Flotek Industries, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. All financial amounts below are in U.S. dollars; dollar figures are in millions unless noted.
Business context
Flotek supplies energy chemicals, drilling and production equipment, and consumer and industrial chemicals. Its four reportable segments are Energy Chemical Technologies, Consumer and Industrial Chemical Technologies, Drilling Technologies, and Production Technologies. The interim financial statements are unaudited.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $116.8 | $98.4 | $324.7 | $270.2 |
| Gross margin | $46.1 | $37.5 | $132.1 | $107.7 |
| Gross margin rate | 39.5% | 38.1% | 40.7% | 39.9% |
| Operating income | $20.8 | $15.1 | $57.3 | $41.2 |
| Net income | $14.3 | $9.0 | $37.3 | $25.2 |
| Diluted EPS | $0.26 | $0.16 | $0.67 | $0.47 |
Q3 revenue grew 18.7% year over year; nine-month revenue grew 20.1%. Net income increased 59% in Q3 and 48% for the nine-month period. SG&A was $21.5 million in Q3 and $63.9 million for nine months, but declined as a share of revenue to 18.4% and 19.7%, respectively. Effective tax rates were 29.8% for Q3 and 33.0% for nine months, down from 38.6% and 36.7% in the prior-year periods.
Cash flow, balance sheet and debt
- Nine-month operating cash flow was $39.9 million, compared with $21.4 million in 2013. The company reported $12.7 million of working-capital use, including an $18.0 million inventory increase.
- Investing cash outflow was $16.7 million, including $13.5 million of capital expenditures and $5.7 million of net acquisition payments, partly offset by $3.3 million of asset-sale proceeds. Financing cash outflow was $20.7 million.
- Cash and cash equivalents were $5.3 million at September 30, 2014, plus $0.8 million of restricted cash. Current assets were $169.2 million and current liabilities $58.6 million.
- Total debt was $41.6 million, down from $62.1 million at December 31, 2013: $37.3 million on the term loan and $4.2 million under the revolving facility. Revolver availability, net of borrowings, was $70.6 million. Management reported compliance with all debt covenants.
- Total assets were $412.4 million and total equity was $297.6 million at quarter-end. Accounts receivable was $69.3 million and net inventory $81.4 million.
Material changes and segment trends
- Energy Chemical Technologies drove growth: Q3 revenue rose 32% to $68.2 million, primarily on stimulation chemical additives. Nine-month revenue rose 34% to $193.1 million. Q3 segment gross margin rate eased to 41.7% from 42.3%, reflecting incentive pricing, logistics costs and inventory adjustments.
- Drilling Technologies Q3 revenue increased 8.5% to $29.9 million, while nine-month revenue fell 4.9% to $82.1 million. Management cited competitive pricing, lower domestic Teledrift rentals, weaker product sales and higher repair costs for the nine-month decline in operating income.
- Consumer and Industrial Chemical Technologies Q3 revenue fell 10.3% to $13.7 million, mainly from lower terpene sales. Nine-month growth reflects Florida Chemical, acquired in May 2013, and is not directly comparable on a same-business basis.
- Production Technologies Q3 revenue rose 28.3% to $4.9 million, but nine-month revenue fell 15.6% to $10.1 million. International valve sales improved Q3 mix; lower pump and pump-equipment sales weighed on the nine-month period.
- Flotek acquired EOGA in January 2014 and SiteLark in April 2014. These acquisitions added EOR and reservoir-engineering capabilities. Goodwill increased to $71.1 million; the filing reported no goodwill or other asset impairment. A final Florida Chemical purchase-accounting adjustment increased current deferred tax assets and reduced goodwill by $1.2 million.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management expected market conditions to remain broadly consistent with recent conditions, while noting that rig-efficiency gains create pricing pressure, particularly for Drilling Technologies. The company planned to expand Energy Chemical and Drilling capacity, develop products and markets, and refocus Production Technologies on niche opportunities. It expected competition for contracts and margins to remain intense, but anticipated potential market-share gains from innovation and FracMax data analytics during the rest of 2014 and into 2015.
Management said 2014 and expected 2015 citrus-oil supplies were sufficient for current needs, but price volatility could cause quarterly revenue and margin fluctuations. The business is exposed to oil-and-gas activity, customer demand, raw-material costs, regulatory action affecting chemical use, and geopolitical and economic changes. One customer represented 12.7% of Q3 revenue and 17.0% of nine-month revenue; more than 93% of that customer’s revenue was in Energy Chemical Technologies. Management reported no litigation expected to materially affect the company. The company had no material off-balance-sheet arrangements and no material changes to reported risk factors.
Flotek announced FracMax Analytics, LLC in October 2014, after quarter-end. The company also said it intended to file a universal shelf registration in the future; it reported no immediate intention to access capital markets.
Important facts for investors to verify
- How much of revenue growth reflects organic demand versus acquisitions, particularly Florida Chemical, EOGA and SiteLark.
- Whether the inventory build and working-capital use convert into cash as sales develop.
- Whether Energy Chemical growth and margins remain durable amid pricing and logistics pressures.
- Whether Drilling Technologies can recover from lower nine-month revenue and repair costs, and whether Production Technologies’ repositioning improves results.
- The effect of customer concentration, oil-and-gas activity, citrus-oil prices and chemical regulation on future results.
- Debt-covenant headroom, revolver availability and planned capital spending, including the proposed Oman manufacturing facility.