Flotek Industries, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Flotek provides specialty chemistry and data analytics products and services, primarily to energy customers, through its Chemistry Technologies (CT) and Data Analytics (DA) segments.
Financial performance
- Revenue: Q2 revenue was $50.6 million, up 72% from $29.4 million a year earlier; first-half revenue was $98.6 million, up 133% from $42.3 million. Related-party revenue was $32.8 million in Q2 and $69.1 million for the first half, principally from ProFrac.
- Profitability: Q2 gross profit was $3.9 million (7.7% margin), versus a $2.3 million gross loss (negative 7.8% margin) in Q2 2022. First-half gross profit was $5.8 million (5.9% margin), versus a $2.8 million gross loss (negative 6.6% margin). Q2 operating income was $0.7 million and net loss was $21,000; first-half operating income was $19.2 million and net income was $21.3 million.
- Nonrecurring and noncash effects: First-half results included a $30.0 million gain from changes in the fair value of ProFrac contract consideration convertible notes and a $4.5 million gain from PPP loan forgiveness. These items materially affect reported earnings and should not be treated as operating cash generation. Q2 included a $3.9 million fair-value gain and a $2.3 million reversal of previously accrued severance costs.
- Cash flow: First-half operating cash use was $2.2 million, improved from $23.9 million used in the prior-year period. Investing activities used $0.3 million and financing activities used $0.9 million. Cash and restricted cash declined $3.4 million to $8.9 million, including unrestricted cash of $8.8 million.
- Liquidity and obligations: At June 30, current assets were $79.0 million and current liabilities were $53.3 million. Accounts payable rose to $44.9 million from $33.4 million at year-end. The company reported $0.3 million of remaining PPP loan debt and $9.5 million of operating lease liabilities. Convertible notes were no longer outstanding after conversion to shares or warrants.
- Equity and dilution: Stockholders’ equity increased to $98.0 million from $2.6 million at year-end, largely reflecting debt conversions. The May conversion of ProFrac contract consideration notes issued 63.5 million common shares. Shares outstanding at June 30 were 151.5 million.
Changes and business drivers
- Revenue growth reflected ProFrac Agreement activity, which began in Q2 2022, and increased activity across the customer base. First-half external revenue also grew in both CT and DA.
- Management attributed improved gross margins to higher volumes and cost management; prior-year Q2 cost of sales included elevated freight and equipment-rental costs related to the start of the ProFrac Agreement.
- ProFrac accounted for 64.8% of Q2 revenue and 70.1% of first-half revenue. The related-party receivable was $23.0 million at June 30. The agreement includes minimum purchase obligations, but terms were amended in February 2023, including a ramp-up period and waiver of certain prior potential shortfall damages.
- Both segments improved gross profit and operating performance from the prior-year period, but the company remains exposed to customer and supplier concentration: three suppliers represented 65.4% of first-half supplier expenditure.
Outlook, risks, and contingencies
- Going concern: Management states that substantial doubt exists about the company’s ability to continue as a going concern over the next 12 months. It expects significant cash use and says current resources and forecast cash flows—principally dependent on the ProFrac Agreement—may not be sufficient. Potential funding measures include equity or debt financing, an asset-based loan, asset sales, improved pricing and cost reductions; there is no assurance funding will be available on acceptable terms.
- Proposed financing: Flotek reported credit approval from a prospective lender for a proposed asset-based loan secured by eligible receivables, inventory and real estate, but stated it could not assure successful closing.
- Management outlook: No quantified financial guidance is provided. Management cited potential support from energy-market conditions and expects independent exploration and production companies to be a stronger source of 2023 activity than large majors. It also described continued efforts to expand Verax analyzer applications and recurring digital analytics revenue.
- Market and operating risks: Risks include energy-market and commodity-price volatility, freight and raw-material cost or availability, port congestion, labor shortages, possible China–U.S. supply disruption, and dependence on ProFrac and the oil and gas industry.
- Listing and controls: The NYSE notified Flotek that its share price had averaged below $1 for 30 consecutive trading days. The company intended to cure the deficiency within the applicable six-month period and was considering options including a reverse stock split. Disclosure controls were deemed ineffective due to an ongoing material weakness involving financial-reporting resources, risk assessment, communication, and controls over leases, prepaid assets and related-party revenue accruals. Remediation was underway but not yet validated.
- Legal matters: The company settled claims with former CEO John Chisholm, reversing $2.3 million of accrued severance, and settled claims with Moss Adams and Hein & Associates. Arbitration with former outside counsel remained outstanding. The filing reported no material subsequent events requiring disclosure.
Important facts for investors to verify
- Whether the proposed asset-based loan closed, its borrowing capacity, conditions and costs, and whether available liquidity is sufficient to address the stated going-concern uncertainty.
- ProFrac’s compliance with amended purchase commitments, the durability and margins of related-party sales, and collection of the $23.0 million receivable.
- How much reported earnings depends on fair-value gains, debt forgiveness and other unusual items versus recurring operations and cash flows.
- The impact of the debt conversions and outstanding warrants on fully diluted shares, and whether Flotek regained NYSE minimum-price compliance.
- Progress and testing results for remediation of the material weakness, and the status or financial effect of the remaining arbitration.