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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
For Annual and Transition Reports pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 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 77040
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (713) 849-9911
Securities registered pursuant to Section 12(b)
of the Exchange Act:
(none)
Securities registered pursuant to Section 12(g)
of the Exchange Act:
Common Stock, $0.0001 par value
(Title of Class)
Check whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities 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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
Revenues for the Company's 2002 fiscal year were $13,260,503.
The aggregate market value of the common stock held by non-affiliates of the
registrant was approximately $3,313,000 on March 25, 2003 based upon the closing
sale price of common stock on such date of $0.60 per share on the OTC Bulletin
Board. As of March 25, 2003, the Registrant had 5,521,670 shares of common stock
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement, dated May 22, 2003, for its 2003
annual meeting of shareholders have been incorporated by reference into Part III
of this Form 10- KSB.
Transitional small business disclosure format: Yes ( ) No ( X )
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TABLE OF CONTENTS
PART I
Item 1. Description of Business..............................................3
Item 2. Description of Properties............................................7
Item 3. Legal Proceedings....................................................7
Item 4. Submission of Matters to a Vote of Security Holders..................7
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters..........................................8
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...........................................9
Item 7. Financial Statements................................................17
Item 8. Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure..................39
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16 (a) of the Exchange Act .................39
Item 10. Executive Compensation..............................................39
Item 11. Security Ownership of Certain Beneficial Owners and Management......39
Item 12. Certain Relationships and Related Transactions......................39
Item 13. Exhibits and Reports On Form 8-K....................................39
Item 14. Controls and Procedures.............................................40
SIGNATURES....................................................................41
2
PART I
Item 1. Description of Business
Business
Flotek Industries, Inc. and subsidiaries (the "Company" or "Flotek") was
originally incorporated under the laws of the Province of British Columbia on
May 17, 1985. On October 23, 2001, the shareholders of the Company approved a
change in its corporate domicile to Delaware and a reverse stock split of 120 to
1 On October 31, 2001, the Company completed a reverse merger ("the Merger")
with Chemical & Equipment Specialties, Inc. ("CESI"). CESI is treated as the
acquirer for accounting purposes. In connection with the Merger, the Company
adopted a calendar year end, which had been the prior reporting basis of CESI.
The business of Flotek prior to the Merger consisted of the Downhole Equipment
segment, as described below. CESI's business was comprised of the Specialty
Chemical and Equipment Manufacturing segments. Flotek is headquartered in
Houston, Texas and its common shares are traded on the OTC Bulletin Board
market. Effective November 5, 2001, in connection with the Merger, the Company
began trading with a new stock ticker symbol, "FLTK", to reflect its change in
status from a foreign-domiciled corporation to a Delaware corporation.
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 cementing, stimulation 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.
Specialty Chemicals
Stimulation of oil and gas wells is comprised of hydraulic fracturing of
sandstone reservoirs and acidizing of carbonate reservoirs. In the Specialty
Chemicals segment, the Company has a full spectrum of cementing, acidizing and
fracturing chemicals and fracturing additives and also markets certain specialty
production chemicals. The Company has a fully-equipped laboratory facility in
Oklahoma which is used to design and test new chemical formulations and enhance
existing products, often in partnership with our customers. The laboratory also
provides quality assurance to our manufacturing operations and expert technical
support to our customers on existing product lines. The customer base for this
division is primarily oil and gas well pumping service companies, including both
major and independent oilfield service companies. The segment manufactures and
packages its products in Oklahoma and has sales and warehousing locations in
Oklahoma and Texas. The Company also works through sales representatives and
agents in Canada, Mexico, South America, the Middle East and Far East. Business
in this segment is highly competitive. The Company attempts to distinguish
itself through the strength of its innovative and proprietary products,
dedication to product quality and superior customer service.
Equipment Manufacturing
In the Equipment Manufacturing segment, the Company designs, manufactures and
rebuilds cement mixing units, hydraulic fracturing blenders, acid pump vehicles,
state of the art control units and other oilfield pumping and mixing equipment.
It also manufactures and rebuilds nitrogen equipment units that are used for
foam fracturing, coiled tubing cleanup operations and industrial cleaning.
