Flotek Industries, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; filed November 7, 2012. Flotek develops and supplies oilfield specialty chemicals, logistics, drilling equipment and artificial-lift products and services. Figures below are in millions of dollars except per-share data.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $78.6 | $75.1 | $236.1 | $183.9 |
| Gross profit / margin | $33.8 / 43.0% | $30.7 / 40.9% | $100.3 / 42.5% | $74.1 / 40.3% |
| Operating income | $14.6 | $16.1 | $46.9 | $33.3 |
| Net income | $9.8 | $17.9 | $26.6 | $30.4 |
| Diluted EPS | $0.19 | $0.35 | $0.52 | $0.55 |
- Q3 revenue rose 4.8%, while nine-month revenue rose 28.4%. Gross profit increased 10.2% and 35.4%, respectively. Management cited oil- and liquids-rich drilling, market penetration, product mix, pricing and cost containment.
- Q3 operating income fell 9.4% and net income fell 45.3%. SG&A increased 31.1% to $17.2 million, including higher compensation, professional fees and insurance. The prior-year quarter included a $7.8 million noncash gain from warrant fair-value changes; there was no such Q3 2012 gain.
- Nine-month operating income increased 41.0%, but net income declined 12.6%. Results included $6.4 million of debt-extinguishment losses in 2012 and a $2.6 million noncash warrant fair-value gain; the comparable 2011 period included an $18.6 million warrant gain. The warrant agreements were amended in June 2012 and the $14.0 million liability was reclassified to equity.
- Segment trends: Chemicals revenue increased 38.2% for nine months and operating income increased 63.5%; Drilling revenue rose 20.4%, but its gross margin percentage declined to 39.0% from 41.6%; Artificial Lift revenue declined 10.1% as weak natural-gas activity weighed on demand.
Cash, liquidity and debt
- Operating cash flow was $38.5 million for the first nine months; capital expenditures were $15.2 million. Investing activities used $11.9 million net, financing activities used $51.3 million, and cash declined $24.8 million to $21.9 million.
- At September 30, cash was $21.9 million, current assets $113.8 million and current liabilities $85.2 million. The current-liability total includes $54.1 million carrying value of convertible notes classified as current.
- The company repurchased all $36.0 million principal of its 2010 secured notes in January and $15.0 million of its 2008 unsecured notes in June. At quarter-end, $55.5 million principal of the 2008 notes remained outstanding, with a $54.1 million carrying value. Holders may put the notes to the company on February 15, 2013; the notes carry 5.25% interest. Capital lease obligations were $1.9 million.
- The $35 million revolving credit facility was undrawn at quarter-end. It was scheduled to expire December 15, 2012; extension to 2014 was at the lender’s discretion and conditioned on satisfactory refinancing or restructuring of the convertible notes. Management said it was in discussions with the lender and believed the facility would be extended. The company reported covenant compliance at September 30.
Outlook, risks and notable items
- No quantified earnings or revenue guidance was provided. Management expected demand and growth initiatives to continue, while noting uncertainty in economic conditions, gas prices and drilling activity. It anticipated relatively stable activity in unconventional oil and liquids-rich plays, but warned of possible pricing pressure, cost pressures and a receding rig count.
- Natural-gas prices and drilling activity were weak: North American gas rigs averaged 706 year to date versus 1,030 in 2011, while the oil-directed rig count increased. The business remains sensitive to commodity prices, customer exploration budgets, activity levels and competitive pricing.
- Customer concentration is material: three customers represented 15.2%, 10.4% and 9.8% of nine-month revenue, respectively. The company also cited limited sources for certain chemical raw materials and overseas sourcing for some equipment parts.
- Management reported disclosure controls were not effective at September 30 due to a material weakness associated with the ERP system launched July 1. Issues included inadequate system reports, untimely or insufficient controls, and excessive access that weakened segregation of duties. Remediation efforts included refining reports and restricting employee access.
- Management reported no litigation expected to materially affect financial condition, results or liquidity, and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How the $55.5 million notes due for a February 2013 put will be repaid, refinanced or otherwise addressed, and whether the revolving facility is extended.
- Progress in remediating the ERP-related material weakness and whether future filings report effective controls.
- Whether operating cash generation can support the company’s elevated capital spending, debt obligations and liquidity needs.
- Whether Chemicals and Drilling growth and margins can offset continued weakness in Artificial Lift and potential industry pricing pressure.
- The effect of customer concentration and dependence on oilfield activity, commodity prices and key raw-material suppliers.