UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File Number 1-13270
FLOTEK INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 90-0023731
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification
Number)
7030 Empire Central Drive, Houston TX 77040
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (713) 849-9911
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes [x] No [_]
The number of shares of the Registrant's common stock outstanding on
November 12, 2002 was 4,910,812.
Transitional Small Business Disclosure Format (check one):
Yes [_] No [x]
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION
Item 1. Financial Information
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statement of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
1. General
2. Acquisitions
3. Stock Settlement
4. Accounts Receivable
5. Inventories and Work in Progress
6. Property, Plant and Equipment
7. Goodwill and Other Intangible Assets
8. Capital Lease Obligation
9. Notes Payable
10. Long-Term Debt
11. Net Loss Per Common Share
12. Segment Information
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 4. Controls and Procedures
PART II.OTHER INFORMATION
Item 1. Legal Proceedings
Item 5. Other Information
Item 6. Exhibits
Signatures
Exhibits: 10.1 Change in Terms Agreement dated September 16, 2002 by and
between Legacy Bank and Flotek Industries, Inc.
99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
ii
PART 1
Item 1 - Financial Information
FLOTEK INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
----------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 24,795 $ 240,438
Accounts receivable, less reserve of $11,073 and $208,333, as of
September 30, 2002 and December 31, 2001, respectively.......... 2,804,376 2,189,566
Inventories and work in progress.................................. 2,494,943 3,704,153
Other current assets.............................................. 190,127 24,735
------------ ------------
Total current assets......................................... 5,514,241 6,158,892
------------ ------------
Property, plant and equipment, net.................................... 4,449,050 3,671,939
Goodwill, net......................................................... 12,866,346 13,111,840
Patents and other intangible assets, net.............................. 262,534 191,333
Other assets.......................................................... 36,824 87,253
------------ ------------
Total assets................................................. $ 23,128,995 $ 23,221,257
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 2,409,454 $ 2,225,219
Accrued liabilities............................................... 192,501 722,910
Amounts due to related parties.................................... 120,839 132,855
Notes payable..................................................... 3,522,916 1,282,966
Current portion of long-term debt................................. 1,162,615 876,737
Capital lease obligations, current portion........................ 50,044 633,894
------------ ------------
Total current liabilities..................................... 7,458,369 5,874,581
------------ ------------
Long-term debt....................................................... 3,069,632 3,339,970
Capital lease obligations, long-term................................. 1,331,166 -
Stockholders' equity:
Preferred stock, $.0001 par value, 100,000 shares authorized, no
shares issued................................................ - -
Common stock, $.0001 par value, 20,000,000 shares authorized,
4,910,812 and 4,850,696 shares issued
and outstanding as of September 30, 2002 and
December 31, 2001, respectively.............................. 491 485
Additional paid-in capital....................................... 15,762,346 15,572,886
Accumulated deficit.............................................. (4,493,009) (1,566,665)
------------ ------------
Total stockholders' equity................................... 11,269,828 14,006,706
------------ ------------
Total liabilities and stockholders' equity................... $ 23,128,995 $ 23,221,257
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
1
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues.................................. $ 2,950,668 $ 4,893,622 $ 9,990,544 $10,100,060
Cost of revenues.......................... 1,982,395 3,804,540 6,502,864 7,063,038
----------- ----------- ----------- -----------
Gross margin.............................. 968,273 1,089,082 3,487,680 3,037,022
----------- ----------- ----------- -----------
Expenses:
Selling, general and administrative.... 1,596,687 325,461 4,883,663 2,544,716
Depreciation and amortization.......... 179,468 198,847 498,322 493,173
Research and development............... 23,582 10,841 109,232 16,205
----------- ----------- ----------- -----------
Total expenses....................... 1,799,737 535,149 5,491,217 3,054,094
----------- ----------- ---------- -----------
Income (loss) from operations............. (831,464) 553,933 (2,003,537) (17,072)
Other income (expense):
Interest expense....................... (191,282) (58,715) (467,697) (282,955)
Interest income........................ 8 9,796 243 47,547
Other, net............................. (3,484) (23,666) (2,608) 20,435
----------- ----------- ----------- -----------
Total other income (expense)....... (194,758) (72,585) (470,062) (214,973)
----------- ------------ ----------- -----------
Income (loss) before
cumulative effect of change in
accounting principle..................... $(1,026,222) $ 481,348 $(2,473,599) $ (232,045)
=========== =========== =========== ===========
Cumulative effect of change in
accounting principle net of
income tax benefit....................... - - (452,745) -
----------- ----------- ----------- -----------
Net income (loss)......................... $(1,026,222) $ 481,348 $(2,926,344) $ (232,045)
=========== =========== =========== ===========
Basic and diluted income (loss)
per common share before
cumulative effect of change in
accounting principle..................... $ (.209) $ .162 $ (.504) $ (.083)
=========== =========== =========== ===========
Cumulative effect of change in
accounting principle..................... $ - $ - $ (.092) $ -
=========== =========== =========== ===========
2
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Basic and diluted net income
(loss) per common share.................. $ (.209) $ .162 $ (.596) $ (.083)
=========== =========== =========== ===========
Weighted average number of
shares outstanding....................... 4,910,812 2,974,579 4,904,709 2,796,885
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
3
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
Common Stock Additional
------------ Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------- ------- ------- -----
Balance at December 31, 2001.................... 4,850,696 $ 485 $ 15,572,886 $(1,566,665) $14,006,706
Common stock issued in acquisitions.............. 60,116 6 189,460 - 189,466
Net loss......................................... - - - (2,926,344) (2,926,344)
--------- ------- ------------ ----------- -----------
Balance at September 30, 2002................... 4,910,812 $ 491 $ 15,762,346 $(4,493,009) $11,269,828
========= ======= ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
-------------------------------
2002 2001
------------ ------------
Cash flows from operating activities:
Net loss..................................................... $ (2,926,344) $ (232,045)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 498,322 493,173
Imputed interest expense................................ - 22,031
(Gain)loss on sale of assets............................ 2,558 20,435
Impairment of goodwill.................................. 452,745 -
(Increase) decrease in:
Accounts receivable................................... (614,810) (305,960)
Inventories and work in progress...................... 1,209,210 (1,071,376)
Other current assets.................................. (165,392) (77,931)
Accounts payable and accrued liabilities.............. (346,174) 554,849
------------ ------------
Net cash used in operating activities................ (1,889,885) (596,824)
------------ ------------