3
The Company relies on suppliers for the development and/or delivery of several
major components such as diesel engines, heat exchange units, pumps and
compression equipment. These units typically require several months to
complete and deliver. Manufacturing operations are based in Duncan,
Oklahoma.
The Company also designs, constructs and manages automated bulk material
handling and loading facilities for other oilfield service companies, either as
the general contractor on these projects or as consulting engineers. Our
client's bulk facilities handle such oilfield products as sand and other
proppant materials for well fracturing operations, dry cement and additives for
oil and gas well cementing, and other supplies and materials used in oilfield
operations.
The customer base for this segment consists of major and large independent
oilfield service companies which specialize in cementing, pressure pumping and
fracturing and our products are sold both in domestic and international markets.
Downhole Equipment
The Company's Downhole Equipment segment manufactures and sells two primary
product lines, the Petrovalve line of downhole pump valves and the Turbeco line
of rigid centralizers used in cementing operations. Both product lines use
patented and/or proprietary product designs to achieve greater efficiency and
effectiveness than competing products.
The Petrovalve line of downhole pump valves was originally designed in the
mid-1980's and has undergone significant improvements in recent years. The
Petrovalve product line provides longer and more reliable downhole pump
performance than the traditional ball and seat valves which are the predominant
product in the industry. Additionally, our valves have been demonstrated to
provide more efficient flow characteristics and can increase our customer's
production volumes in many circumstances. The new "Gas Breaker" technology
allows us to provide a solution to gas lock problems often encountered on wells
with lower flow rates or high gas ratios. The Company outsources manufacturing
of most of the machined valve components, but assembles and performs final
quality assurance on all valves in Houston.
The Turbeco line of fixed rigid centralizers is used in oil and gas well
cementing programs to increase the effectiveness of such operations. Our primary
products include the Cementing Turbulator, which Flotek acquired and began
distributing in 1994. The main purpose of this tool is to assure the pipe is
properly centered in the well bore and to improve placement of cement to obtain
an effective bond with the formation. The Company was one of the first companies
to distribute spiral-vane cementing turbulators. The Turbulator has gained
widespread acceptance through its ability to improve oil and gas well cementing
programs and is effective in deep, directional and horizontal well applications.
New products that have been introduced in this segment are the Integral Pump
Centralizer, the Eccentric Turbulator (jointly patented with Marathon Oil), and
the recently patented Turbo-lok Centralizer. Recently, the Company completed
design and testing of its proprietary close tolerance Pressure-Actuated Casing
("C-PAC") Centralizer. This pressure-actuated tool is designed to accommodate
"slim-hole" deviated well completion programs. The C-PAC Centralizer is an
integral part of the casing and does not activate until it is in its final
position in the well, thus reducing drag during insertion of the casing in the
well bore. It can also be used in smaller well bore diameters which would
prevent the use of traditional fixed centralizers. Once in place, the vanes are
pressure-activated to expand and centralize the casing to maximize the integrity
of the cementing process. Patent applications are pending and marketing efforts
are in progress.
The Company's competition in the Petrovalve product line is comprised of rod
pump manufacturers and pump maintenance and service shops using the industry
standard API ball and seat product, as well as other proprietary valve products.
In the cementing centralizer market, the Company competes with both large,
diversified oilfield service companies and smaller independent competitors.
Competition is high and is expected to continue for the foreseeable future.
4
The Company's customers in the Downhole Equipment segment are primarily oil and
gas exploration and production companies, including major oil companies, which
are involved in the drilling and cementing of oil wells and own producing oil
and gas wells. The Company's active customer base is distributed among major oil
companies and smaller independent operators. The Company's marketing area is
focused in the Gulf of Mexico region, although the Company has a significant
customer base in Venezuela for its Petrovalve products and is continuing to
expand its market both internationally and domestically.
Product Demand and Marketing
The demand for the Company's products and services is generally correlated to
the level of oil and gas drilling activity, both in the United States and
internationally. Drilling activity, in turn, is generally dependent on the price
levels of oil and gas. Certain of the Company's products, particularly the
Petrovalve line of downhole pump valves and certain of its specialty chemicals,
are more closely related to the production of oil and gas and demand for these
products is less dependent on drilling activity.
