Flotek Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; figures are unaudited. Flotek develops and sells oilfield chemistry and services, alongside citrus-based compounds and specialty chemicals for consumer and industrial markets. Its continuing operations comprise Energy Chemistry Technologies (ECT) and Consumer and Industrial Chemistry Technologies (CICT); previously sold Drilling Technologies and Production Technologies are presented as discontinued operations.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $59.1 million | $85.2 million | $119.6 million | $165.1 million |
| Operating loss | $46.5 million | $1.3 million | $53.3 million | $1.9 million |
| Net loss attributable to Flotek | $75.0 million | $3.8 million | $75.0 million | $15.8 million |
| Loss per share, diluted | $1.30 | $0.07 | $1.30 | $0.27 |
| Operating cash flow | Not stated for quarter | $(19.0) million | $(7.2) million |
- Revenue declined 30.6% in Q2 and 27.6% in the first half year over year. The contraction was concentrated in ECT: Q2 revenue fell 40.0% to $39.5 million and first-half revenue fell 36.3% to $80.6 million. CICT revenue was broadly stable, at $19.5 million for Q2 and $39.0 million for the half year.
- Cost of revenue, excluding depreciation and amortization, was 79.1% of revenue in Q2 versus 68.8% a year earlier, and 77.3% for the half year versus 66.7%. The corresponding gross margin was approximately 20.9% and 22.7%, compared with 31.2% and 33.3%.
- Q2 and first-half operating results included a $37.2 million impairment that eliminated all ECT goodwill. Excluding that charge, ECT still recorded operating losses of $0.7 million in Q2 and $0.9 million in the first half, versus operating income in the comparable 2017 periods. CICT operating margin was 3.3% in Q2 and 7.9% for the half year, down from 6.3% and 12.8%.
- Q2 included a $2.6 million write-down of assets held for sale. Income tax expense was $23.5 million for Q2 and $15.9 million for the first half, largely reflecting a valuation allowance recorded after management concluded certain deferred tax assets were unlikely to be realized. Net deferred tax assets fell from $12.7 million at year-end to zero.
- At June 30, cash was $3.1 million, net accounts receivable $43.2 million, and inventory $90.8 million, up from $75.8 million at December 31. Total assets were $281.0 million and equity was $194.3 million. Net working capital was $64.0 million.
- Six-month operating cash use was $19.0 million, including a $17.1 million cash outflow from higher inventory. Investing cash use was $3.4 million, including $3.2 million of capital expenditures. Financing provided $20.9 million, principally from net revolving-credit borrowings; cash declined $1.5 million.
Debt, liquidity and outlook
- Revolving-credit borrowings were $49.1 million, up from $28.0 million at December 31, 2017. The facility has a $75 million maximum; available borrowing capacity net of borrowings was $17.0 million. Together with cash, reported total liquidity was $20.1 million.
- The borrowing is classified as current because of the lockbox arrangement and subjective acceleration clause, although the credit facility runs through May 2022. Flotek reported compliance with covenants at June 30. The June amendment suspended fixed-charge coverage and leverage-ratio testing through year-end 2018, subject to an availability trigger; those tests are scheduled to begin in 2019. Verify the terms and headroom, as liquidity is limited.
- Management expects U.S. oilfield activity to remain stable if crude prices remain relatively stable and regulatory impediments are limited. It expects to continue marketing CnF and PCM chemistry offerings, while noting near-term customer purchasing shifts and business-model challenges. No quantified revenue or earnings guidance was provided.
- Management forecast 2018 capital spending of $9–$13 million; $3.2 million had been spent in the first half. The credit agreement caps annual capital expenditures at $26 million.
- In Q2, the company committed to divest certain ECT business-line assets and expected to complete the sale by year-end 2018. Separately, it cited citrus-crop shortages and price volatility, oilfield demand and activity, raw-material costs, customer concentration, weather, and regulatory actions as risks.
Contingencies and other notable matters
- A securities class-action dismissal was on appeal. Derivative lawsuits remained pending; management said it could not reasonably estimate their outcome. The SEC had concluded its related inquiry and stated it did not intend to recommend enforcement action.
- Management attributed weaker results to ECT sales declines, product mix, weather and operational challenges, reduced orders from certain customers, direct-sourcing shifts by E&P companies, higher raw-material and labor costs, lower manufacturing throughput, inventory adjustments, and logistics spending.
- Disclosure controls were assessed as effective at June 30, 2018; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether ECT sales and margins stabilize, and whether management’s oilfield-market assumptions and product adoption expectations are supported by subsequent results.
- The assumptions behind the $37.2 million goodwill impairment and whether further impairment or tax-asset valuation allowances could be required.
- Current borrowing availability, covenant trigger conditions, debt classification, and the company’s ability to fund operations and planned capital expenditures with limited cash and liquidity.
- Inventory quality and conversion to sales and cash, given the $15.1 million increase since year-end and the reported inventory reserve.
- Progress, proceeds, and any additional costs from the planned ECT asset divestiture, as well as developments in the pending litigation.