Flotek Industries, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018. Flotek develops and supplies chemistry and services to the oil and gas industry. Its Consumer and Industrial Chemistry Technologies (CICT) business is reported as discontinued operations and was sold during the quarter.
Financial performance and condition
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Continuing-operations revenue | $43.3 million | $41.1 million |
| Loss from operations | $14.3 million | $9.2 million |
| Operating margin | (33.0)% | (22.5)% |
| Loss from continuing operations | $15.4 million | $9.5 million |
| Income from discontinued operations, net of tax | $48.4 million | $9.6 million |
| Net income | $33.0 million | $0.1 million |
| Net cash used in operating activities | $25.7 million | $12.2 million |
- Revenue grew 5.3%, but operating expenses excluding depreciation and amortization rose 21.7% to $44.6 million, exceeding revenue. Flotek attributed the increase mainly to material and labor costs and logistics.
- Energy Chemistry Technologies (ECT) revenue was $43.3 million; its operating loss was $5.3 million, versus $0.2 million in Q1 2018, with operating margin of (12.3)% versus (0.4)%. Management cited margin compression, higher costs, logistics, and a customer-balance write-down.
- Net income was driven by the CICT sale: the filing reports a $69.8 million gain on sale before tax within discontinued operations. CICT itself reported an operating loss of $0.6 million in Q1 2019.
- Cash and cash equivalents were $96.8 million at March 31, up from $3.0 million at year-end; restricted cash was another $0.7 million. The increase primarily reflected sale proceeds. Investing cash inflow was $169.3 million, including $169.7 million in proceeds from the business sale.
- Operating cash outflow increased, with working capital consuming $34.1 million, mainly from increases in other current assets and inventory and reductions in accrued liabilities and accounts payable.
- Flotek repaid and terminated its PNC revolving credit facility on March 1. Reported borrowings were zero at quarter-end. Total liabilities were $47.7 million; operating and finance lease liabilities totaled approximately $19.3 million.
- Total assets were $282.8 million and stockholders’ equity was $235.0 million at March 31. The filing does not present a separate liquidity ratio.
Material changes and significant events
- Flotek completed the CICT sale to ADM on February 28 for $175.0 million cash consideration. Amounts held in escrow included $4.4 million for working-capital adjustments and $13.1 million for potential indemnification claims. Flotek retained $11.1 million of historical inventory.
- The sale marked a strategic shift to an oilfield-focused business. Flotek also entered into a terpene supply agreement through September 2023, with an option to extend, and a minimum annual purchase requirement.
- Q1 interest expense increased to $2.0 million from $0.5 million, primarily due to accelerated amortization of unamortized debt issuance costs when the credit facility was terminated.
- Adoption of the lease accounting standard added approximately $18.4 million of operating lease right-of-use assets and related liabilities; management said adoption did not materially affect earnings or cash flows.
Outlook, commentary, and risks
- Management expected global oilfield activity to remain stable through 2019, assuming relatively stable crude prices and limited regulatory impediments. It noted activity remained below pre-2014 downturn levels.
- Flotek is promoting its Complex nano-Fluid and Prescriptive Chemistry Management offerings, while adapting to E&P customers buying more directly from manufacturers. Management said near-term challenges may persist but believes customer relationships and demonstrated product value can support growth over time.
- The company disclosed the loss of several key sales personnel in Q1 and early Q2, warning that near-term sales and revenue for the remainder of 2019 could be negatively affected. A new Senior Vice President of Global Sales & Business Development was hired in April.
- Capital spending was $0.5 million in Q1. Management cited approximately $4.0 million in expected 2019 maintenance spending in its outlook discussion and approximately $3.5 million for the remainder of 2019 in its liquidity discussion; it reported no specific growth projects planned or committed.
- Management said it believed available cash was adequate for operations and capital spending. A Strategic Capital Committee was formed to evaluate deployment of sale proceeds, subject to Board approval.
- Key exposures include oil and gas activity and prices, customer demand, raw-material costs, regulatory actions, customer concentration, and sales-force retention. Two customers represented 19.0% and 12.6% of Q1 revenue.
- Flotek accrued a potential $2.4 million employment-tax liability related to CEO compensation for 2014–2018 and recorded an equal receivable based on indemnification from affiliated companies, supported by the CEO’s personal guaranty. The filing notes the IRS notified the company of the proposed adjustment on May 1, 2019.
- A securities class-action dismissal was affirmed by the Fifth Circuit on February 7, 2019. Management reported no other pending or threatened litigation expected to materially affect the company.
Important facts for investors to verify
- Whether ECT can restore margins after its operating loss widened despite revenue growth.
- How much of the reported cash balance is unrestricted and ultimately available after escrow releases, working-capital adjustments, and planned uses of sale proceeds.
- Whether sales-team departures affect customer retention, revenue, or the adoption of Flotek’s chemistries.
- The final amount and timing of the potential employment-tax liability and the collectability of the related indemnification receivable.
- The difference between the two disclosed 2019 maintenance-capital-spending estimates: approximately $4.0 million for the year and $3.5 million for the remainder of the year.
- Performance and obligations under the terpene supply agreement, including its minimum annual purchase requirement.