We market our products primarily through direct sales to our customers by
company managers and sales employees. We generally have established customer
relationships which provide for repeat sales. As a result of the significant
consolidation which has occurred in the industry over the past 16 years, our
sales have tended to be concentrated in larger customer relationships. Four
customers accounted for 44.2% of our consolidated revenues for the year ended
December 31, 2002. Three of these customers were in the Specialty Chemicals
segment of our business and they collectively accounted for 65.2% of the
revenues in this segment. The remaining customer was in the downhole equipment
segment of our business and it accounted for 52.1% of the revenues in this
segment.
Government Regulation, Operating Risks and Insurance
We are subject to federal, state and local environmental and occupational safety
and health laws and regulations in the United States and other countries in
which we do business. The Company has endeavored to fully comply with these
requirements and is not aware of any material instances of noncompliance.
However, these requirements are complex and assuring compliance is often
difficult. The enforcement of these laws and regulations may become more
stringent in the future and could have a material impact on our costs of
operations. Non-compliance could also subject us to material liabilities, such
as government fines, third-party lawsuits or even the suspension of operations.
Many of the products within our specialty chemicals segment are considered
hazardous or flammable. The majority of such products are reasonably stable and
generally require only ordinary care in handling and transportation. However, we
do have risks in handling the materials in this segment and if a leak or spill
occurs in connection with our operations, we could incur material costs to
remediate any resulting contamination.
In addition, our Company's products are used for the exploration and production
of oil and natural gas. Such operations are subject to hazards inherent in the
oil and gas industry, such as fires, explosions, blowouts and oil spills, which
can cause personal injury or loss of life, damage to or destruction of property,
equipment, the environment and marine life, and suspension of operations.
Litigation arising from an occurrence at a location where the Company's products
or services are used or provided could, in the future, result in the Company
being named as a defendant in lawsuits asserting potentially significant claims.
The Company maintains insurance coverage that it believes to be reasonable and
customary in the industry against these hazards.
The Company has a legal action pending. Reference is made to Item 3 of this
report on Page 7. No significant losses have been recognized as a result of this
pending litigation.
Research and Development and Intellectual Property
The Company is actively involved in developing proprietary products to expand
its existing product lines and in developing new technologies. The Company has
followed a policy of seeking patent protection both within and outside the
5
United States for products and methods that appear to have commercial
significance and qualify for patent protection. The decision to seek patent
protection considers whether such protection can be obtained on a cost-effective
basis and is likely to be effective in protecting the commercial interests of
the Company. The Company believes that its patents and trademarks, together with
its trade secrets and proprietary design, manufacturing and operational
expertise, are reasonably adequate to protect its intellectual property and
provide for the continued operation of its business. However, the Company's
competitors may attempt to circumvent these patent protections or develop new
technologies which compete with the Company's products.
International Operations
Substantially all of the Company's revenues and operations are currently derived
and conducted, respectively, within the United States. However, the Company has
been expanding its international sales efforts and expects international sales
to increase in the future. The Company is utilizing a third party in Canada to
blend and distribute Chemical products for customers in Canada. Other than this
operation, there are no current plans to locate any additional production
operations or maintain any significant amounts of inventory outside the U.S.
However, these plans are subject to change in the future based on management's
assessment of business opportunities in the global markets.
One of the Company's product lines, Petrovalve downhole pumps, is currently sold
into markets in South America, particularly Venezuela, and the Middle East. As
discussed in Note 5 of the Notes to Consolidated Financial Statements, we have
experienced difficulties in collecting accounts receivable from these sales on a
timely basis due to political instability and a work disruption by the national
oil company of Venezuela. At December 31, 2002, we had approximately $1,227.0
thousand in accounts receivable from a customer in Venezuela which are now past
due and had not been collected as of the date this Form 10-KSB was filed.
International sales involve additional business and credit risks inherent in
doing business in countries with legal and political policies different from
those in the United States. Those risks can include war, boycotts, legal and
political changes, and fluctuations in currency exchange rates. Although it is
impossible to predict the probability of such occurrences or their effect on the
Company, management believes that these risks are outweighed by the commercial
opportunities of developing sales markets outside the United States.
Employees
As of December 31, 2002, the Company employed approximately 93 full-time
employees. None of the Company's employees are covered by collective bargaining
agreements. The Company believes that its relationship with its employees is
satisfactory.