Cash flows from investing activities:
Acquisition of subsidiaries, net............................ (122,250) (7,219,513)
Capital expenditures........................................ (1,357,695) (1,157,766)
Proceeds from sales of assets............................... 110,312 230,888
Deposits and other.......................................... 44,189 -
------------ ------------
Net cash used in investing activities................ (1,325,444) (8,146,391)
------------ ------------
Cash flows from financing activities:
Issuance of stock for cash.................................. - 4,112,000
Proceeds from borrowings.................................... 3,131,215 3,830,721
Proceeds from sale/leaseback transaction.................... 761,000 -
Repayments of indebtedness.................................. (865,945) (346,883)
Proceeds from (payments to) related parties................. (12,016) -
Principal payments on capital leases........................ (14,568) (21,000)
------------ ------------
Net cash provided by financing activities............ 2,999,686 7,574,838
------------ ------------
Net decrease in cash and cash equivalents........................ (215,643) (1,168,377)
Cash and cash equivalents - beginning of period.................. 240,438 1,293,142
------------ ------------
Cash and cash equivalents - end of period........................ $ 24,795 $ 124,765
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
5
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(UNAUDITED)
Nine Months Ended
September 30,
------------------------------------
2002 2001
----------------- ---------------
Supplemental schedule of noncash investing and financing activities:
Land and building acquired under capital lease................ $ - $ 630,794
======== ==========
Supplemental disclosures of cash flow information:
Acquisition of subsidiaries:
Assets (liabilities) acquired:
Cash....................................................... $ - $ 224,584
Accounts receivable........................................ - 1,104,156
Inventories and work in progress........................... - 1,278,812
Other current assets....................................... - 9,080
Property and equipment..................................... - 1,498,073
Marketable securities...................................... - 204,573
Patents and other intangibles.............................. 104,466 -
Goodwill................................................... 207,250 7,671,530
Other assets............................................... - 21,770
Debt....................................................... - (495,829)
Accounts payable and accrued liabilities................... - (979,149)
-------- ----------
311,716 10,537,600
Common stock issued.......................................... (189,466) (1,950,000)
Promissory notes issued...................................... - (1,400,000)
-------- ----------
Net cash paid to sellers and transaction costs............. $122,250 $7,187,600
======== ==========
Cash paid for interest......................................... $467,697 $ 282,955
======== ==========
6
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 1 - General
The condensed consolidated financial statements included herein are unaudited
and have been prepared by Flotek Industries, Inc. (the "Company") pursuant to
the rules and regulations of the Securities and Exchange Commission. Certain
information relating to the Company's organization and Note disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles has been condensed or omitted in this Form 10-QSB pursuant
to such rules and regulations. These financial statements reflect all
adjustments which the Company considers necessary for the fair presentation of
such financial statements for the interim periods presented and the Company
believes that the disclosures included herein are adequate to make the interim
information presented not misleading. These financial statements should be read
in conjunction with the audited consolidated financial statements and Notes
thereto included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2001. The results of operations for interim periods are not
necessarily indicative of the results expected for the full year.
Note 2 - Acquisitions
In January 2002, the Company issued 26,116 shares of common stock valued at
$82,309 to the former shareholders of Material Translogistics, Inc. ("MTI").
Under the original acquisition agreement, which had an effective date of June
29, 2001, the shareholders of MTI could receive up to 52,232 additional shares
of common stock, contingent upon the execution of two future contracts. One of
these contracts became effective in January 2002 and the shares issued above
relate to that contract. The other contract had not been executed as of
September 30, 2002.
On February 19, 2002, the Company acquired 100% of the common stock of IBS 2000,
Inc. ("IBS"), a Denver-based company engaged in the development and
manufacturing of environmentally neutral chemicals for the oil industry. IBS is
in the development stage and has had limited operating history. The Company paid
$100,000 in cash and issued 34,000 shares of common stock valued at $107,157 to
acquire IBS. Including legal and other transaction costs, the acquisition
resulted in the recording of approximately $197,000 of goodwill and other
intangibles. Revenue and operations of IBS were immaterial.
Note 3 - Stock Settlement
In early 2002, the Company became aware of an accounting issue regarding the
application of the percentage of completion accounting method in one of the
subsidiaries of CESI prior to the merger of Flotek and CESI (the "Merger"),
during the time CESI was a private company. Further review resulted in
adjustments to the financial statements to reflect a proper application of the
percentage of completion accounting method. These adjusted financial statements
differed materially from the ones provided to the Company by CESI prior to the
Merger. After discussions with representatives of CESI, certain former
shareholders of CESI agreed to surrender 180,000 of the common shares which were
received by them pursuant to the Merger. On July 19, 2002, these shares were
redistributed for the benefit of the shareholders of Flotek Industries, Inc.
other than former CESI shareholders. This was accomplished by declaring a stock
dividend to all shareholders and securing the agreement of all former CESI
shareholders to waive their beneficial interest in the stock dividend. The stock
dividend was also waived by all other shareholders who received shares
subsequent to the Merger. The net effect of these transactions was to distribute
180,000 shares to the shareholders of Flotek Industries, Inc. Accordingly, with
the cancellation of the 180,000 shares surrendered by certain CESI shareholders,
there was no net change in the outstanding shares of the Company as a result of
this settlement.
7
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 4 - Accounts Receivable
At September 30, 2002, the Company had approximately $1,403,000 of accounts
receivable from a customer in Venezuela, all of which arose from goods shipped
in the first half of 2002. As a result of political instability and work
disruptions in the country, these amounts have not been paid within the
customary payment terms for this customer. The ultimate customer for these goods
is PDVSA, the national oil company of Venezuela. Our customer holds a contract
to deliver over $5 million of our proprietary products to PDVSA during the next
three years. However, PDVSA has delayed acceptance of the majority of the goods
shipped until its field operations return to higher activity levels. Our
customer is unable to pay for the goods until payment has been received from
PDVSA. In the second quarter of 2002 we were informed by PDVSA that field
operations would return to higher levels of activity and that acceptance of
goods shipped would begin. During the second and third quarters of 2002, we
received payments totaling $200,000 and $629,000, respectively, and PDVSA is
continuing to accept goods previously shipped. We expect to collect the entire
September 30, 2002 outstanding balance and have not provided a reserve for
doubtful accounts associated with this balance.
