Flotek Industries, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; comparative periods ended September 30, 2010. Flotek supplies oilfield products, services and equipment, including specialty chemicals and logistics, drilling tools, and artificial-lift products.
Financial results and liquidity
- Q3 revenue: $75.1 million, up 87.7% year over year. Gross profit was $30.7 million; gross margin expanded to 40.9% from 40.2%.
- Q3 earnings: Operating income was $16.1 million versus $6.0 million. Net income was $17.9 million versus a $1.2 million loss; diluted EPS was $0.35 versus a $0.09 loss.
- Nine-month results: Revenue was $183.9 million, up 84.8%; gross profit was $74.1 million and gross margin was 40.3%, versus 35.6%. Operating income was $33.3 million versus an operating loss of $1.1 million. Net income was $30.4 million versus a $16.8 million loss; diluted EPS was $0.55 versus a $0.90 loss.
- Cash flow: Nine-month operating cash flow was $8.1 million, compared with $2.0 million. Investing used $2.4 million and financing provided $0.1 million. Cash increased $5.6 million to $25.5 million. Receivables rose $19.1 million and inventory rose $8.5 million, weighing on operating cash flow.
- Balance sheet and liquidity: Current assets were $111.3 million and current liabilities $27.7 million. Total assets were $211.0 million; stockholders’ equity was $75.0 million, compared with a $3.5 million deficit at year-end 2010.
- Debt: Convertible notes, net of discount, totaled $98.4 million; capital-lease obligations were $1.6 million. The $33.6 million term loan was repaid in June 2011. A $35 million revolving facility was signed in September; it was undrawn at quarter-end. The notes carry 5.25% interest and holders’ first put option is February 15, 2013.
- Unusual earnings item: A $18.6 million noncash gain from the decline in the fair value of warrant liabilities materially contributed to nine-month net income. The quarter included a $7.8 million warrant-liability gain. Nine-month debt-extinguishment losses were $3.2 million.
Material changes and operating drivers
- Growth reflected stronger drilling activity, increased product and rental demand, pricing actions, market-share gains, and domestic and international expansion. North American average rig count increased 21.2% for Q3 year over year; oil-directed rigs rose 59.0% while natural-gas rigs declined 7.4%.
- Chemicals: Q3 revenue increased 139.7% to $43.6 million. Gross margin dollars rose, but segment margin rate fell to 39.9% from 44.8%, with higher raw-material, transportation and international facility costs among the reasons.
- Drilling: Q3 revenue increased 56.9% to $27.0 million; margin rate improved to 41.1% from 37.1%, supported by price increases, product mix and cost control.
- Artificial Lift: Q3 revenue was $4.5 million, slightly below prior year; higher-margin international sales supported profitability amid weaker natural-gas-related installation activity.
- Flotek raised $29.4 million from a May common-stock placement and received $4.6 million from warrant exercises. The preferred stock was converted into common shares; outstanding shares increased substantially during the nine months.
Outlook, risks and contingencies
- Management expected Q4 drilling and completion activity to increase or remain comparable with the first three quarters of 2011. It anticipated pricing to increase or remain competitive, while warning that cost pressures could limit margin improvement. No formal earnings guidance was provided.
- Management forecast approximately $12.2 million of 2011 capital expenditures after an October budget increase; $6.0 million had been spent through September 30. Actual spending could change with demand and operating results.
- Management cited commodity-price volatility, economic uncertainty, customer spending, pricing competition, and cost inflation as risks. One customer and its affiliates represented $25.2 million of nine-month revenue, primarily in Chemicals.
- A previously identified material weakness in timely and effective account reconciliations remained unresolved at September 30; disclosure controls were therefore considered ineffective. An Oracle-based ERP system began operational field testing October 1.
- The company reported routine litigation and noted an unexpected uninsured or under-reserved judgment could be material, though management did not identify a currently pending matter expected to have a material effect. The new revolver is secured by substantially all personal property and includes financial and capital-spending covenants.
Key facts for investors to verify
- How much reported profit and EPS depended on noncash warrant-liability remeasurement, and the potential dilution from remaining warrants and convertible notes.
- Whether strong revenue growth converts to cash, given the substantial increases in receivables and inventory.
- Progress in remediating the account-reconciliation material weakness and the effectiveness of the new ERP system.
- The convertible notes’ 2013 holder put, refinancing or restructuring options, and compliance with the revolver’s covenants.
- Whether chemicals margins recover as pricing offsets input, freight and international costs, and whether customer concentration or commodity-market weakness affects demand.