Risk Factors
The Company faces various business risks specific to its industry, product
lines, financial resources and competitive position, as well as general economic
and financial risks. The following risk factors, among others, may cause the
Company's operating results and/or financial position to be adversely affected:
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.
6
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 and cash flow from operations 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.
Item 2. Description of Properties
The following table sets forth certain information with respect to the Company's
principal properties:
Facility Size
(Sq. Feet)
Location Tenure Utilization
---------------------------- --------------- --------------- -------------------------------------------
Houston, Texas................ 9,000 Leased Corporate Office and Warehouse
Mason, Texas.................. 12,000 Owned Manufacturing Downhole Equipment
Alice, Texas.................. 3,200 Leased Warehouse for Downhole Equipment
Duncan, Oklahoma.............. 41,000 Leased Equipment Manufacturing
Marlow, Oklahoma.............. 15,500 Owned Specialty Chemicals Blending
Denver, Colorado.............. 1,200 Leased Specialty Chemicals Sales Office
Lafayette, Louisiana.......... 5,000 Leased Warehouse for Downhole Equipment
Raceland, Louisiana........... 4,000 Owned Transload for Oilfield Services Material
Raceland, Louisiana........... 700 Leased Administrative Offices
The Company considers its facilities to be in good condition and suitable for
the conduct of its business. All of our facilities are subject to mortgages or
security agreements as described in the Notes to the Consolidated Financial
Statements.
Item 3. Legal Proceedings
Milam Tool Company and the Estate of Jack J. Milam vs. Flotek Industries, Inc.,
Turbeco, Inc. and Jerry Dumas, individually, C.A. No. H-02-1647 (Jury Demanded),
in the United States District Court, Southern District of Texas, Houston
Division.
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. The Company strongly denies the
assertions in the complaint and intends to vigorously contest this matter.
Item 4. Submission of Matters to a Vote of Security Holders
None.
7
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's common stock is traded on the OTC Bulletin Board under the symbol
"FLTK". The following table sets forth, on a per share basis for the periods
indicated, the high and low sales prices reported by the OTC Bulletin Board, as
adjusted for the 120 to 1 reverse stock split which was given effect on November
5, 2001.
High Low
2002
Fourth quarter ended December 31, 2002................. $ 3.00 $ 0.51
Third quarter ended September 30, 2002................. $ 2.75 $ 1.10
Second quarter ended June 30, 2002..................... $ 4.94 $ 1.92
First quarter ended March 31, 2002..................... $ 3.75 $ 1.35
2001
Fourth quarter ended December 31, 2001................. $10.00 $ 2.00
Third quarter ended September 30, 2001................. $12.00 $ 5.40
Second quarter ended June 30, 2001..................... $10.80 $ 4.20
First quarter ended March 31, 2001..................... $ 6.00 $ 3.60
As of March 25, 2003, the closing stock price, as quoted on the OTC Bulletin
Board, was $0.60. As of March 25, 2003, there were 5,521,670 common shares
outstanding held by approximately 135 holders of record and an estimated 800
beneficial holders.
Dividend Policy
The Company has never paid cash dividends on its common stock. The Company
intends to retain future earnings, if any, to meet its working capital
requirements and to finance the future operations of its business. Therefore,
the Company does not plan to declare or pay cash dividends to holders of its
common stock in the foreseeable future. In addition, certain of the Company's
credit agreements contain provisions that limit the Company's ability to pay
cash dividends on its common stock.
Recent Issuance of Unregistered Securities
In December 2002, the Company issued 609,499 shares of its common stock in a
private offering to "accredited investors" in exchange for $609,499 of
subscription proceeds, which was paid by the tender to the Company of $609,499
of cash.
The foregoing issuance of common stock was made in reliance upon the exemption
from registration set forth in Section 4(2) of the Securities Act of 1933 for
transactions not involving a public offering. No underwriters were engaged in
connection with the foregoing sales of securities. The sales were made without
general solicitation or advertising. Each purchaser was an "accredited investor"
or a sophisticated investor with access to all relevant information necessary to
evaluate the investment who represented to the Company that the sales were being
acquired for investment.