Note 5 - Inventories and Work in Progress
Inventories consist of raw materials, finished goods and parts and materials
used in manufacturing and construction operations. Finished goods inventories
include raw materials, direct labor and production overhead. Inventories are
carried at the lower of cost or market using the average cost method. The
Company maintains a reserve for impaired or obsolete inventory, which is
reviewed for adequacy on a periodic basis. Work in progress consists of
percentage of completion revenues recognized in excess of customer billings plus
any provision for estimated losses on contracts. The components of inventories
and work in progress at September 30, 2002 and December 31, 2001 were as
follows:
September 30, December 31,
2002 2001
------------------ ------------------
Raw materials...................................... $ 340,049 $ 496,332
Finished goods..................................... 1,572,113 1,856,011
Manufacturing parts and materials.................. 272,405 708,036
Work in progress................................... 660,614 1,000,799
Inventory valuation reserve........................ (350,238) (357,025)
----------- -----------
Inventories and work in progress, net......... $ 2,494,943 $ 3,704,153
=========== ===========
8
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 6 - Property, Plant and Equipment
At September 30, 2002 and December 31, 2001, property, plant and equipment were
comprised of the following:
September 30, December 31, 2001
2002
------------------ ------------------
Land $ 118,700 $ 145,000
Buildings and leasehold improvements............... 3,184,334 2,115,078
Machinery and equipment............................ 1,148,741 1,195,632
Furniture and fixtures............................. 67,936 67,936
Transportation..................................... 612,407 456,690
Computer equipment................................. 116,850 76,497
----------- -----------
Total property and equipment................... 5,248,968 4,056,833
Less accumulated depreciation..................... (799,918) (384,894)
----------- -----------
Net property and equipment.................... $ 4,449,050 $ 3,671,939
=========== ===========
Note 7 - Goodwill and Other Intangible Assets
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") effective January 1,
2002. This statement addresses accounting and reporting for acquired goodwill
and intangible assets. In the third quarter, we completed our initial assessment
of goodwill impairment as required under SFAS No. 142. In accordance with the
transitional provisions of SFAS No. 142, the Company determined, with the
assistance of an independent appraiser, that the carrying value of goodwill and
related assets of the Equipment Specialties reporting unit exceeded its fair
value. There was approximately $1.3 million of goodwill attributable to the
Equipment Manufacturing segment which consists of two reporting units, Equipment
Specialties and MTI. As a result, the Company recognized a charge to income of
$452,745 ($.092 loss per share) for the Equipment Specialties reporting unit
which represents all of this unit's goodwill. Our test concluded there was no
impairment for MTI. The goodwill impairment is reflected as the cumulative
effect of change in accounting principle during the first quarter of 2002. As of
the end of each period presented, all of the Company's other intangible assets
had definitive lives and were being amortized accordingly.
Following is a reconciliation of goodwill:
Beginning balance, December 31, 2001............... $13,111,840
Acquisitions....................................... 207,251
Goodwill impairment, January 1, 2002
associated with the Equipment Specialties
reporting unit................................... (452,745)
------------
Ending balance, September 30, 2002................ $ 12,866,346
============
9
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Following is a reconciliation of the reported net income (loss) to the adjusted
net income (loss) reflecting the impact of the adoption of SFAS No. 142 on all
periods presented:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
2002 2001 2002 2001
------------ ------------- ------------ ------------
Reported net income (loss):
Reported net income (loss)............. $ (1,026,222) $ 481,348 $ (2,926,344) $ (232,045)
Add back: Cumulative effect of
accounting change for
impairment of goodwill................ - - 452,745 -
Goodwill amortization...... - 101,293 - 271,474
------------ ------------- ------------ ------------
Adjusted net income (loss)............. $ (1,026,222) $ 582,641 $ (2,473,599) $ 39,429
============ ============= ============ ============
Basic and Diluted earnings per share:
Reported net income (loss)............. $ (.209) $ .162 $ (.596) $ (.083)
Add back: Cumulative effect of
accounting change for
impairment of goodwill................ - - (.092) -
Goodwill amortization...... - .034 - .097
------------ ------------- ------------ ------------
Adjusted net income (loss)............. $ (.209) $ .196 $ (.504) $ .014
============= ============= ============ ============
Since the impairment review was not performed until the third quarter of 2002,
SFAS No. 142 requires that the result be recorded in the Company's first
reporting period which is the quarter ended March 31, 2002. Thus, the first
quarter's results were restated to reflect the impact of the impairment charge.
The following table reports the effects of recording the goodwill impairment on
previously reported net income (loss) for the three months and six months ended
March 31, 2002 and June 30, 2002, respectively.
10
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Restated operating results for effect of cumulative change in accounting
principle:
Three Months Ended Six Months Ended
March 31, 2002 June 30, 2002
--------------------- -------------------
Reported loss before cumulative effect
of change in accounting principle............................ $ (266,754) $(1,447,377)
Goodwill impairment........................................... (452,745) (452,745)
----------- -----------
Net loss...................................................... $ (719,499) $(1,900,122)
=========== ===========
Reported basic and diluted loss per common share
before cumulative effect of change in accounting
principle.................................................... $ (.055) $ (.295)
Cumulative effect of change in accounting principle........... (.092) (.092)
----------- -----------
Restated basic and diluted net loss per common share.......... $ (.147) $ (.387)
=========== ===========
The Company evaluates the recoverability of its intangible assets subject to
amortization in accordance with Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 requires long-lived assets to be reviewed for impairment
whenever events or changes in circumstances indicate that their carrying amount
may not be recoverable. An impairment is recognized in the event that the net
book value of an asset exceeds the sum of the future undiscounted cash flows
attributable to such asset or the business to which such asset relates and the
net book value exceeds fair value. The impairment amount is measured as the
amount by which the carrying amount of a long-lived asset (asset group) exceeds
its fair value. As of September 30, 2002, the Company did not recognize any
impairment associated with its long-lived assets.
11
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Other intangible assets are comprised of the following:
September 30, 2002 December 31, 2001
------------------------------------ -------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
---------------- ----------------- ------------------ ----------------
Patents................................... $ 266,148 $ 87,185 $ 266,148 $ 74,815
Other Intangibles......................... 104,464 20,893 - -
------------- ------------- ------------- -------------
Total................................... $ 370,612 $ 108,078 $ 266,148 $ 74,815
============= ============= ============= =============
Aggregate Expense for the Three Aggregate Expense for the Nine
Months Ended Months Ended
------------------------------------ -----------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---------------- ----------------- ------------------ -----------------
Patents................................... $ 6,463 $ - $ 12,371 $ 118
Other Intangibles......................... 10,446 - 20,893 -
------------- ------------- ------------- -------------
Total................................... $ 16,909 $ - $ 33,264 $ -
============= ============= ============= =============
Estimated Amortization Expense:
For the year ended December 31, 2003 $ 68,400
For the year ended December 31, 2004 $ 57,954
For the year ended December 31, 2005 $ 26,616
For the year ended December 31, 2006 $ 26,616
For the year ended December 31, 2007 $ 26,616
Note 8 - Capital Lease Obligation
On February 28, 2002, the Company sold its rights and obligation to purchase the
land and buildings covered by a capital lease obligation, together with capital
improvements to the property totaling approximately $750,000, to Oklahoma
Facilities, LLC ("Facilities"). An officer of the Company has a minority
investment interest in and is an officer of Facilities. The total consideration
at closing was $1,400,000, with net cash proceeds to the Company of $761,000.
