Flotek Industries, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are with Q1 2014 unless noted. Flotek supplies energy-related chemistries, drilling and production technologies, and consumer and industrial chemistries. Results are unaudited.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Revenue | $82.4 million | $102.6 million |
| Gross margin | $26.5 million; 32.2% | $43.7 million; 42.6% |
| Operating income (loss) | $(1.3) million | $18.8 million |
| Net income (loss) | $(1.5) million; $(0.03) per share | $12.0 million; $0.22 per share |
| Operating cash flow | $6.5 million | $15.5 million |
| Capital expenditures | $5.6 million | $4.1 million |
Revenue fell 19.7%, while gross margin declined 39.3%. Gross margin contracted mainly because of incentive pricing for strategic relationships, product mix, and price concessions. SG&A rose 10.7% to $23.9 million, including higher stock compensation and a $0.4 million EPA-related penalty, partly offset by cost reductions. A $1.2 million gain on asset sales was included in operating cash flow adjustments.
Segments and material changes
- Energy Chemistry Technologies: Revenue decreased 25.2% to $46.6 million; operating income fell to $6.8 million from $21.6 million. Revenue decline broadly tracked reduced drilling activity, and margins were pressured by pricing structures and mix.
- Drilling Technologies: Revenue fell 24.9% to $18.7 million, and the segment recorded a $0.6 million operating loss versus $3.3 million of income. Lower rentals, product sales, and services, pricing pressure, and fixed costs weighed on results.
- Consumer and Industrial Chemistry Technologies: Revenue increased 3.3% to $13.5 million, but gross margin declined as terpene costs rose; operating income was broadly flat at $2.4 million.
- Production Technologies: Revenue grew 57.6% to $3.6 million, primarily from a new location, but the segment’s operating loss widened to $0.5 million as it invested in sales, R&D, and expansion.
Average North American rig count declined 25.5% year over year. U.S. and Canadian rig counts fell 21.1% and 40.4%, respectively. U.S. crude prices had fallen from approximately $106 per barrel in June 2014 to around $50 in the period discussed.
Cash, debt, and liquidity
At March 31, 2015, cash was $2.5 million and total debt was $48.0 million ($24.4 million classified as current), resulting in net debt of $45.5 million. Cash increased $1.2 million during the quarter. Operating cash flow was lower year over year despite a $22.6 million reduction in receivables, partly offset by a $12.0 million inventory increase and declines in accounts payable and accrued liabilities.
The company reported $57.5 million of unused revolving-credit capacity and total liquidity of approximately $60.0 million, including cash. It said it was in compliance with all debt covenants at quarter-end. The secured credit facility includes financial covenants, a $75 million revolving commitment, and a $50 million term loan; the filing describes a required excess-cash-flow payment of up to $3.0 million, paid in March 2015. The company repurchased $2.7 million of shares under its authorization during the quarter.
Outlook, risks, and contingencies
- Management expected reduced North American oilfield demand and similar challenges internationally amid lower oil prices and customer spending cuts. It provided no specific revenue or earnings guidance.
- Management expected approximately $21 million of 2015 capital spending, including about $8 million for the Houston Global Research & Innovation Headquarters; approximately $15 million remained planned for the rest of 2015 at quarter-end. It said spending would be adjusted to market conditions.
- Management cited cost reductions, including facility consolidation, headcount reductions, hiring restrictions, vendor savings, and other expense controls. It expected competition and margin pressure to remain intense, while targeting market-share gains through product innovation and its FracMax analytics platform.
- The company acquired International Artificial Lift, LLC in January for $1.3 million cash plus 60,024 shares. It also announced a commercialization relationship with Solazyme for Flocapso drilling-fluid additive and certain marketing rights for Encapso lubricant.
- FC Pro agreed to a $410,868 EPA administrative penalty and operating-procedure requirements concerning alleged hazardous-waste regulatory violations. FC Pro neither admitted nor denied the allegations; the agreement was signed by EPA and awaited ratification by the regional judicial officer. The penalty was recorded in Q1 SG&A.
- Key exposures include dependence on oil and gas activity, customer and receivables concentration, pricing and raw-material volatility, and interest-rate and foreign-currency risks. Two customers accounted for 12.0% and 10.3% of Q1 revenue; over 93% of their revenue was in Energy Chemistry Technologies.
Important facts for investors to verify
- Whether the steep year-over-year declines in energy chemistry and drilling demand, revenue, and margins continue or stabilize.
- Whether the company sustains covenant compliance and liquidity as earnings and operating cash flow weaken, while meeting debt payments and planned capital spending.
- Whether inventory growth, customer collections, and working-capital movements convert into cash in subsequent quarters.
- Whether the planned research headquarters spending and newer products, partnerships, and acquisitions generate the expected commercial returns.
- Final ratification and fulfillment of the EPA agreement, and any further costs or operational obligations arising from the matter.