8
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes information regarding the Company's equity
securities that are authorized for issuance under individual non-qualified stock
option compensation agreements:
Equity Compensation Agreement Information
Number of securities
remaining available
for future issuance
Number of under equity
securities to be Weighted-average compensation
issued upon exercise price of agreements (excluding
exercise of outstanding securities reflected
outstanding options and in column (a))
options and warrants (c)
warrants (b)
Plan category (a)
--------------------------------------- ------------------- ------------------- ------------------------
Equity compensation
agreements approved by
security holders..................... - - -
Equity compensation agreements not
approved by security holders (1):
Individual stock
compensation agreements... 176,747 $ 4.70 -
Warrants........................... 56,030 $14.40 -
-------
Total................................. 232,777 $ 7.03 -
=======
(1) See Note 11 in Notes to Consolidated Financial Statements contained in Item 7 of this report on Page 34.
Item 6. 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 the Merger with 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.
9
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.
("MTI") in June 2001. These five companies are referred to collectively as the
"CESI Acquired Businesses".
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
cementing, stimulation, 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.
Our businesses serve the oil and gas industry. All of our businesses 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
certain 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 rig count remained at a low level throughout 2002. The U.S. rig count, as
measured by Baker Hughes Incorporated, began 2002 at 883 active rigs and ended
the year at 862, with an average of 830 active rigs. This was a 28% decrease
from the average activity level in 2001. Subsequent to the end of 2002, the rig
count has begun to increase slightly with the average number of rigs at 946 as
of the middle of March. Natural gas prices have begun to strengthen as a result
of a colder winter season and strong gas withdrawals. Gas in storage has fallen
to 636 bcf and Henry Hub prices hit $18.00 during the winter season and the
current twelve-month strip price is $5.37. Crude oil prices averaged $26 for the
year but did not translate into stronger oil related drilling. Our businesses
were affected by this decreased level of drilling activity throughout all of
2002. Many industry observers expect drilling activity levels to increase in
2003 based on higher oil and gas prices and an expected rebound in overall
economic activity. However, we face a challenging industry environment in the
near term and there can be no assurance that these expected improvements will
occur.
The following is a discussion of our results of operations on both an historical
and a pro forma combined basis for the last two years. This discussion should be
read in conjunction with our consolidated financial statements and notes thereto
that are included in Item 7 of this filing. Due to the significance of the
CESI-Flotek Merger, the discussion of comparative results of operations will
focus primarily on the pro forma combined information. The pro forma combined
statements of operations and related pro forma segment information give effect
to the acquisition of the CESI Acquired Businesses by CESI and the Merger
between Flotek and CESI. The basis of presentation and pro forma adjustments for
the statement of operations for the year ended December 31, 2001 and the
supporting pro forma segment information for the year ended December 31, 2001
are included as Exhibits 99.1 and 99.2 to the Company's Form 10-KSB which was
filed with the Commission on April 15, 2002 and should be read in conjunction
with the information in those exhibits. The pro forma combined results of
operations presented herein do not purport to represent what the Company's
results of operations actually would have been had such events occurred at the
beginning of the periods presented, as assumed, or to project the Company's
results of operations for any future period or the future results of any of the
acquired businesses. They are presented to allow for a more informative
discussion and comparative analysis of the Company's performance.
10
The Company is also subject to various Risk Factors as discussed in Item 1 of
this filing, and the following discussion should be read in light of those
factors, which could have a material effect on our business in the future.
Results of Operations
Pro Forma
Combined
Historical Audited Unaudited
Years ended December 31, 2002 2001 2002 2001
------------------ ---------------- ---------------- ----------------
Revenues.......................... $13,260,503 $12,561,499 $13,260,503 $15,982,449
Cost of revenues.................. 8,711,032 9,078,121 8,711,032 10,778,063
----------- ----------- ----------- -----------
Gross margin................... 4,549,471 3,483,378 4,549,471 5,204,386
----------- ----------- ----------- -----------
Gross margin %................. 34.3% 27.7% 34.3% 32.6%
Selling, general and
administrative................. 7,477,189 3,767,873 7,477,189 5,306,193
Goodwill impairment............... 600,000 - 600,000 -
Depreciation and amortization.....
