemical was excluded from the internal-control evaluation as a recently acquired business.
Important facts for investors to verify
- Whether Florida Chemical’s acquired revenue, margins, and expected integration benefits are sustainable, including exposure to citrus-oil availability and seasonality.
- Whether operating cash flow and working-capital management improve as inventory and receivables expand.
- Debt covenant headroom, revolver availability, repayment requirements, and exposure to variable interest rates.
- Underlying segment margins and oilfield demand, particularly product mix, motor-rental trends, and customer concentration.
- Progress and final terms, if any, of the non-binding Eclipse IOR Services transaction.