The transaction did not generate any gain or loss. The Company simultaneously
entered into a capital lease agreement with Facilities under which it is
obligated to pay average rent of $18,000 per month for a fixed term of ten
years. The Company has the right to buy the property at any time during the
first two years of the lease for a fixed price of $1,400,000. The Company also
has the option to purchase the building for a fixed price of $420,000 at the end
of the ten-year lease term.
12
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 9 - Notes Payable
Notes payable at September 30, 2002 and December 31, 2001 consisted of the
following:
September 30, December 31,
2002 2001
---- ----
Revolving line of credit, secured by accounts receivable and inventory,
bearing interest at the prime rate plus 1.25%, due in May 2003, with
maximum borrowings of $1,414,035 (1)................................... $ 1,414,035 $ 1,252,966
Revolving line of credit, secured by accounts receivable and inventory,
bearing interest at the prime rate plus 1.25%, due in January 2003,
with maximum borrowings of $1,608,100 (2).............................. 1,578,881 -
Note payable, secured by accounts receivable, bearing interest
at the prime rate plus 4.25%, payable in monthly installments of
$8,045 including interest, due upon collection of the pledged accounts
receivable or August 1, 2003,
whichever is earlier.................................................. 500,000 -
Other notes payable...................................................... 30,000 30,000
----------- -----------
Total notes payable.................................................... $ 3,522,916 $ 1,282,966
=========== ===========
On July 25, 2002, the Company borrowed $500,000 under a promissory note from
Oklahoma Facilities LLC ("Facilities"). An officer of the Company has a minority
investment interest in and is an officer of Facilities. The note is secured by
an account receivable from the Company's major customer in Venezuela. The note
requires payments of interest only for the first three months and fixed payments
of $8,045 per month thereafter. The note is due upon the collection of the
account receivable, but in any event must be paid in full by August 1, 2003.
Proceeds from the loan will be used to meet general corporate purposes.
At September 30, 2002, the Company was not in compliance on its borrowing base
requirements for its revolving lines of credit. This noncompliance is
attributable to two items as follows:
1. Over 90 day accounts receivable are to be excluded in the calculation
of eligible asset base in the borrowing base calculation. The
majority, approximately $1,403,000, of the over 90 day accounts
receivable relates to amounts due from a customer in Venezuela as
further explained in Note 4 to the Consolidated Financial Statements.
On October 7, 2002, the Lender for the revolving lines of credit
granted the Company a 90 day waiver from excluding over 90 accounts
receivable in the borrowing base calculation. The waiver expires on
January 1, 2003. With the wavier the Company is in compliance with its
revolving line credit agreements; however,
2. Even with the over 90 accounts receivable waiver mentioned above, the
Company's borrowings against its revolving lines of credit exceeded
the eligible asset base by approximately $140,000 at September 30,
2002. The Lender has not determined the impact of the event on the
Company's revolving lines of credit.
(1) Limited to a borrowing base amount calculated as 60% of eligible accounts
receivable and inventory.
(2) Limited to a borrowing base amount calculated as 50% of eligible accounts
receivable and inventory.
13
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 10 - Long-Term Debt
Long-term debt at September 30, 2002 and December 31, 2001, consisted of the
following:
September 30, December 31,
2002 2001
---- ----
Notes payable to shareholders of acquired businesses, unsecured, bearing
interest at 9% payable quarterly, due in five annual installments of
$200,000 each beginning January 2002................................... $ 800,000 $ 1,000,000
Note payable to bank, bearing interest at the prime rate plus 1%, payable
in monthly installments of $39,812 including interest, due in January
2008 2,114,425 2,439,532
Note payable to bank, bearing interest at the prime rate plus 1%, payable
in monthly installments of $14,823 including interest, due in
September 2004......................................................... 348,582 464,538
Construction loan payable to bank, bearing interest at the prime rate plus
1%, payable in monthly installments of $25,923 including interest, due
in January 2005........................................................ 663,273 -
Mortgage note on property, bearing interest at 10%, payable in monthly
installments of $1,451 including interest, with final payment of
$111,228 due in December 2002.......................................... 111,366 115,877
Notes payable to Duncan Area Economic Development Foundation, unsecured,
interest at 6%, payable in monthly installments of $1,934 including
interest, due in May 2006.............................................. 74,469 87,620
Secured vehicle and other equipment loans................................... 120,132 109,140
----------- -----------
Total.................................................................. 4,232,247 4,216,707
Less current maturities................................................ 1,162,615 876,737
----------- -----------
Long-term debt..................................................... $ 3,069,632 $ 3,339,970
=========== ===========
The revolving lines of credit and bank notes payable are owed to the Company's
primary lending bank and are secured by substantially all of the assets of the
Company. They have also been personally guaranteed by an officer of the Company.
Note 11 - Net Income (Loss) Per Common Share
Net income (loss) per common share is calculated by dividing net income (loss)
attributable to common stockholders by the weighted average number of common
shares outstanding. Diluted income (loss) per share is calculated by dividing
net income (loss) attributable to common stockholders by the weighted average
number of common shares and dilutive potential common shares outstanding. There
were no potentially dilutive common shares as of September 30, 2002 or December
31, 2001.
14
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001
Note 12 - Segment Information
The Company has three reportable segments, as follows:
o The Specialty Chemicals segment develops, manufactures, packages and
sells chemicals used by other oilfield service companies in oil and gas
well stimulation, cementing and production.
o The Equipment Manufacturing segment designs, manufactures and rebuilds
specialized cementing and stimulation equipment, including heavy
vehicles used for pressure pumping, blending and bulk material
transport. This segment also designs, constructs and manages automated
bulk material handling and loading facilities for other oilfield
service companies.
o The Downhole Equipment segment manufactures and markets the Petrovalve
line of downhole pump components and the Turbeco line of casing
centralizers.
The Company's reportable segments disclosed in Form 10-KSB are strategic
business units that offer different products and services. Each business segment
requires different technology and marketing strategies and is managed
independently. The accounting policies used in each of the segments are the same
as those described in the significant accounting policies disclosed in Form
10-KSB. The Company evaluates the performance of its operating segments based on
operating income excluding unusual charges. Intersegment sales and transfers are
not material.