704,732 744,305 704,732 853,061
Research and development.......... 139,371 34,938 139,371 109,650
----------- ----------- ----------- -----------
Total expenses................. 8,921,292 4,547,116 8,921,292 6,268,904
----------- ----------- ----------- -----------
Operating loss................. (4,371,821) (1,063,738) (4,371,821) (1,064,518)
----------- ----------- ----------- -----------
Operating loss %............... (33.0%) (8.5%) (33.0%) (6.7%)
Interest expense.................. (639,918) (415,431) (639,918) (457,391)
Interest income................... 2,217 43,819 2,217 43,819
Other, net........................ (566) 27,415 (566) 35,050
----------- ----------- ----------- -----------
Other income (expense),
net........................... (638,267) (344,197) (638,267) (378,522)
----------- ----------- ----------- -----------
Loss before change in
accounting principle.......... $ 5,010,088) $(1,407,935) $(5,010,088) $(1,443,040)
=========== =========== =========== ===========
Loss %......................... (37.8%) (11.2%) (37.8%) (9.0%)
Total revenues on a pro forma combined basis decreased by $2.7 million, or 17.0%
in 2002 compared to 2001. All three of our reportable segments produced lower
revenues in 2002 compared to the prior year. The majority of the decrease is
attributable to reduced exploration and production activity for oil and gas due
to a 28% decline in the average daily rig count in the US in 2002, compared to
2001, and various global economic and political uncertainties. All three
segments are heavily dependent on the US oil and gas market, except the
Petrovalve line of downhole pump components, which is more dependent on
International oil and gas production activity.
On an aggregate basis, the gross margin as a percentage of revenue increased
1.7% from 32.6% in 2001 to 34.3% in 2002. The majority of this percentage
increase came from the Material Translogistic, Inc. product line as a result of
completion of additional projects in 2002 with improved margins and the start up
of the bulk material transload facility in the Gulf Coast in August 2002. This
operation is part of the Equipment Manufacturing segment.
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
generally included in cost of revenues. SG&A amounted to 56.4% of revenue in
2002, compared to 33.2% of unaudited pro forma combined revenues in 2001, an
increase of 23.2%. Had 2002 revenue been flat with unaudited pro forma revenue
in 2001, SG&A as a percent of revenue would have been 46.8%, a 13.6% increase.
The costs of administration increased as a result of the Merger and the
increased size and complexity of the Company. Due to the Merger, sales personnel
11
were added in several of the reporting segments, professional fees (legal,
auditing, accounting and consulting) increased as a result of a now larger
public company with more complex issues, director and officer and general
liability insurance costs increased, and salaries increased with the addition of
several key management employees. Making the MTI bulk material transload
facility in the Gulf Coast operational in 2002 added $124.5 thousand in SG&A
costs. In addition, as discussed in Note 5 of the Notes to Consolidated
Financial Statements, a reserve for doubtful accounts of $878.0 thousand was
recorded for potential uncollectibility of a Venezuela accounts receivable. This
amount represents 6.6% of 2002 revenue. Action was taken in 2002 to reduce these
costs to the optimum level, but not below a core infrastructure needed to
support anticipated business growth in 2003.
Interest expense was $182.5 thousand, or 40%, higher than unaudited pro forma
interest expense for 2001. The Company added a revolving line of credit totaling
$1.6 million at a variable interest rate of prime plus 1.25% and financed, via a
construction loan, totaling $854.4 thousand, the MTI bulk material transload
facility at a rate of prime plus 1%. In addition, as discussed in Note 7 of the
Notes to Consolidated Financial Statements the Company entered into a sale lease
back transaction with Oklahoma Facilities, LLC ("Facilities") on land and
buildings for our Equipment Manufacturing segment that increased interest costs
for lease of this facility. Also, as discussed in Note 8 of the Notes to
Consolidated Financial Statements the company borrowed $500.0 thousand, at prime
plus 4.25%, under a short-term promissory note to Facilities. These specific
transactions added $209.1 thousand in interest expense during 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.
