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FTK > SEC Filings for FTK > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for FLOTEK INDUSTRIES INC/CN/

Form 10-Q for FLOTEK INDUSTRIES INC/CN/


7-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q (the "Quarterly Report"), and in particular, Part I, Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains "forward-looking statements" within the meaning of the safe harbor provisions, 15 U.S.C. § 78u-5, of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Forward-looking statements are not historical facts but instead represent the Company's current assumptions and beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside the Company's control. Such statements include estimates, projections, and statements related to Flotek Industries, Inc.'s ("Flotek" or the "Company") business plan, objectives and expected operating results and assumptions upon which those statements are based. The forward-looking statements contained in this Quarterly Report are based on information available as of the date of this Quarterly Report.
The forward-looking statements relate to future industry trends and economic conditions, forecast performance or results of current and future initiatives and the outcome of contingencies and other uncertainties that may have a significant impact on the Company's business, future operating results and liquidity. These forward-looking statements generally are identified by words including, but not limited to, "anticipate," "believe," "estimate," "continue," "intend," "expect," "plan," "forecast," "project" and similar expressions, or future-tense or conditional constructions such as "will," "may," "should," "could," etc. The Company cautions that these statements are merely predictions, not to be considered guarantees of future performance. Forward-looking statements are based upon current expectations and assumptions that are subject to risks and uncertainties that can cause actual results to differ materially from those projected, anticipated or implied.
A detailed discussion of potential risks and uncertainties that could cause actual results and events to differ materially from forward-looking statements is included in Part I, Item 1A - "Risk Factors" of the Annual Report on Form 10-K for the year ended December 31, 2012 (the "Annual Report") and periodically in subsequent reports filed with the Securities and Exchange Commission (the "SEC"). The Company has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events, except as required by law.
Executive Summary
Flotek is a diversified, global, oilfield, technology services driven company that develops and supplies oilfield products, services and equipment to the oil, gas and mining industries. The Company's strategic focus includes oilfield specialty chemicals and logistics, down-hole drilling tools and down-hole production related tools. The Company also provides automated bulk material handling, loading facilities and blending capabilities. Customers include major integrated oil and natural gas companies, oilfield services companies, independent oil and natural gas companies, pressure-pumping service companies, national and state-owned oil companies and international supply chain management companies. Flotek's products and services enable customers to drill wells more efficiently, increase existing and scheduled well production and decrease well operating costs.
In May 2013, Flotek Acquisition Inc., a direct, wholly owned subsidiary of the Company ("Acquisition Sub") and Florida Chemical Company, Inc. ("Florida Chemical"), entered into an Agreement and Plan of Merger under which Acquisition Sub agreed to acquire 100% of the issued and outstanding shares of common stock and assume all outstanding debt of Florida Chemical. According to the terms of the Merger Agreement, which was unanimously approved by the Boards of Directors of both the Company and Florida Chemical, Florida Chemical was merged with and into Acquisition Sub with Acquisition Sub continuing as the surviving entity (the "Merger"). The closing of the Merger occurred simultaneously with the signing of the Merger Agreement. At the time of the closing, the name of Acquisition Sub was changed to Florida Chemical Company, Inc. Florida Chemical is a leader in the citrus industry by pioneering solvent, chemical synthesis, and flavor and fragrance applications from citrus oils.
Through its acquisition of Florida Chemical, Flotek further diversified its business by acquiring the world's largest processor of citrus oils, bringing a portfolio of high performance renewable and sustainable chemistries that perform well in the oil and gas industry as well as non-energy related markets. Non-energy Chemical Technologies ("NECT") provides alternative chemistries to the household and industrial markets as well as citrus derivatives to the flavor and fragrance industry.
Through the newly acquired business Flotek now processes citrus oils into high value compounds that are used as additives by companies in the flavors and fragrances markets and environmentally friendly chemicals for use primarily in the oil and gas industry. Through its acquired capabilities of Florida Chemical, Flotek sources citrus oil domestically and internationally and estimates it currently processes approximately one third of the global supply of citrus oil. Additionally, the Company will combine the research efforts of the newly acquired business with existing organic R&D effort to strengthen its focus on developing environmentally responsible products for the oil and gas industry and other markets.


