Business context and reporting period
Flotek Industries, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It develops specialty chemistry for oil and gas markets and citrus-based compounds for consumer and industrial customers. In the fourth quarter, Flotek began marketing its Drilling Technologies and Production Technologies businesses for sale and classified them as discontinued operations. Continuing operations are Energy Chemistry Technologies and Consumer and Industrial Chemistry Technologies (CICT).
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue, continuing operations | $262.8 million | $270.0 million |
| Gross profit / margin | $90.7 million / 34.5% | $96.3 million / 35.7% |
| Operating income (loss) | $(7.3) million | $12.3 million |
| Income from continuing operations | $1.9 million | $7.2 million |
| Net income (loss), including discontinued operations | $(49.1) million | $(13.5) million |
| Basic EPS | $(0.88) | $(0.25) |
| Cash from operating activities | $2.1 million | $25.5 million |
Fourth-quarter 2016 revenue was $70.6 million and gross profit was $22.8 million. Continuing operations earned $3.9 million, but discontinued operations lost $17.8 million, resulting in a quarterly net loss of $13.9 million.
- Segments: Energy Chemistry revenue fell 11.9% to $188.2 million; operating income declined to $29.0 million from $43.9 million. CnF sales volume increased 14.7%, while non-CnF revenue fell about 40.8%. CICT revenue increased 32.3% to $74.6 million, primarily reflecting higher citrus terpene prices and increased flavor and fragrance volumes; its gross margin declined to 21.6% from 25.5%.
- Cash, debt, and liquidity: Year-end cash was $4.8 million. Debt totaled $48.4 million ($38.6 million revolver and $9.8 million term loan), or net debt of approximately $43.6 million. Available revolver capacity was $16.5 million. Operating cash flow fell substantially, with $6.1 million used by working capital. Current assets were $188.7 million and current liabilities $91.1 million, including held-for-sale balances.
- Investment and funding: Capital expenditures were $14.0 million, including $6.3 million for the new research center; the IPI acquisition cost $7.9 million in cash plus 247,764 shares. A July share placement generated $30.1 million net proceeds from 2.45 million shares.
- Balance sheet: Total assets were $386.6 million and stockholders’ equity was $287.3 million at year-end. The company reported $52.0 million of assets held for sale net of valuation allowances and $5.0 million of related liabilities.
Material changes versus prior period
Continuing revenue decreased 2.6% year over year, while gross margin contracted 1.2 percentage points. SG&A rose 14.1% to $80.2 million, and research and innovation expense rose 40.0% to $9.3 million. The company recorded a $12.7 million gain from a legal settlement; excluding this unusual gain, its reported operating loss underscores pressure from elevated overhead and weaker results.
The much larger consolidated loss primarily reflects discontinued businesses. Their combined 2016 net loss was $51.0 million, versus a $20.6 million loss in 2015. The discontinued segments recorded $40.4 million of inventory and long-lived-asset impairment charges and $25.1 million of write-downs of assets held for sale; Drilling Technologies also recorded a $1.2 million loss on a partial sale. North American average rig count fell 45.4% in 2016 compared with 2015.
Outlook, risks, contingencies, and unusual items
- Management expected North American oilfield activity to improve modestly during 2017, assuming relatively stable crude prices and fewer regulatory impediments. It expected Energy Chemistry sales to outperform activity metrics over time, supported by CnF chemistry and direct-to-operator sales.
- Management expected 2017 capital spending of $15 million to $20 million and planned to fund operations and investment through internally generated cash and, if needed, the revolver. No specific revenue or earnings guidance was provided.
- Flotek expected citrus terpene prices to remain elevated because of reduced crop supply and citrus greening disease; it cited supply relationships, formulation development, and pricing strategies as mitigants. Guar also carries agricultural and geopolitical supply risks.
- The company intended to complete the sale or disposition of Drilling and Production Technologies by the end of 2017, but said a sale on favorable terms, or a sale at all, was not assured. The credit agreement includes financial covenants beginning in 2017, variable interest rates, and a $20 million annual capital-expenditure limit.
- Two customers generated 16% and 13% of 2016 consolidated revenue; the largest three represented 36%. Customer concentration, oilfield activity and pricing, raw-material costs, and collections are material risks.
- A securities class action and derivative litigation remained pending, and the SEC had opened an inquiry into similar issues. The company said it believed the lawsuits were without merit; it could not reasonably estimate their outcomes.
- The CFO had notified the company of his decision to retire effective in the first quarter of 2017. The independent auditor issued unqualified opinions on the financial statements and internal control; the acquired IPI business was excluded from the 2016 internal-control assessment.
Most important facts for investors to verify
- Progress, terms, proceeds, and any remaining liabilities or costs associated with the planned divestitures.
- Whether continuing operations can restore operating profitability and cash generation without the $12.7 million settlement gain.
- Revolver availability, covenant compliance and headroom, upcoming debt payments, and sensitivity to variable interest rates.
- Whether CnF volume growth and the expected oilfield recovery translate into revenue and margins, and whether citrus and guar costs can be passed through.
- Developments in the securities litigation and SEC inquiry, and any resulting financial or disclosure consequences.