Specialty Chemicals
The following table presents the operating results of our Specialty Chemicals
segment on a pro forma combined basis for 2002 and 2001:
Pro Forma
Combined
Audited Unaudited
Years ended December 31, 2002 2001
------------------ ------------------
Revenues......................... $6,845,403 $7,329,596
Gross margin..................... $2,822,396 $3,032,815
Gross margin %................... 41.2% 41.4%
Operating income................. $ 854,165 $1,113,588
Operating margin................. 12.5% 15.2%
Specialty Chemical revenue decreased $484.2 thousand or 6.6% in the current year
from 2001 levels. Sales in this segment are heavily dependent on drilling
activity and the decrease in revenue is primarily attributable to sharply lower
(28%) US average drilling activity in 2002 compared to 2001. Average product
pricing levels in this segment declined as lower market demand put pressure on
product pricing.
The gross margin percentage in this segment stayed relatively flat between
years. During 2002 we added, via acquisition, certain environmentally friendly
chemicals that command higher margins than other chemicals sold by this segment.
These higher margins were offset by lower margins for other products as we
attempted to maintain sales levels and market share. 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 $259.4 thousand, or 23.3%, in 2002 compared to 2001
primarily as a result of lower revenues and gross margins. We took action to
reduce selling, general and administrative expenses in this segment to keep
these costs in line with reduced revenue levels. However, these costs could not
be reduced at the same rate as revenue resulting in a decrease in operating
income margin percentage in this segment from 15.2% in 2001 to 12.5% in 2002.
12
Equipment Manufacturing
The following table presents the operating results of our Equipment
Manufacturing segment on a pro forma combined basis for 2002 and 2001:
Pro Forma
Combined
Audited Unaudited
Years ended December 31, 2002 2001
------------------ ------------------
Revenues......................... $ 3,720,929 $ 5,233,039
Gross margin..................... $ 539,174 $ 412,983
Gross margin %................... 14.5% 7.9%
Operating loss................... $ (1,646,509) $ (1,177,139)
Operating loss %................. (44.2%) (22.5%)
Equipment Manufacturing revenues decreased $1.5 million or 28.9% in 2002
compared to 2001. This decrease is a direct result of reduced demand for oil
field service cementing and stimulation equipment, both heavy rolling and bulk
material handling equipment and facilities, due to a 28% decline in US drilling
activity. 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
off-set by the start-up of MTI's bulk material transload facility in the Gulf
Coast which became operational in August 2002.
Gross margins increased from 7.9% in 2001 to 14.5% in 2002 or 6.6%. Primarily
all of this increase is attributable to the positive gross margins of the bulk
material transload facility mentioned above. Without these positive operating
results, the Equipment Manufacturing segment gross margins would have been
essentially flat between years. Operating performance continues to improve in
this business segment from significant focus placed on improving operational
controls and work processes. With improved market conditions this segment could
produce significantly improved operating results in 2003 compared to 2002.
Operating losses increased $469.4 thousand or 39.9% in 2002 compared to the
prior year. This is a direct result of the revenue decrease mentioned above,
poor operating performance in the first half of 2002 and operating expenses not
being reduced below a core infrastructure in the fourth quarter of 2002 due to
anticipated increase in business expected in the first half of 2003. The MTI
bulk material transload facility in the Gulf Coast did produce positive
operating results in 2002.
The current market outlook for this segment is optimistic. Quotes, request for
quotes and orders have increased significantly since the first of the year. We
are seeing signs of increased activity by our customers in response to high oil
and gas commodity prices and steady improvement in US drilling activity.
Economic and political uncertainties still play a major role in the overall
improvement in the markets we serve. The Company believes that actions taken in
2002 to address operational performance and work processes together with
expected increases in customer spending for 2003 will allow this segment to
become profitable in 2003.
As more fully discussed in Note 10 of the Notes to 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
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets". There was approximately $1.3 million of goodwill
attributable to this segment, of which we have identified two reporting units,
Equipment Specialties, Inc. ("ES") and MTI. Our test concluded that all of the
goodwill attributable to ES, totaling $452,744, 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.