The following table presents the revenues and operating income by business
segment and on a comparable basis:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- --------------------------------
2002 2001 2002 2001
--------------- ------------ ---------------- --------------
Revenues:
Specialty Chemicals.................. $ 2,000,633 $ 1,934,128 $ 4,900,972 $ 5,752,638
Equipment Manufacturing.............. 618,173 2,959,494 2,824,655 4,347,422
Downhole Equipment................... 331,862 - 2,264,917 -
----------- ----------- ----------- -----------
Consolidated....................... $ 2,950,668 $ 4,893,622 $ 9,990,544 $10,100,060
=========== =========== =========== ===========
Income (loss) from operations:
Specialty Chemicals.................. $ 412,051 $ 370,271 $ 672,783 $ 1,081,993
Equipment Manufacturing.............. (557,049) 266,033 (1,427,252) (674,771)
Downhole Equipment................... (252,779) - 143,892 -
Corporate and Other.................. (433,687) (82,371) (1,392,960) (424,294)
----------- ----------- ----------- -----------
Consolidated....................... $ (831,464) $ 553,933 $(2,003,537) $ (17,072)
=========== =========== =========== ===========
15
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Business Overview
Flotek was established in 1985 and is currently traded on the OTC Bulletin Board
market. On October 31, 2001, the Company completed a Merger with Chemical &
Equipment Specialties, Inc. ("CESI"). The Merger has been accounted for as a
reverse acquisition using the purchase method of accounting. In the Merger, the
shareholders of the acquired company, CESI, received the majority of the voting
interests in the surviving consolidated company. Accordingly, CESI was deemed to
be the acquiring company for financial reporting purposes and the historical
financial statements of the Company are the historical financial statements of
CESI. All of the assets and liabilities of Flotek were recorded at fair value on
October 31, 2001, the date of the Merger, and the operations of Flotek have been
reflected in the operations of the combined company only for periods subsequent
to the date of the Merger.
CESI was incorporated on June 27, 2000 to acquire businesses in the specialty
chemical and equipment manufacturing segments of the oilfield service industry.
It had no revenues or operations prior to the acquisitions of Esses, Inc.,
Plainsman Technology, Inc., Neal's Technology, Inc., and Padko International,
Inc. in January 2001. It subsequently acquired Material Translogistics, Inc. in
June 2001. These five companies are referred to collectively as the "CESI
Acquired Businesses".
The Company's product lines are divided into three segments within the oilfield
service industry:
o The Specialty Chemicals segment develops, manufactures, packages and
sells chemicals used by other oilfield service companies in oil and gas
well stimulation, cementing and production.
o The Equipment Manufacturing segment designs, manufactures and rebuilds
specialized cementing and stimulation equipment, including heavy
vehicles used for pressure pumping, blending and bulk material
transport. This segment also designs, constructs and manages automated
bulk material handling and loading facilities for other oilfield
service companies.
o The Downhole Equipment segment manufactures and markets the Petrovalve
line of downhole pump components and the Turbeco line of casing
centralizers.
All of the Company's businesses serve the oil and gas industry and are affected
by changes in the worldwide demand for and price of oil and natural gas. The
majority of our products are dependent on the level of exploration and
development activity and the completion phase of oil and gas well drilling.
Other products and services, such as our Petrovalve downhole pump products and a
small number of our specialty chemicals are more closely tied to the production
of oil and gas and are less dependent on drilling activity.
The oil and gas industry has been subject to significant volatility in recent
years due to changes in the demand, supply and pricing of oil and natural gas.
The U.S. rig count, as measured by Baker Hughes Incorporated, began 2001 at
around 1,100 active rigs and reached a peak of almost 1,300 in July 2001. During
the third quarter of 2001, the demand for oil and natural gas began to weaken in
response to slowing growth in worldwide economies. This resulted in a slowdown
in North American drilling rig activity, with a steady decline in the rig count
during the second half of 2001 until it had reached a level of just under 900
active rigs at December 31, 2001. During the quarter ended September 30, 2002,
the U.S. rotary rig count was 875. This was a slight increase compared to the
847 rigs working at the end of the second quarter. Natural gas and crude oil
prices have continued their upward trend moving from $3.40 per MCF and $27.00
per barrel, respectively, at the end of the second quarter to $4.14 per MCF and
$30.59 per barrel, respectively, at the quarter ended September 30, 2002.
Although our business will steadily benefit from these oil and gas commodity
prices, we are not seeing increased spending in the short term from our
customers as a result of these higher commodity prices.
16
Results of Operations
Nine months ended September 30, 2002 2001
--------------- ---------------
Revenues........................................... $ 9,990,544 $10,100,060
Cost of revenues................................... 6,502,864 7,063,038
----------- -----------
Gross margin.................................... 3,487,680 3,037,022
----------- -----------
Gross margin %.................................. 34.9% 30.1%
Selling, general and administrative................ 4,883,663 2,544,716
Depreciation and amortization...................... 498,322 493,173
Research and development........................... 109,232 16,205
----------- -----------
Total expenses.................................. 5,491,217 3,054,094
----------- -----------
Operating loss.................................. (2,003,537) (17,072)
----------- -----------
Operating loss %................................ (20.1%) (.017%)
Interest expense................................... (467,697) (282,955)
Interest income.................................... 243 47,547
Other, net......................................... (2,608) (20,435)
----------- -----------
Other income (expense), net.................... (470,062) (214,973)
----------- -----------
Pre-tax income (loss) before cumulative
effect of change in accounting principle...... $(2,473,599) $ (232,045)
=========== ===========
Total revenues decreased by $109,516 or 1.1%, in the first nine months of 2002
compared to the comparable period in 2001. As discussed in the segment analysis
below, the Specialty Chemicals segment and the Equipment Manufacturing segment
experienced a significant decrease in revenues in 2002 compared to 2001, while
the Downhole Equipment segment had higher revenues in the first nine months of
2002. The Downhole Equipment increase resulted primarily from business
combinations, as discussed earlier in this Business Overview, whose operations
were not reflected in the first nine months of 2001.
On an aggregate basis, the gross margin as a percentage of revenues increased
from 30.1% in 2001 to 34.9% in 2002. The gross margin is best analyzed on a
segment by segment basis, discussed below, as the margin varies significantly
between operating segments and can vary significantly from period to period in
certain of our operating segments.