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The transaction was financed through increased long term debt of $25.0 million, additional borrowings on the Company's existing revolving credit facility of $28.7 million and issuance of 3.3 million shares of the Company's common stock. In the Merger, all of the issued and outstanding shares of Florida Chemical common stock were converted into the right to receive an aggregate amount of consideration equal to 3,284,180 shares of common stock of the Company and $49.5 million in cash. The Merger Agreement also provides for an escrow agreement that establishes an escrow fund totaling $10.0 million to cover the indemnification obligations of Florida Chemical's former stockholders, consisting of equal parts cash and common stock of the Company.
Flotek operates in over 20 domestic and international markets, including the Gulf Coast, Southwest, Rocky Mountains, Northeastern and Mid-Continental regions of the United States (the "U.S."), Canada, Mexico, Central America, South America, Europe, Africa, Australia and Asia.
Flotek's operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by chief operating decision-makers in deciding how to allocate resources and assess performance. With its acquisition of Florida Chemical Company, Inc. on May 10, 2013 (see Note 3), the Company added operations in a new segment, Non-energy Chemical Technologies. The operations of the Company are now categorized into 4 reportable segments: Chemical Technologies, Non-energy Chemical Technologies, Drilling Technologies and Artificial Lift Technologies.
• Chemical Technologies designs, develops, manufactures, packages and markets specialty chemicals, some of which hold patent protection, used in oil and gas well cementing, stimulation, acidizing, drilling and production. Activities in this segment also include construction and management of automated material handling facilities and management of loading facilities and blending operations for oilfield services companies.

• Non-Energy Chemical Technologies designs, develops and manufactures products that are sold to companies in the flavor and fragrance industry and specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.

• Drilling Technologies rents, sells, inspects, manufactures and markets downhole drilling equipment used in energy, mining, water well and industrial drilling activities.

• Artificial Lift Technologies assembles and markets artificial lift equipment, including the Petrovalve product line of rod pump components, electric submersible pumps, gas separators, valves and services that support natural gas, oil and coal bed methane production activities.

Historical North American drilling activity and commodity prices are reflected in the table below:

                                           Three months ended June 30,               Six months ended June 30,
                                         2013          2012      % Change           2013          2012      % Change
North American Average Active
Drilling Rigs
U.S.                                     1,761         1,970        (10.6 )%       1,759          1,980      (11.2 )%
Canada                                     152           177        (14.1 )%         342            380      (10.0 )%
Total Average North American
Drilling Rigs                            1,913         2,147        (10.9 )%       2,101          2,360      (11.0 )%
U.S. Average Active Drilling Rigs by
Type
Vertical                                   455           569        (20.0 )%         448            585      (23.4 )%
Horizontal                               1,088         1,169         (6.9 )%       1,107          1,170       (5.4 )%
Directional                                218           232         (6.0 )%         204            225       (9.3 )%
Total Average U.S. Drilling Rigs by
Type                                     1,761         1,970        (10.6 )%       1,759          1,980      (11.2 )%
Oil vs. Natural Gas Average North
American Drilling Rigs
Oil                                      1,489         1,496         (0.5 )%       1,607          1,588        1.2  %
Natural Gas                                424           651        (34.9 )%         494            772      (36.0 )%
Total Average Oil vs Natural Gas
Drilling Rigs                            1,913         2,147        (10.9 )%       2,101          2,360      (11.0 )%
Average Commodity Prices
West Texas Intermediate Crude Oil
($/bbl)                              $   94.05       $ 93.43          0.7  %   $   94.18        $ 98.15       (4.0 )%
Natural Gas Prices ($/mmBtu)         $    4.02       $  2.29         75.5  %   $    3.76        $  2.37       58.6  %

Sources: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); Commodity prices:
Department of Energy, Energy Information Administration (www.eia.doe.gov). Rig counts are the averages of the weekly rig count activity. Oil and gas prices are the average of the daily average spot price.


