Flotek Industries, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing reports annual results; fourth-quarter figures below are unaudited. Flotek supplies specialty oilfield chemistry and citrus-derived ingredients and chemistries. Following a strategic restructuring, its continuing businesses are Energy Chemistry Technologies (ECT) and Consumer and Industrial Chemistry Technologies (CICT); Drilling Technologies and Production Technologies were sold or disposed of during 2017 and reported as discontinued operations.
Financial performance and liquidity
| Metric | 2017 | 2016 |
|---|---|---|
| Revenue from continuing operations | $317.1 million | $262.8 million |
| Operating loss | $2.9 million | $7.3 million |
| Continuing-operations result | Loss of $13.1 million | Income of $1.9 million |
| Discontinued-operations loss, net of tax | $14.3 million | $51.0 million |
| Net loss | $27.4 million | $49.1 million |
| Net cash provided by operating activities | $17.1 million | $2.1 million |
| Cash and cash equivalents at year-end | $4.6 million | $4.8 million |
| Total debt at year-end | $28.0 million | $48.4 million |
- Revenue increased 20.6%, primarily as ECT revenue rose 29.2% with recovering oilfield activity. CICT revenue declined 0.8%.
- Cost of revenue excluding depreciation and amortization increased to 67.8% of revenue from 64.8%, reducing the corresponding gross margin to 32.2% from 35.2%. Management cited higher ECT inventory, freight and manufacturing costs, and higher citrus oil prices.
- ECT operating income increased to $33.6 million, but its operating margin fell to 13.8% from 15.4%. CICT operating income declined to $7.5 million from $9.7 million, and margin fell to 10.1% from 13.0%.
- The 2017 income tax provision was $8.8 million despite a $4.2 million pretax loss, producing a reported 210% effective tax rate. The provision included a provisional $7.3 million charge associated with the Tax Cuts and Jobs Act and a $2.0 million reduction in tax benefit related to share-based awards.
- Operating cash flow improved to $17.1 million. Investing activities provided $9.7 million, including $18.5 million of business-sale proceeds, while financing activities used $27.3 million, principally for net debt repayments and share repurchases.
- At year-end, the company had $28.0 million outstanding on a $75 million revolving facility and reported $43.9 million in available borrowing capacity. The term loan was repaid in May 2017. The revolving balance was classified as current debt; the facility matures in 2022. The company reported compliance with debt covenants.
Material changes and unusual items
- Flotek completed sales or disposals of the Drilling Technologies and Production Technologies businesses. Reported sale proceeds included $17.0 million for substantially all Drilling Technologies assets sold to National Oilwell Varco, $1.0 million plus a $1.0 million note receivable for remaining Drilling Technologies assets, and $2.9 million for Production Technologies assets. Some proceeds were subject to holdbacks or working-capital adjustments.
- Discontinued operations produced a $14.3 million net loss in 2017, including losses on sale and write-downs of assets held for sale. This was lower than the $51.0 million discontinued-operations loss in 2016, which included substantial impairment charges.
- In 2016, a $12.7 million legal-settlement gain benefited continuing results; no comparable gain was recorded in 2017.
- Fourth-quarter 2017 revenue was $72.5 million, operating income was $2.1 million, and the continuing-operations loss was $7.8 million. The fourth-quarter discontinued-operations loss was $0.7 million.
Outlook, risks and contingencies
- Management expected a modest recovery in U.S. oilfield activity in 2018, assuming relatively stable crude prices and limited regulatory impediments. It expected ECT sales to outperform market activity over time through its CnF chemistry offerings and direct-to-operator sales effort.
- Management planned $12 million to $16 million of 2018 capital expenditures, compared with $9.0 million in 2017, emphasizing projects expected to generate returns or strategic benefits. It stated that internally generated funds and, if needed, revolver borrowings would fund operations and investment.
- CICT faces citrus supply constraints and price volatility associated with citrus greening disease and adverse weather. Management cited supply relationships, alternative formulations and pricing strategies as mitigation efforts.
- Key risks include oil and gas price and activity volatility; customer and supplier concentration; raw-material cost and availability; competition and product innovation; environmental and hydraulic-fracturing regulation; international, currency and collection risks; and the company’s ability to meet credit-facility covenants and maintain liquidity.
- One customer represented 12.8% of 2017 consolidated revenue; the three largest represented approximately 25.7%. Most major-customer revenue came from ECT. The company generally relies on purchase orders and short-term arrangements rather than long-term customer contracts.
- The securities class-action dismissal was appealed. Related derivative suits remained pending, and management said it could not reasonably estimate their outcome. The SEC informed the company in August 2017 that its related inquiry was concluded and that staff did not intend to recommend enforcement action.
- The company reported no goodwill impairment in 2017, but goodwill valuations depend on assumptions including projected cash flows and discount rates. A hypothetical 10% unfavorable change in weighted-average cost of capital reduced estimated reporting-unit fair values, underscoring sensitivity to assumptions.
Investor verification points
- Review the audited statements and tax note for the $8.8 million tax provision, provisional Tax Act accounting and recoverability assumptions for deferred tax assets.
- Confirm post-sale holdbacks, the $1.0 million note receivable, remaining discontinued-operation receivables and liabilities, and final disposal costs.
- Monitor cash generation, inventory growth, revolver availability, borrowing costs and compliance with increasingly restrictive leverage and fixed-charge covenants.
- Assess whether recovering ECT demand translates into improved margins, and whether CICT can manage citrus supply costs without losing volumes or customers.
- Track the appeal and derivative litigation, customer concentration, and the impact of the planned 2018 capital spending on liquidity and returns.