Selling, general and administrative ("SG&A") costs represent the costs of
selling, operations and overhead expenses not directly attributable to products
sold or services rendered. The revenues from services are less than 10% of
consolidated revenues and the direct costs of providing these services are
included in cost of revenues. SG&A amounted to 48.9% of revenues in 2002, an
increase of 23.7% of revenues from the level of 25.2% in 2001. The costs of
administration have increased as a result of the merger and the increased size
and complexity of the Company. Also, administration costs increased in the
second quarter of 2002 due to activities associated with the stock settlement as
explained in Note 3 to the Consolidated Financial Statements. Actions have been
and continue to be taken to reduce these costs to the optimum level as we work
to grow the business.
Interest expense increased approximately $185,000 in the first nine months of
2002 compared to same period in 2001. The average amount of outstanding debt
under the Company's credit agreements was significantly higher in 2002 as a
result of the financing of capital expenditures and increased working capital
needs during the year. In addition, payments associated with the long-term
capital lease mentioned in Note 8 to the Consolidated Financial Statements
started in the second quarter of 2002. The majority of the Company's
indebtedness carries a variable interest rate tied to the prime rate and is
adjusted on a quarterly basis.
17
As more fully discussed in Note 7 to the Consolidated Financial Statements, we
completed in the third quarter, our initial assessment, with the assistance of a
third-party appraiser, of goodwill impairment as required under SFAS No. 142.
There was approximately $1.3 million of goodwill attributable to the Equipment
Manufacturing segment, of which we have identified two reporting units,
Equipment Specialties and MTI. Our test concluded that all of the goodwill
attributable to Equipment Specialties, totaling $452,745, was impaired.
Consequently, we have recognized this impairment loss as of the first interim
period which was March 31, 2002. Out test concluded that no impairment loss
existed for the MTI reporting unit.
Results by Segment
Specialty Chemicals
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ----------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- -----------------
Revenues................................ $ 2,000,633 $ 1,934,128 $ 4,900,972 $ 5,752,638
Gross margin............................ $ 871,245 $ 803,756 $ 2,057,056 $ 2,502,588
Gross margin percentage............. 43.5% 41.6% 42.0% 43.5%
Operating income........................ $ 412,051 $ 370,271 $ 672,783 $ 1,081,993
Operating margin percentage......... 20.6% 19.1% 13.7% 18.8%
Specialty Chemical revenues decreased $851,666, or 15%, in the first nine months
of 2002 compared to the same period in 2001. Sales in this segment are heavily
dependent on drilling activity and the decrease in revenue is primarily
attributable to sharply lower (32%) drilling activity in the first nine months
of 2002 compared to 2001. Average product pricing levels in this segment
declined as lower demand caused our pricing to come under pressure.
The gross margin in this segment also declined from 43.5% for the first nine
months of 2001 to 42.0% in the same comparable period for 2002. In certain
cases, in trying to maintain sales levels and market share, we sold our products
at a lower gross margin. The combination of lower revenues due to reduced
drilling activities and lower gross margins had a significant adverse effect on
our operating margin and overall levels of operating income.
Operating income fell $409,210, or 38%, in the first nine months of 2002
compared to the same period in 2001, primarily as a result of lower revenues and
gross margins. We took actions to reduce selling, general and administrative
expenses in this segment to keep these costs in line with the reduced revenue
levels. However, these costs could not be reduced at the same rate as revenue
resulting in a significant decrease in operating income margin percentage in
this segment from 18.8% in 2001 to 13.7% in 2002.
Operating results for the third quarter of 2002 compared to the same period in
2001 were higher due to a 3% increase in revenue between periods driven
primarily by the sale of new products. Gross margins improved between periods by
1.9% from 41.6% in 2001 to 43.5% in 2002 primarily due to changes in product mix
and the sale of new products with higher margins.
18
Equipment Manufacturing
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ----------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- -----------------
Revenues................................ $ 618,173 $ 2,959,494 $ 2,824,655 $ 4,347,422
Gross margin............................ $ 13,419 $ 285,326 $ 258,467 $ 534,433
Gross margin percentage............. 2.2% 9.6% 9.2% 12.3%
Operating income (loss)................. $ (557,049) $ 266,033 $(1,427,252) $ (674,771)
Operating margin percentage......... (90.1%) 9.0% (50.5%) (15.5%)
Equipment Manufacturing revenues decreased $1,522,767, or 35.0%, in the first
nine months of 2002 over 2001 levels. This decrease primarily resulted from an
overall slow down in equipment manufacturing activity due to sharply lower (32%)
drilling activity in the first nine months of 2002 compared to the same period
in 2001. This lower activity, combined with various economic and political
uncertainties, has caused many of our customers to curtail or stop spending on
the manufacture or refurbishment of cementing and stimulation equipment and
automated bulk handling and loading facilities. This decrease was partially
offset by the addition of MTI, a company that was acquired on June 29, 2001.
Under purchase accounting, MTI's results of operations are included only for
periods subsequent to the acquisition; therefore, it is only reflected in the
year-to-date results for 2001 from June 29, 2001 forward. During the first six
months of 2002, MTI had revenues of $1,076,000 and positive operating income of
$48,000. We continued, in the third quarter, to experience poor operating
results in our Equipment Specialties operations (formerly Neal's Technology,
Inc.) primarily due to a lack of work. However, in the third quarter of this
year, we also experienced a slow down in construction projects for MTI, which
has been partially offset by positive operating results from the start-up of our
MTI Transload facility in the Gulf Coast. Actions have been and continue to be
taken to reduce operating expenses and improve efficiencies in this segment in
line with expected revenues.
Gross margins also decreased 3.1% between years from 12.3% in 2001 to 9.2% in
2002. This year-to-date decrease is primarily due to the decline in business
discussed above and poor operating performance earlier in 2002. There has and
continues to be significant focus placed on improving operational controls and
work processes.
Operating losses, although 17% less, continued into the third quarter from the
second quarter primarily due to the significant decrease (44%) in revenue
between these periods. This revenue reduction is a direct result of customers
curtailing or stopping capital spending on equipment and construction projects.
Operating expenses have been reduced between the second and third quarters of
this year, but have not been taken below a core infrastructure to service
expected customer needs in the fourth quarter and beyond. A positive aspect of
this segment is the Transload facility in the Gulf Coast. This facility off
loads and blends bulk commodities for a major oil and gas service company. It
became fully operational midway through the third quarter and is yielding
positive operating results. Near term results have been impacted, though not
significantly, by the recent storms in the Gulf Coast.
Operating results for the third quarter of 2002 compared to the same period in
2001 were lower for much of the same reasons mentioned above regarding the first
nine months of 2002.