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Market Conditions and Outlook
Flotek's ability to compete in the oilfield services market depends on the Company's ability to differentiate and provide superior products and services while maintaining a competitive cost structure. Domestic operations are sensitive to fluctuations in natural gas and oil well drilling activity, well depth and drilling conditions, number of well completions and level of work-over activity in North America. Correspondingly, North American drilling activity is aligned with and responsive to the volatility of natural gas and crude oil commodity prices and market expectations of future prices. The Company's results of operations are heavily dependent upon the sustainability of prices charged to customers, which is also dependent on drilling activity levels, availability of equipment and other resources, and competitive pricing pressures.
Customers' exploration and production ("E&P") budgets, in many instances, depend upon revenue generated from natural gas, oil and precious mineral sales. Lower gas, oil and mineral prices usually translate into lower exploration and production budgets with increased exploration and productions budgets when gas, oil and mineral prices are high. Underlying commodity prices are influenced by changes in market supply and demand driven by overall economic activity, weather, pipeline capacity, inventory storage, commodity markets, futures trading, and a variety of other factors. The continued price divergence between gas and oil drilling objectives continues to drive a shift in active rig counts from natural gas drilling to liquid-rich gas and oil drilling activity. During the three and six months ended June 30, 2013, total North American active drilling rig count saw a decrease when compared to the comparable periods of 2012, primarily in natural gas drilling rigs. Overall activity decreased in both periods by approximately 11% compared to the same periods in 2012. The average spot price for West Texas Intermediate was $94.18 for the first six months of 2013, relatively consistent with the average spot price of $98.15 for the first six months of 2012. The average spot price for West Texas Intermediate was $94.05 for the three months ended June 30, 2013, relatively consistent with the average spot price of $93.43 for the three months ended June 30, 2012, a decrease of only 0.7%. The stable prices of petroleum year over year have provided relative stability in North American active drilling rigs. Similarly, total average U.S. drilling rigs by type have remained relatively consistent with prior periods decreasing likewise by 11% for the three and six months ended June 30, 2013 compared to the same periods of 2012. Within U.S. drilling rigs by type, a modest shift did occur with decreases ranging from 5% to 9% in drilling rig activity by horizontal and directional drilling rigs for the three and six months ended June 30, 2013 periods when compared to the comparable periods of 2012, with a decrease of 20% and 23% in vertical drilling rig activity for the three and six months ended June 30, 2013, respectively, when compared to the 2012 periods.
Average North American oil drilling rig activity remained relatively flat as well decreasing by only 0.5% and increasing by only 1.2% for the three and six months ended June 2013, respectively, when compared to the same periods of 2012. As a direct result of a continuation of depressed natural gas prices average North American natural gas drilling rigs have decreased by 35% and 36% for the three and six months ended June 30, 2013, respectively, compared to the same periods of 2012. Although average natural gas prices have improved during the first six months of 2013 by $1.39, or 58.6%, to $3.76 from the average natural gas price for the six months ended June 30, 2012 of $2.37 and by $1.73, or 75.5%, to $4.02 from the average natural gas price for the three months ended June 30, 2012 of $2.29, prices are only 50% of the average annual 2008 natural gas prices of $8.07 only 5 years ago. Natural gas prices remain depressed as a result of excess natural gas production within unconventional U.S. shale regions and consequential impact on natural gas inventories, as well as the impact of natural gas drilling efficiencies resulting from such technologies as fracturing and enhanced oil recovery techniques and warmer winter temperatures. Future economic conditions are expected to remain volatile throughout the remainder of 2013 because of ongoing market and economic uncertainties. During the three months ended June 30, 2013, the Company noted continued pricing pressures as rig activity for the period struggled to increase. Given the continued volatility within the current economy and the discriminatory nature of credit access from the financial markets, the Company anticipates the level of drilling and workover activity and the demand for services to remain competitive as customer capital budgets remain tight.
Market assessment and operational management efforts remain diligent to mitigate and lessen the potential impact of unfavorable economic conditions and drilling activity volatility. The Company continues to focus on increased research and development activities, differentiation of products and services, increased marketing efforts surrounding the enhanced recovery capabilities of the Company's green products and development, production infrastructure expansion, geographic market expansion, and organic and inorganic growth to help mitigate downward cyclical risk exposure by balancing drilling and production, rental and service activities within unconventional areas such as the Bakken, Eagle Ford and Marcellus shales, and Permian Basin and international markets. The Company works to maintain a portfolio of products which are adaptable to meet our customer's demands for customized products for the various drilling environments and terrain in which our customers operate.


