Flotek Industries, Inc. — Q2 2015 Form 10-Q
Business context and period. Flotek supplies energy, drilling and production technologies, alongside consumer and industrial chemistries. This unaudited report covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. The company cited sharply lower North American drilling activity amid falling oil prices.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $87.0 million | $105.3 million | $169.4 million | $207.9 million |
| Gross margin | $29.3 million (33.6%) | $42.3 million (40.2%) | $55.8 million (32.9%) | $86.0 million (41.4%) |
| Operating income (loss) | $(18.6) million | $17.7 million | $(19.9) million | $36.5 million |
| Net income (loss) | $(12.5) million | $11.0 million | $(14.1) million | $23.1 million |
| Diluted EPS | $(0.23) | $0.20 | $(0.26) | $0.42 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $11.5 million | $18.4 million |
- Q2 revenue declined 17.4%; first-half revenue declined 18.5%. Gross margin percentage fell 6.6 and 8.5 percentage points, respectively.
- The company recorded a $20.4 million pretax impairment charge in Q2: $19.6 million related to Drilling Technologies inventory and rental equipment and $0.8 million related to Production Technologies inventory. The charge followed segment strategy changes and lower expected asset utilization.
- For the six months, investing cash outflow was $8.3 million and financing cash outflow was $1.8 million. Cash increased $1.2 million to $2.5 million.
- At June 30, total debt was $52.2 million ($30.3 million classified as current); total debt less cash was $49.7 million. Revolver availability, net of borrowings, was $49.7 million, for reported total liquidity of $52.2 million.
- Total assets were $403.4 million, down from $423.3 million at year-end 2014; total equity was $290.2 million, down from $306.4 million. The company reported compliance with debt covenants.
Material changes and segment performance
- The filing attributed revenue and margin pressure primarily to depressed oilfield activity, pricing concessions, strategic incentive pricing and product mix. Average North American rig counts were down 51.0% year over year in Q2 and 37.5% for the first half.
- Energy Chemistry Technologies revenue fell 9.8% in Q2; its gross margin rate dropped to 36.2% from 43.8%. CnF sales volume nevertheless rose 76% from Q1 2015 and 34% from Q2 2014.
- Consumer and Industrial Chemistry Technologies revenue increased 22.8% in Q2, with higher flavor-and-fragrance and terpene sales; operating income also improved.
- Drilling Technologies revenue fell 54.7% in Q2 and recorded a $19.6 million impairment. Excluding impairment, the segment reported an operating loss of $1.7 million for the quarter.
- Production Technologies Q2 revenue declined 4.7%; margin pressure reflected product mix, and the segment recorded a $0.8 million inventory impairment.
- SG&A increased 10.4% in Q2 and 9.8% year to date, reflecting higher stock compensation, professional fees, sales staffing and a $410,868 EPA penalty, partly offset by cost reductions.
Outlook, risks and unusual items
- Management described continued challenging market conditions and expected competition for contracts and margins to remain intense. It said product innovation, service improvements and FracMax analytics could support market-share gains in the second half of 2015 and into 2016; this is not quantified earnings guidance.
- Management expected 2015 capital spending of approximately $25 million, including about $10 million for laboratory facilities; approximately $16 million remained planned or committed for the rest of the year. The company reported first-half capital expenditures of $9.0 million.
- Flotek refocused Drilling Technologies on markets with better prospects for profitable growth and shifted Production Technologies toward oil production and away from coal-bed methane. It acquired International Artificial Lift for $1.3 million cash plus 60,024 shares and announced a Solazyme commercialization arrangement.
- Liquidity and performance remain exposed to oil and gas activity, commodity prices, customer demand, pricing pressure, citrus-oil supply and pricing, and regulatory limits on chemical use. Two customers represented 19.5% and 12.1% of Q2 revenue; more than 96% of revenue from these customers was in Energy Chemistry Technologies.
- The EPA matter was resolved without admission or denial of the allegations; FC Pro paid the $410,868 penalty and adopted specified procedures. Management said routine litigation was not expected to materially affect the company.
- The board authorized an additional $50 million stock-repurchase program in June. The company repurchased $7.3 million of shares in the first half under its programs and reported $57.3 million of remaining authorization at June 30.
Investor verification points
- Assess whether weaker rig activity, lower pricing and product mix continue to compress revenue and gross margins, and whether CnF volume growth translates into sustainable profitability.
- Verify the basis and future implications of the $20.4 million impairment, including asset utilization and the planned Drilling and Production Technologies repositioning.
- Monitor operating cash generation, working-capital needs, debt levels, revolver availability and compliance with credit-facility covenants, particularly given limited cash on hand and substantial planned capital spending.
- Track execution and returns on the Houston research facilities, product launches and IAL acquisition against management’s stated expectations.
- Review customer concentration, repurchase activity and the resolved EPA matter for any subsequent material developments.