Flotek Industries, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet figures are as of March 31, 2012. Unless otherwise indicated, amounts below are in U.S. dollars.
Business context
Flotek develops and supplies oilfield specialty chemicals and logistics, down-hole drilling and production equipment, and artificial-lift products. Its three reportable segments are Chemicals, Drilling, and Artificial Lift. Results reflect a market shift toward oil and liquids-rich drilling, supporting Chemicals and Drilling, while low natural-gas prices weighed on Artificial Lift.
Financial results and liquidity
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Revenue | $79.2 million | $52.9 million |
| Gross profit / margin | $33.5 million / 42.2% | $21.1 million / 40.0% |
| Operating income / margin | $16.7 million / 21.1% | $9.3 million / 17.5% |
| Net income | $3.6 million | $10.4 million |
| Diluted EPS | $0.07 | $0.13 |
| Operating cash flow | $5.7 million | $(2.8) million |
| Capital expenditures | $4.1 million | $1.2 million |
- Revenue increased 49.7% year over year. Chemicals revenue rose 76.9% to $47.6 million; Drilling rose 28.1% to $29.0 million; Artificial Lift fell 23.3% to $2.6 million.
- Gross margin improved 2.2 percentage points, with management citing product mix, pricing, cost controls, and market penetration. SG&A rose 44.2% to $14.9 million, primarily from higher labor, stock compensation, and medical costs.
- Net income fell despite stronger operating results, principally because Q1 2012 included a $5.4 million debt-extinguishment loss and a $3.9 million noncash warrant-liability expense. Q1 2011 instead included $7.6 million of noncash warrant-liability income. The prior-period net income also included preferred-stock dividends and accretion, reducing income attributable to common holders.
- Operating cash flow less capital expenditures was approximately $1.6 million. Cash declined from $46.7 million at year-end to $13.3 million, mainly reflecting repayment of the $36.0 million secured convertible notes and related interest. Accounts receivable and inventory increased as working capital supported higher activity.
- At March 31, cash was $13.3 million, current assets $104.9 million, and current liabilities $95.4 million. The $35 million PNC revolving credit facility was undrawn. Total debt included $70.5 million principal of unsecured convertible notes and $2.0 million of capital-lease obligations.
Material changes, outlook, and risks
- On January 5, 2012, Flotek repurchased all $36.0 million of its secured 2010 Notes for 104.95% of principal plus accrued interest. The notes were cancelled and their liens released. The remaining 2008 Notes carry 5.25% interest; holders may first require repurchase on February 15, 2013. Flotek classified the notes as current and was exploring repayment, refinancing, or renegotiation alternatives.
- Flotek breached the Credit Facility fixed-charge coverage covenant as of March 31 following the debt repayment. PNC waived compliance on May 7, 2012 and amended the coverage-ratio calculation. The facility also has an EBITDA-to-debt covenant, a capital-expenditure limit, and a stated term through December 15, 2012, subject to a lender extension option and acceptable refinancing or restructuring of the convertible notes.
- Management expected operating cash flow and available cash to cover anticipated operations, capital spending, and debt service through the remainder of 2012. It forecast continued favorable oil-directed activity and demand for specialty chemicals, while noting uncertainty over natural-gas activity, economic conditions, geopolitical events, competition, pricing pressure, and cost inflation. No specific revenue or earnings guidance was provided.
- The 2012 capital budget was approximately $14.4 million, with $11.0 million remaining at quarter-end. Management planned capacity and equipment investment, international expansion, product development, working-capital management, and possible sales of non-core assets.
- Risks include dependence on oil-and-gas activity and commodity prices, concentration in a small number of customers, credit exposure from receivables, reliance on limited sources for certain raw materials and imported components, and the financing or refinancing of the near-term convertible-note obligation. Two customers represented 16% of Q1 2012 revenue; more than 97% of the cited customer revenue concentration related to Chemicals.
- Management reported no known litigation expected to materially affect the company and no material changes to the previously disclosed risk factors. Disclosure controls were considered effective at March 31, 2012.
Important facts for investors to verify
- How Flotek intended to address the $70.5 million principal obligation and the February 2013 holder put right, including any subsequent refinancing or repayment developments.
- The effect and ongoing requirements of PNC’s May 7 covenant waiver and amendment, and whether the revolving facility remained available on acceptable terms.
- Whether Chemicals and Drilling growth and gross-margin gains persisted, and whether low natural-gas prices continued to pressure Artificial Lift.
- Cash conversion, receivables and inventory needs, capital spending, and the company’s ability to maintain liquidity after the substantial cash reduction.
- The sensitivity of reported earnings to the Level 3 warrant-liability valuation and other noncash or one-time items.