Flotek Industries, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; compared with the corresponding 2010 periods. Unless otherwise noted, figures below are in U.S. dollars and millions. Flotek supplies oilfield chemicals, logistics, drilling tools and artificial-lift equipment and services.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $55.9 | $31.2 | $108.8 | $59.5 |
| Gross margin | $22.2 | $11.4 | $43.4 | $19.4 |
| Gross margin rate | 39.8% | 36.4% | 39.9% | 32.5% |
| Operating income (loss) | $7.9 | $(3.4) | $17.2 | $(7.1) |
| Net income (loss) | $2.1 | $(6.2) | $12.5 | $(15.7) |
| Basic EPS | $0.05 | $(0.28) | $0.19 | $(0.84) |
- Revenue increased 79.4% in Q2 and 82.8% in the first half year over year. Management attributed growth to stronger oil-directed and liquids-rich drilling, pricing, product demand, market-share gains and international expansion.
- Q2 gross margin rate rose 3.4 percentage points; first-half rate rose 7.4 points. Drilling margins improved substantially, while Chemicals’ margin rate declined on higher raw-material and freight costs and a shift toward lower-margin newer products.
- Q2 interest expense was $4.5 million; first-half interest expense was $9.3 million. First-half net income included a $10.8 million noncash gain from the change in fair value of warrant liabilities. The company also recorded a $3.2 million debt-extinguishment loss in the first half.
- First-half operating cash flow was negative $3.4 million, versus negative $4.9 million in 2010, despite reported net income. Working capital used $18.8 million, mainly reflecting higher receivables and inventory. Investing cash flow was negative $1.6 million; capital expenditures were $3.7 million.
- Cash was $15.1 million at June 30, down from $19.9 million at year-end. Current assets were $94.1 million and current liabilities $25.0 million, for working capital of approximately $69.0 million.
- The company repaid its $33.6 million term loan during the first half, using proceeds that included a $29.4 million common-stock placement and $4.6 million from warrant exercises. At June 30, convertible notes had $106.5 million principal outstanding ($97.1 million net carrying value); capital-lease obligations were $1.1 million. The notes bear 5.25% interest and holders’ first put date is February 15, 2013.
- Stockholders’ equity improved from a $3.5 million deficit at year-end to $54.8 million at June 30. Preferred stock was converted to common stock; share issuance and warrant exercises also increased the common-share base.
Material changes and segment trends
- Chemicals: Q2 revenue rose 107.9% to $29.1 million. Gross margin increased in dollars, but the margin rate fell to 37.8% from 45.7%, primarily due to input costs, mix and higher transport and international fees.
- Drilling: Q2 revenue rose 64.6% to $24.5 million. Gross margin rate improved to 44.2% from 28.4%, reflecting price increases, product mix and cost controls; the segment moved from an operating loss to $5.9 million operating income.
- Artificial Lift: Q2 revenue was broadly flat at $2.3 million. Gross margin rate declined to 18.4% from 31.9%; management cited depressed gas activity, input costs and limited ability to pass on price increases.
- One customer and its affiliates represented $7.1 million of Q2 revenue and $14.3 million for the first half, largely in Chemicals.
Outlook, risks and unusual items
- Management expected second-half 2011 drilling and completion activity to remain relatively stable versus the first half and second half of 2010, with North American conditions improving slightly. It expected competitive pricing and warned that cost pressures could limit margin improvement. These are management expectations, not guarantees.
- Management forecast approximately $5.1 million of additional capital expenditures for the remainder of 2011, within an annual budget of about $8.8 million. It also planned international expansion, product development, cost management and exploration of financing alternatives, including a traditional commercial banking relationship.
- Business results remain sensitive to oil and natural-gas prices, rig activity, customer spending, competitive pricing, input and freight costs, and geopolitical and broader economic uncertainty. Management noted that natural-gas activity remained weaker than oil-directed activity.
- A material weakness in internal control over financial reporting—timely and effective account reconciliations during the monthly close—remained unresolved at June 30. Management said remediation was ongoing and not yet fully tested; disclosure controls were therefore considered ineffective.
- The company reported routine litigation and said it knew of no pending or threatened matter expected to materially affect its financial position, results or liquidity, while noting that an unexpected uninsured or excessive judgment could be material. It reported no material change to the risk factors in its 2010 Form 10-K.
- The filing reports no material off-balance-sheet arrangements and no significant market risk at June 30. Warrant fair-value changes are noncash and affect reported earnings; remaining warrants are expected to be settled through exercise or forfeiture, not cash settlement.
Investor facts to verify
- Whether receivables and inventory growth converts into operating cash flow, and whether collections and inventory management improve.
- The company’s ability to meet the convertible notes’ February 2013 holder put date and secure suitable refinancing or other funding.
- How dilution from the 2011 share issuance, remaining warrants, stock awards and convertible notes affects per-share results.
- Whether the internal-control material weakness is remediated and independently tested.
- Whether Chemicals’ lower margin rate and Artificial Lift’s weaker performance persist, and whether customer concentration changes.