The current market outlook for this segment is guarded. Orders and opportunities
to bid have declined significantly from the second quarter of 2002; however, we
have either been awarded or are in negotiations on some significant projects for
both Equipment Specialties and MTI, with start dates in the fourth quarter of
19
this year. The Company cannot give assurance that it will not continue to
experience losses in its Equipment Manufacturing operations, or in the Equipment
Manufacturing segment as a whole.
As more fully discussed in Note 7 to the Consolidated Financial Statements, we
completed in the third quarter, our initial assessment, with the assistance of a
third-party appraiser, of goodwill impairment as required under SFAS No. 142.
There was approximately $1.3 million of goodwill attributable to this segment,
of which we have identified two reporting units, Equipment Specialties and MTI.
Our test concluded that all of the goodwill attributable to Equipment
Specialties, totaling $452,745, was impaired. Consequently, we have recognized
this impairment loss as of the first interim period which was March 31, 2002.
Our test concluded that no impairment loss existed for the MTI reporting unit.
Downhole Equipment
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
Revenues................................ $ 331,862 $ - $ 2,264,917 $ -
Gross margin............................ $ 83,608 $ - $ 1,172,157 $ -
Gross margin percentage............. 25.2% - 51.8% -
Operating income (loss)................. $ (252,779) $ - $ 143,892 $ -
Operating margin percentage......... (76.2%) - 6.4% -
The Downhole Equipment segment became part of the consolidated group after the
Merger became effective on October 31, 2001. These operations, which consist of
manufacturing and marketing the Petrovalve line of downhole pump components and
the Turbeco line of casing centralizers, were the original operations of Flotek
Industries, Inc. prior to the Merger. Since the Merger was recorded for
accounting purposes as a reverse merger, the results of operations of this
segment were included in the consolidated results of operations only for periods
subsequent to the Merger and are not reflected in the first nine months of 2001.
Consolidating the 2002 results of operations for this segment has a significant
impact on gross margins for the consolidated company.
Petrovalve sales, totaling $1,503,000 in the first nine months of 2002, were
exclusively to one customer in Venezuela, except for $100,000 to various other
customers. As more fully discussed in Note 4 of the Notes to Consolidated
Financial Statements and the Capital Resources and Liquidity section, below,
this customer has not paid for these goods within the customary payment terms.
These sales carry a high gross margin and are significantly profitable to this
segment. Operating results for this reporting unit declined between the second
and third quarter of 2002 due to a lack of large sales to the international
market. We expect to receive orders totaling $300,000 to $600,000 in the fourth
quarter which would yield improved operating profits for this portion of the
Downhole segment.
Sales of the Turbeco line of casing centralizers, which constitute the balance,
$762,000, of the revenues in this segment, are very dependent on the level of
drilling activity and have suffered from the drilling decline and lower demand
this year. However, sales have increased 19% between the second quarter and
third quarter of 2002 and we are positive about the outlook for the balance of
the year.
Capital Resources and Liquidity
In the first nine months of 2002, the Company sustained a loss, before the
cumulative effect of change in accounting principle, of $2,473,599 and had
negative cash flow from operations of $1,889,885. These losses resulted
primarily from the poor operating results in the Equipment Manufacturing
segment, and general corporate expenses. Management has taken and will continue
20
to take appropriate steps to improve performance and attempt to limit the
losses/return to profitability in the Equipment Manufacturing segment. The
negative cash flow resulted primarily from the operating losses mentioned
previously and from delays in collecting accounts receivable from sales to a
Venezuelan customer, as discussed below, and delay in shipment of an export
equipment sale totaling approximately $521,000.
As of September 30, 2002, net working capital was negative $1,944,128, resulting
in a current ratio of .74 to 1. Inventories have decreased significantly,
approximately $1,209,000, during the first nine months of 2002, primarily due to
completion of manufactured equipment and bulk construction projects, and a
concerted effort to move slow moving inventory.
As disclosed in Note 4 of the Notes to Consolidated Financial Statements, at
September 30, 2002, the Company had approximately $1,403,000 of accounts
receivable from a customer in Venezuela, all of which arose from goods shipped
in the first half of 2002. As a result of political instability and work
disruptions in the country, these amounts have not been paid within the
customary payment terms for this customer. The ultimate customer for these goods
is PDVSA, the national oil company of Venezuela. Our customer holds a contract
to deliver over $5 million of our proprietary products to PDVSA during the next
three years. However, PDVSA has delayed acceptance of the majority of the goods
shipped until its field operations return to higher activity levels. Our
customer is unable to pay for the goods until payment has been received from
PDVSA. In the second quarter of 2002 we were informed by PDVSA that field
operations would return to higher levels of activity and that acceptance of
goods shipped would begin. During the second and third quarters of 2002, we
received payments totaling $200,000 and $629,000, respectively, and PDVSA is
continuing to accept goods previously shipped. We fully expect to collect the
entire outstanding balance and have not provided a reserve for doubtful accounts
associated with this balance. The delay in collecting this accounts receivable
balance has had a significant adverse effect on the cash flow of the Company.
Additionally, all invoice amounts, as discussed in Note 9 of the Notes to
Consolidated Financial Statements, which are greater than 90 days old cannot be
included in the borrowing base under our lines of credit.
On February 28, 2002, the Company sold its rights and obligation to purchase the
land and buildings covered by a capital lease obligation, together with capital
improvements to the property totaling approximately $750,000 to Oklahoma
Facilities, LLC ("Facilities"). An officer of the Company has a minority
investment interest in and is an officer of Facilities. This transaction
resulted in net cash proceeds to the Company of $761,000. The Company
simultaneously entered into an agreement to lease back the facility over ten
years. This transaction has been recorded as a capital lease as discussed in
Note 8 of the Notes to Consolidated Financial Statements.
The Company has borrowed $3.13 million in the first nine months of 2002 under
its line of credit arrangements, including a new $1.6 million line of credit
which was executed in January of 2002 and short-term borrowing of $500,000
executed in July 2002. In addition, our primary lending bank has extended a $1.4
million line of credit until May 29, 2003. The Company has borrowings which have
exceeded its eligible asset base by approximately $140,000 at September 30,
2002. We also made total debt service payments of approximately $865,000 during
the first nine months of this year. The company has estimated minimum debt
service obligations in 2002 of $1.3 million. This amount includes the minimum
principal and interest payments on the new credit agreements mentioned above and
in Note 9 of the Consolidated Financial Statements and the capital lease
obligation incurred during the first quarter of 2002.
