Flotek Industries, Inc. — FY2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing also reports unaudited fourth-quarter results. Amounts are in U.S. dollars; financial figures are generally in millions unless otherwise noted.
Business context and reporting period
Flotek supplies oilfield products and services through three segments: Chemicals and Logistics, Drilling Products, and Artificial Lift. Its offerings include specialty chemicals, bulk-material logistics, downhole drilling tools, and artificial-lift equipment. Performance is closely tied to oil and gas activity, commodity prices, customer spending, and competition.
Financial performance and liquidity
| Metric | FY2011 | FY2010 |
|---|---|---|
| Revenue | $258.8 | $147.0 |
| Gross margin | $105.8; 40.9% | $53.0; 36.0% |
| Operating income (loss) | $48.9 | $(6.3) |
| Net income (loss) | $31.4 | $(43.5) |
| Net income (loss) attributable to common stockholders | $26.5 | $(50.0) |
| Diluted EPS | $0.56 | $(1.94) |
| Operating cash flow | $32.4 | $12.1 |
| Cash and cash equivalents at year-end | $46.7 | $19.9 |
Fourth-quarter 2011 revenue was $74.9 million, gross margin $31.7 million, net income $1.0 million, and diluted EPS $0.02. Annual net income differs from income attributable to common stockholders because preferred-stock dividends and discount accretion are deducted from net income.
At year-end, current assets were $132.1 million and current liabilities $33.7 million. The company reported $106.5 million of convertible-note principal outstanding, plus $1.6 million of capital lease obligations; the balance-sheet carrying amount of convertible notes was $99.7 million after discount. The $33.6 million term loan reported in 2010 was repaid in June 2011. A $35 million revolving facility was undrawn at year-end and was scheduled to mature December 15, 2012, with extension subject to lender discretion and refinancing or restructuring of senior notes. In January 2012, Flotek repurchased the $36.0 million secured notes for cash, including a premium and accrued interest.
Capital expenditures were $10.0 million in 2011. The company reported no off-balance-sheet arrangements considered material to investors.
Material changes versus prior comparable periods
- Revenue rose 76.1% year over year, reflecting increased oil-directed and horizontal drilling activity, higher volumes, product mix, market-share gains, and price increases.
- Gross margin increased from 36.0% to 40.9%; SG&A rose 20.8% in dollars but declined as a share of revenue, from 28.5% to 19.6%.
- All three segments grew revenue. Chemicals revenue increased 113.0% to $140.8 million; Drilling Products revenue increased 55.8% to $102.5 million and returned to operating profit; Artificial Lift revenue increased 2.7% to $15.5 million.
- Operating cash flow increased to $32.4 million, but working capital used $16.5 million, including increases in receivables and inventory.
- Stockholders’ equity improved from a $3.5 million deficit to $78.3 million. The company issued 3.665 million common shares in a $29.4 million private placement and converted preferred stock into common shares.
Outlook, management commentary, risks, and unusual items
- Management expected 2012 drilling and completion activity to increase or remain comparable with 2011, with North American and international conditions forecast to improve slightly. It cautioned that cost pressures could limit margin improvement and that natural-gas prices and activity remained weak.
- The 2012 capital-expenditure budget was approximately $14.4 million. Management expected R&D spending to remain near 2011’s $2.3 million and planned international expansion, product development, cost management, and ERP implementation.
- FY2011 included a $9.6 million noncash gain from a reduction in the fair value of warrant liabilities, equal to 36.1% of net income. Earnings therefore included a material valuation item that did not represent operating cash generation. Debt-extinguishment losses were $3.2 million in 2011; the January 2012 repurchase generated a separately reported $5.4 million loss.
- Key risks include dependence on oil and gas industry spending and volatile commodity prices; intense competition and pricing pressure; rising or constrained raw-material supplies; customer and supplier concentration; environmental, hydraulic-fracturing, and other regulatory changes; international, foreign-exchange, and collection risks; and possible difficulty funding growth or refinancing debt.
- One customer and its affiliates accounted for 13% of 2011 revenue; the top three customers accounted for 28%. Management disclosed that a previously identified material weakness in account reconciliations was remediated by year-end, and management and the auditor concluded internal control over financial reporting was effective as of December 31, 2011.
Important facts for investors to verify
- Review the January 2012 secured-note repurchase terms, total cash cost, and effect on liquidity; separately assess the remaining $70.5 million of unsecured convertible notes and their February 2013 holder put option.
- Reconcile reported net income with common-stockholder income and assess how much earnings depended on the noncash warrant-liability gain and other nonrecurring financing items.
- Track working-capital needs, receivable collections, inventory growth, and whether operating cash flow can support the $14.4 million 2012 capital budget.
- Test the sustainability of 2011 revenue and margin gains, particularly Chemicals’ lower segment gross-margin percentage and exposure to raw-material costs and customer concentration.
- Confirm the revolving facility’s renewal or extension, covenant compliance, and the status and effectiveness of the new ERP system and control remediation.