Flotek Industries, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Flotek supplies energy, consumer and industrial chemistries, drilling tools, and production equipment. Results were materially affected by the oilfield downturn.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $73.7m | $87.9m | $218.3m | $257.3m |
| Gross profit / margin | $25.4m / 34.4% | $31.2m / 35.5% | $74.2m / 34.0% | $87.0m / 33.8% |
| Operating income (loss) | $(4.3)m | $2.8m | $(53.0)m | $(17.1)m |
| Net income (loss) | $(2.7)m | $2.0m | $(35.2)m | $(12.1)m |
| Basic and diluted EPS | $(0.05) | $0.04 | $(0.63) | $(0.22) |
- Q3 revenue declined 16.2% year over year; nine-month revenue declined 15.2%. Q3 gross margin fell 1.1 percentage points, while nine-month gross margin was broadly stable.
- Nine-month results include $40.4m of inventory and long-lived asset impairments, recorded in Q1 2016; the comparable 2015 period included $20.4m of impairment charges. Excluding impairments, nine-month operating losses were $10.9m in 2016 and $3.3m in 2015.
- Q3 segment revenue: Energy Chemistry $45.0m (down 25.2%); Consumer and Industrial Chemistry $19.3m (up 39.2%); Drilling Technologies $7.2m (down 33.4%); Production Technologies $2.1m (down 30.4%). Consumer and Industrial Chemistry growth reflected higher prices and volumes; oilfield segments remained pressured.
- Nine-month operating cash flow was $(0.9)m, versus $17.3m provided in 2015. Working-capital changes used $20.5m, including increased receivables, inventory, and income taxes receivable. Investing cash flow was $(18.7)m and financing cash flow was $20.8m; ending cash was $3.5m.
- At September 30, total debt was $42.6m ($32.6m revolver and $10.0m term loan); reported net debt was $39.1m. Current liabilities were $72.6m against current assets of $160.8m. Available revolver capacity was $22.3m, giving total stated liquidity of $25.8m including cash.
Material changes and financing
- North American rig counts averaged 43.2% lower in Q3 and 52.8% lower for the nine-month period versus 2015, although activity improved sequentially from Q2 2016.
- Flotek closed its July acquisition of International Polymerics, Inc. for $7.9m cash, net of cash acquired, plus 247,764 shares. It also completed a private placement of approximately 2.45m shares, receiving $29.9m net; proceeds were used to reduce revolver borrowings and fund the acquisition.
- A September 30 credit-facility amendment extended maturity to May 2020 and maintained $65m total borrowing capacity. It establishes fixed-charge and leverage covenants beginning in 2017, as well as a $20m annual capital-expenditure limit. The revolver is classified as current debt.
Outlook, risks, and unusual items
- Management expected North American oilfield activity to remain depressed through the rest of 2016 and into the first half of 2017; recovery remained uncertain. No specific revenue or earnings forecast was provided.
- Management expected 2016 capital expenditures of $14m–$16m, including $6.8m to complete its Houston research and innovation center. It cited cost reductions and continued marketing of chemistry and newer production products.
- Management reported no goodwill impairment, but the Production Technologies reporting unit’s Q3 estimated fair value exceeded carrying value by approximately $8.1m (36.9%). Further industry deterioration or different assumptions could result in future impairment charges.
- Four securities class actions were consolidated, derivative litigation was pending, and the SEC had opened an inquiry concerning similar issues. The company said it considered the lawsuits without merit, intended to defend them, and could not reasonably estimate the outcome.
- Customer and industry concentration, oilfield activity and pricing, citrus terpene supply and prices, variable interest rates, and impairment assumptions are material risks. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Investor verification priorities
- Track whether oilfield activity and demand recover as management expected, particularly CnF chemistry volumes and the drilling and production segments’ margins.
- Assess operating cash conversion and working-capital requirements, given negative nine-month operating cash flow and low cash relative to debt.
- Monitor compliance with the amended credit-facility covenants, borrowing availability, debt repayment requirements, and planned capital spending.
- Review the assumptions supporting goodwill and asset valuations, especially for Production Technologies and Drilling Technologies.
- Follow developments in the securities litigation and SEC inquiry, and evaluate the dilution and integration effects of the share issuance and IPI acquisition.