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The Company's commitment to research and development ("R&D") continues to permit the Company to remain responsive to increased demand and continued growth within unconventional liquid-rich and oil sand formation plays. The Company continues investment in research and development, capital investment and organic as well as inorganic expansion where strategic opportunities may arise. The Company remains committed to continued development of its product technologies and believes the new growth of its business through the recent acquisition of Florida Chemical will strategically advance our existing assets and technologies to better serve our customers' needs as well as expand our customer base and improve revenue and margins. Due to the success in unconventional areas such as the Niobrara and Eagle Ford, the Company believes Flotek is well positioned to respond to increased demand for the Company's suite of hydrocarbon stimulation and completion products, particularly the Company's CnF® chemistries. In addition, Drilling Technologies adapted designs within the motor and Teledrift Pro-series Tool product lines has and will continue to allow the Company to more successfully contest in market areas such as Oklahoma and West Texas and other drilling markets.
Capacity expansion for Chemical Technologies' production, in response to increasing customer demand, continues to be a priority in 2013. In addition, the Company is expanding Drilling Technologies' product offerings. The Company continues to pursue and develop new and existing market opportunities associated with the Company's specialty chemical and measurement while drilling ("MWD") products.
Capital expenditures totaled $9.1 million and $9.5 million for the six months ended June 30, 2013 and 2012, respectively. The Company actively manages capital expenditures to be responsive to the market, take advantage of strategic opportunities and further increase the Company's international presence. Future capital expenditures remain contingent upon results of operations. Consolidated Results of Operations (in thousands):

                                   Three months ended June 30,           Six months ended June 30,
                                     2013               2012               2013               2012
Revenue                        $      93,586       $      78,303     $     171,829       $    157,498
Cost of revenue                      (55,992 )           (45,278 )        (101,605 )          (91,022 )
Gross margin                          37,594              33,025            70,224             66,476
Selling, general and
administrative costs                 (21,081 )           (15,776 )         (39,098 )          (30,689 )
Depreciation and
amortization                          (2,003 )            (1,038 )          (3,193 )           (1,996 )
Research and development                (979 )              (622 )          (1,854 )           (1,454 )
Income from operations                13,531              15,589            26,079             32,337
Loss on extinguishment of
debt                                       -                (995 )               -             (6,386 )
Change in fair value of
warrant liability                          -               6,524                 -              2,649
Interest and other expense,
net                                     (361 )            (2,507 )            (907 )           (4,765 )
Income before income taxes            13,170              18,611            25,172             23,835
Income tax expense                    (4,730 )            (5,433 )          (8,967 )           (7,051 )
Net income                     $       8,440       $      13,178     $      16,205       $     16,784

Consolidated Results of Operations: Three and Six Months Ended June 30, 2013 Compared to the Three and Six Months Ended June 30, 2012 Consolidated revenue for the second quarter and year to date periods ended June 30, 2013 increased $15.3 million, or 19.5%, and $14.3 million, or 9.1%, respectively, relative to the comparable periods of 2012. The increase in revenue for both periods was primarily due to the acquisition of Florida Chemical contributing incremental revenue of $14.5 million during the periods. Excluding the impact of the acquisition, revenue for the quarter ended June 30, 2013 increased by $0.8 million or 1.0% to $79.1 million, the second highest revenue generating quarter in the Company's history. Excluding the impact of the acquisition, year to date earnings decreased $0.2 million or 0.1%, essentially flat when compared with the year to date 2012 revenue, while total average North American drilling activity decrease by 11%.
The consolidated gross margin for the quarter and year to date periods ended June 30, 2013 increased $4.6 million, or 13.8%, and $3.7 million, or 5.6%, respectively, relative to comparable periods of 2012. The increase in gross margin was primarily due to the acquisition of Florida Chemical Company contributing incremental gross margin of $4.9 million. Excluding the impact on gross