Capital expenditures in the first nine months of 2002 were $1,357,695. The
majority of these capital expenditures relate to a bulk material transload
facility which the Company is constructing in Raceland, Louisiana and a paint
shop for Equipment Specialties in Duncan, Oklahoma. With the exception of an
additional $300,000 in capital expenditures required to complete the
construction and possible expansion of the Raceland transload facility, the
Company does not at this time expect to have any major requirements for capital
expenditures for the remainder of 2002.
21
The Company believes its operations are capable of generating sufficient cash
flow to meet its debt service obligations if we successfully collect amounts due
from our Venezuelan customer and our export equipment sale. The export sale has
shipped. However, the collection of these amounts, and certain other factors
involved in executing our business strategy, are beyond our control. In
addition, we face a challenging near-term industry environment. As a result, we
believe the Company will need to raise additional capital through the sale of
its debt or equity securities. There can be no assurance that the Company will
be able to secure such financing on acceptable terms.
It is uncertain that we will be able to collect the amounts from our Venezuelan
customer, limit our losses in the Equipment Manufacturing segment, reduce
corporate expenses in line with revenue, and/or obtain additional equity or debt
financing. Accordingly, investors are advised that the Company faces significant
financial risks in the near future as we attempt to meet these challenges.
Forward Looking Statements
Except for the historical information contained herein, the discussion in this
Form 10-QSB includes "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933, as amended and Section 21E of the Securities
Exchange Act of 1934, as amended. The words "anticipate," "believe," "expect,"
"plan," "intend," "project," "forecast," "could" and similar expressions are
intended to identify forward-looking statements. All statements other than
statements of historical facts included in this Form 10-QSB regarding the
Company's financial position, business strategy, budgets and plans and
objectives of management for future operations are forward-looking statements.
Forward-looking information involves risks and uncertainties and reflects our
best judgment based on current information. Our results of operations can be
affected by inaccurate assumptions we make or by known or unknown risks and
uncertainties. In addition, other factors may affect the accuracy of our
forward-looking information. As a result, no forward-looking information can be
guaranteed. Actual events and the results of operations may vary materially.
While it is not possible to identify all factors, we continue to face many risks
and uncertainties that could cause actual results to differ from our
forward-looking statements including:
o The Company is dependent on the oil and gas industry, and activity levels in
the industry are volatile.
o Oil and gas prices are volatile and have a direct impact on the spending
levels of our customers.
o Severe weather conditions, for example, hurricanes, can have a
direct impact on activity levels in the affected areas, and oil
and gas prices.
o The oilfield service industry is highly competitive and we must
compete with many companies possessing greater financial
resources and better established market positions.
o The introduction of new products and technologies by competitors
may adversely affect the demand for our products and services.
o The Company's debt service obligations may limit our ability to
fund operations and capital spending or provide for future
growth.
o Changes in political conditions, governmental regulations,
economic and financial market conditions, unexpected litigation
and other uncertainties may have an adverse effect on our
operations.
22
Item 4 - Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer (collectively,
the "Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. Such officers have concluded
(based upon their evaluation of these controls and procedures as of a date
within 90 days of the filing of this report) that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in this report is accumulated and communicated to the
Company's management, including its principal executive officers as appropriate,
to allow timely decisions regarding required disclosure.
The Certifying Officers also have indicated that there were no significant
changes in the Company's internal controls or other factors that could
significantly affect such controls subsequent to the date of their evaluation,
however, there are corrective actions required with respect to significant
deficiencies and material weaknesses in internal controls as follows:
Weakness Solution
--------------------------------------------------------------------------------------------
1. A contingency plan has not been developed for Develop a backup plan by March 31,
alternative processing of data in the event of loss 2003
or interruption of the IT server(s)
2. Off premises storage is not maintained for Identify applications and related
applications and related documentation documentation that need to be stored off
site and move to off-site storage by
March 31, 2003
3. Annual property plant and equipment (PP&E) Complete annual physical inventory of
inventories have not been taken PP&E by December 31, 2002
4. Physical controls of Equipment Specialties inventory Move inventory to a secure site by
need improvement December 31, 2002
23
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
On May 1, 2002, Milam Tool Company and the Estate of Jack J. Milam filed a
complaint against Flotek Industries, Inc., Turbeco, Inc., and Jerry D. Dumas,
Sr., individually, in the United States District Court for the Southern District
of Texas, Houston Division. The complaint asserts that the sale of TURBO-LOK
turbulators, which are part of the Company's Downhole Equipment segment,
violates an agreement among the parties and infringes a United States patent
controlled by the plaintiffs. Plaintiffs seek injunctive relief and unspecified
damages. The Company has answered the complaint. At a Scheduling Conference on
July 3, the court deferred discovery on issues related to damage allegations and
entered a scheduling order governing the consideration of liability issues. The
court did not set a trial date, but did schedule a hearing on May 16, 2003 to
consider construction of the claims of the Milam patent. The Company strongly
denies the assertions in the complaint and intends to vigorously contest this
matter.
Item 5 - Other Information
We intend to hold an annual meeting of shareholders during the month of May
2003. Proposals of shareholders intended for presentation at that annual meeting
and intended to be included in our Proxy Statement and Form of Proxy for that
meeting must be received at our executive offices by February 1, 2003.
Item 6 - Exhibits
(a) Exhibits
Exhibit
Number Description of Exhibit
------ ----------------------
10.1 Change in Terms Agreement dated September 16, 2002 by and between
Legacy Bank and Flotek Industries, Inc.
99.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FLOTEK INDUSTRIES, INC.
Date: November 12, 2002 /s/ Mark D. Kehnemund
--------------------------------------------
Mark D. Kehnemund
Sr. Vice President & Chief Financial Officer
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Flotek Industries, Inc. on Form
10-QSB for the quarter ended September 30, 2002, as filed with the Securities
and Exchange Commission on the date hereof, I, Jerry D. Dumas, Sr., the Chief
Executive Officer of the Company, certify, pursuant to and for purposes of 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, that:
1. I have reviewed this quarterly report on Form 10-QSB of Flotek Industries,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Jerry D. Dumas, Sr.
-----------------------------
Jerry D. Dumas, Sr.
Chief Executive Officer
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Flotek Industries, Inc. on Form
10-QSB for the quarter ended September 30, 2002, as filed with the Securities
and Exchange Commission on the date hereof, I, Mark D. Kehnemund, the Chief
Financial Officer of the Company, certify, pursuant to and for purposes of 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, that:
1. I have reviewed this quarterly report on Form 10-QSB of Flotek Industries,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Mark D. Kehnemund
--------------------------------------------
Mark D. Kehnemund
Sr. Vice President & Chief Financial Officer