Flotek Industries, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Flotek supplies specialty oilfield chemistries and services, and citrus-derived compounds for consumer and industrial markets. Its continuing segments are Energy Chemistry Technologies (ECT) and Consumer and Industrial Chemistry Technologies (CICT); previously sold Drilling Technologies and Production Technologies are reported as discontinued operations.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $71.0 million | $79.5 million | $190.6 million | $244.6 million |
| Operating loss | $3.2 million | $3.1 million | $56.5 million | $5.0 million |
| Net loss attributable to Flotek | $3.9 million | $3.1 million | $78.9 million | $18.9 million |
| Loss per diluted share | $0.07 | $0.05 | $1.36 | $0.33 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $(23.9) million | $1.2 million |
| Capital expenditures | $1.3 million | $1.6 million | $4.6 million | $6.2 million |
Q3 revenue fell 10.7% year over year; nine-month revenue declined 22.1%. Cost of revenue (excluding depreciation and amortization) rose to 76.2% of revenue in Q3 from 72.0%, and to 76.9% for the nine months from 68.4%, indicating weaker gross margin. Q3 operating margin was (4.5)%; the nine-month margin was (29.6%), including a $37.2 million goodwill impairment. Excluding that impairment, ECT’s nine-month operating income was $3.0 million, compared with $24.7 million in 2017.
Segments and material changes
- ECT: Q3 revenue declined 12.2% to $53.7 million; operating income fell to $3.9 million from $6.9 million. Nine-month revenue declined 28.5% to $134.3 million. Excluding the impairment, nine-month operating income was $3.0 million versus $24.7 million. The filing cites customer and product mix changes, lower sales activity, increased material and labor costs, inventory adjustments, and logistics spending. Q3 revenue increased 35.8% sequentially, primarily from higher international sales.
- CICT: Q3 revenue declined 5.5% to $17.3 million and operating income was $0.9 million versus $1.0 million. Nine-month revenue was nearly flat at $56.3 million, while operating income declined to $3.9 million from $5.9 million. Raw-material costs, product mix, and costs associated with a new still contributed to lower results.
- Corporate and segment selling and administrative costs declined, reflecting cost reductions and lower incentive and stock compensation expense. The company sold the Dalton, Georgia facility assets in September for $1.8 million and recorded a $0.4 million loss; a $2.6 million write-down had been recorded earlier in 2018.
- The company recorded a $37.2 million ECT goodwill impairment in Q2 after sustained underperformance and reduced expectations. It also established a valuation allowance against certain deferred tax assets; the nine-month tax provision was $15.6 million.
Liquidity, debt and balance sheet
- At September 30, cash was $1.8 million, total assets $293.3 million, and total equity $192.8 million. Cash declined $2.8 million from year-end 2017.
- Revolver borrowings were $53.4 million, up from $28.0 million at December 31, 2017, and were classified as current. The $75 million facility had $15.2 million of available borrowing capacity; reported total liquidity, including cash, was $17.0 million. Net debt was $51.6 million.
- The company reported compliance with debt covenants at quarter-end. Fixed-charge coverage and leverage covenant testing was suspended through December 31, 2018, subject to a trigger tied to undrawn availability; availability for that trigger calculation was $21.0 million. Covenant testing is scheduled to begin in 2019 if not triggered earlier.
- Operating cash use was driven in part by working-capital investment: accounts receivable and inventory together used $28.8 million, partly offset by an $8.5 million increase in accounts payable. Inventory, net, rose to $93.2 million from $75.8 million at year-end.
Outlook, risks and contingencies
- Management expected global oilfield activity to remain stable heading into 2019, assuming relatively stable crude prices and limited regulatory impediments. It expected to pursue further market penetration for its CnF and PCM chemistry offerings, while acknowledging near-term customer purchasing shifts toward direct sourcing and related changes to its customer base, inventory, distribution, and business model.
- Management projected 2018 capital spending of $6–$8 million, with $1.4–$3.4 million planned for the remainder of the year. It said liquidity was adequate for ongoing operations and capital spending, while noting it may seek external financing for liquidity or acquisitions.
- Risks include oilfield activity and commodity-price volatility, customer concentration in oil and gas, raw-material and citrus-crop availability and pricing, foreign exchange, and regulatory restrictions on chemical use. Saudi Arabia represented 18.6% of Q3 revenue; one customer represented 19.4% of Q3 revenue, with most sales to major customers in ECT.
- A securities class-action dismissal was on appeal, and derivative litigation remained pending; the company said it could not reasonably estimate the outcome of the derivative cases. The SEC had concluded its related inquiry without intending to recommend enforcement action. Management reported disclosure controls effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether ECT revenue and margins recover after the significant year-to-date decline and goodwill impairment.
- Working-capital trends, especially receivables and inventory, and their effect on operating cash flow and revolver use.
- Revolver availability, covenant trigger conditions, and the company’s ability to meet financial covenants beginning in 2019.
- Assumptions supporting management’s stable-activity outlook, capital spending plans, and liquidity assessment.
- Potential effects of the pending litigation, tax valuation allowance, and continuing exposure to customer, commodity, citrus-supply, and regulatory risks.