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margin of the acquisition, gross margins for the quarter and year to date ended June 30, 2013 decreased by $0.3 million, or 1.0% and $1.1 million, or 1.7% respectively. The decline in gross margins was primarily due to a shift in product mix within the Chemical Technologies segment from high margin products to lower margin products, offset by increased gross margins attributed to product price increases within the Drilling Technologies segment. Selling, general and administrative expenses ("SG&A") are not directly attributable to products sold or services provided. SG&A for the quarter ended June 30, 2013 increased by $5.3 million, or 33.6% compared to the same period of 2012. Excluding the incremental SG&A costs of the Florida Chemical business acquired ($1.7 million), SG&A costs increased $3.6 million, or 22.8% compared to the same period of 2012. SG&A cost increased $3.6 million as a result of increased headcount and travel related costs to support efforts to expand the Company's customer base ($1.7 million), expenses related to the Florida Chemical acquisition ($1.1 million) and increased insurance and other costs related to operational growth and facility expansion ($.8 million).
SG&A costs for the year to date period ended June 30, 2013 increased by $8.4 million, or 27.4% compared to the same period of 2012. Excluding the incremental SG&A costs of the Florida Chemical business acquired ($1.7 million), SG&A cost increased $6.7 million as a result of increased headcount and travel related costs to support efforts to expand the Company's customer base ($2.6 million), insurance costs related to increased operational growth and facility expansion ($1.3 million), expenses related to the Florida Chemical acquisition ($1.1 million), executive severance incurred in the first quarter of 2013 ($0.9 million), and costs incurred primarily in the first quarter of the 2013 period associated with implementation of the Company's new ERP system ($0.8 million). Depreciation and amortization expense for the quarter and year to date periods ended June 30, 2013 increased by $1.0 million or 93.0%, and $1.2 million or 60.0% relative to comparable periods of 2012, respectively. This increase for the quarter and year to date periods was primarily attributable to incremental amortization of intangible assets recognized as part of the acquisition of Florida Chemical ($0.6 million). The remaining increase in the quarter and year to date periods ended June 30, 2013 is due to increased depreciation expenses resulting from capital assets additions during the second half of 2012, unmatched in the first half of 2013, related to the new ERP system and new corporate offices.
R&D expense increased $0.4 million or 57.4% and $0.4 million or 27.5% for the quarter and year to date periods ended June 30, 2013, respectively, over the same comparable periods of 2012. The increase in R&D is primarily attributable to new product development, and remaining responsive to increased demand and continued growth of our existing product lines. Management remains committed to R&D investment.
Interest and other expense for the quarter and year to date periods ended June 30, 2013 decreased by $2.1 million, or 85.6%, and $3.9 million, or 81.0% relative to comparable periods of 2012, respectively. The decline in interest expense was primarily due to the repayment of the Company's convertible notes of $50.3 million at the end of the fourth quarter of 2012 and $5.2 million during the first quarter of 2013.
The Company recorded an income tax provision of $4.7 million for the quarter ended June 30, 2013, corresponding to an effective tax rate of 35.9% compared to an income tax provision of $5.4 million for the quarter ended June 30, 2012, reflecting an effective tax rate of 29.2%. The income tax provision was $9.0 million corresponding to an effective tax rate of 35.6% for the six months ended June 30, 2013, compared to an income tax provision of $7.1 million reflecting an effective tax rate of 29.6% for the comparable period in 2012. Fluctuations in effective tax rates were historically impacted by non-cash changes in the fair value of the Company's warrant liability, permanent tax differences with no associated income tax impact, and existing deferred tax asset valuation allowances.

Results by Segment
Chemical Technologies
(dollars in thousands)
                                   Three months ended June 30,            Six months ended June 30,
                                     2013               2012               2013               2012
Revenue                        $      47,709       $      45,992     $      92,359       $      93,639
Gross margin                          20,586              20,217            39,699              41,132
Gross margin %                          43.1 %              44.0 %            43.0 %              43.9 %
Income from operations                14,729              16,350            29,053              33,472
Income from operations %                30.9 %              35.5 %            31.5 %              35.7 %


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Chemical Technologies Results of Operations: Three and Six Months Ended June 30, 2013 Compared to the Three and Six Months Ended June 30, 2012 Chemical Technologies revenue for the quarter ended June 30, 2013 increased $1.7 million, or 3.7%, relative to the comparable period of 2012. Excluding the incremental revenue impact of the Florida Chemical acquisition of $1.8 million, revenue remained flat ($45.9 million) for the quarter ended June 30, 2013, a decrease of $0.1 million, or 0.2% compared to the same period of 2012. The slight decrease of $0.1 million was due to decreased international product . . .

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