13
Downhole Equipment
The following table presents the operating results of our Downhole Equipment
segment on a pro forma combined basis for 2002 and 2001:
Pro Forma
Combined
Audited Unaudited
Years ended December 31, 2002 2001
------------------ ------------------
Revenues......................... $ 2,694,171 $ 3,419,814
Gross margin..................... $ 1,187,901 $ 1,758,588
Gross margin %................... 44.1% 51.4%
Operating income (loss).......... $(1,687,605) $ 367,537
Operating margin................. (62.6%) 10.7%
The Downhole Equipment segment became part of the consolidated group after the
Merger became effective 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 historical consolidated results of operations only
for periods subsequent to the Merger. The proforma unaudited amounts include
this segment for all of 2001. Consolidating the 2002 results of operations for
this segment has a significant impact on gross margins for the consolidated
company.
Downhole Equipment revenues decreased $725.6 thousand, or 21.2% in 2002 compared
to 2001. Sales of both the Turbeco line of casing centralizers and the
Petrovalve line of downhole pump components were lower in 2002 compared to 2001.
The Turbeco line of casing centralizers is very dependent on the level of US
drilling activity and has suffered as result of the 28% decline in drilling
activity in 2002. Petrovalve sales, totaling, $1.5 million in 2002 were almost
exclusively to one customer in Venezuela. Sales to this customer in 2002 were
approximately $110.8 thousand higher than 2001; however, sales to other Latin
America customers were significantly lower in 2002 compared to 2001 due to
curtailed production. In addition, sales to Venezuela stopped after April of
2002 due to political unrest in that country. As more fully discussed in Note 5
of the Notes to Consolidated Financial Statements and the Capital Resources and
Liquidity section, below, the Venezuela customer has not paid for the majority
of goods sold in 2002 within the customary payment terms. These sales carry a
high gross margin and are very profitable to this segment.
Gross margin percentage decreased 7.3% from 51.4% in 2001 to 44.1% in 2002. This
decrease was mostly attributable to lower gross margins in the Turbeco line of
casing centralizers. Average product pricing levels in this product line
declined as lower drilling activity and market demand caused our pricing to come
under pressure resulting in increased discounts to customers, and revaluing
inventory to net realizable values.
Operating income fell $2,055.1 thousand, or 559.2% from 2001 levels. Several
factors contribute to this significant decrease as follows:
o Gross margins declined $570.7 thousand due the explanation immediately above.
o An allowance for doubtful accounts totaling $878.0 thousand was established
for possible uncollectibility on sales of material to Venezuela. This is
explained more fully in Note 5 of the Notes to Consolidated Financial
Statements.
14
o Goodwill impairment totaling $600.0 thousand was recognized for the Petrovalve
reporting unit. This is explained more fully in Note 10 of the Notes to
Consolidated Financial Statements.
Selling, general and administrative expenses were essentially flat between
periods. These costs were not reduced below a core infrastructure as improved
operating results are anticipated in 2003 for this segment.
Capital Resources and Liquidity
In 2002, the Company sustained a loss of $5.46 million and had negative cash
flow from operations of $2.2 million. These losses resulted primarily from poor
operating results in the Equipment Manufacturing and Downhole Equipment
segments. As stated above, and in Note 2 of the Notes to Consolidated Financial
Statements, management has taken and will continue to take appropriate steps to
improve performance in all business segments in 2003.
As of December 31, 2002, net working capital was negative $3.2 million,
resulting in a current ratio of .56 to 1. Inventories have decreased
significantly, approximately, $1.9 million, during 2002, primarily due to
completion of manufactured equipment and bulk construction projects, a reduced
number of these projects in progress at year end, a concerted effort to move
slow moving inventory and reserve (approximately $174.0 thousand) for additional
slow moving inventory at year-end.
Cash and cash equivalents are $0.00 at December 31, 2002. As discussed in Note
15 of the Notes to Consolidated Financial Statements, several short-term
financing arrangements have been made to help the Company with the extreme
short-fall in cash. Overall, business, subsequent to December 31, 2002, is
improving and cash flow from operations is increasing, but cash flow is still
tight.
As discussed in Note 5 of the Notes to Consolidated Financial Statements, at
December 31, 2002, the Company had approximately $1,227.0 thousand 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 due to the recent political unrest and oil and gas industry work
curtailment in Venezuela. Currently, we are waiting on payment for approximately
$27 thousand of product shipped to and accepted by PDVSA. The remaining $1.2
million has not been shipped to the end customer (PDVSA). Our contacts within
PDVSA inform us that our product will be needed as they begin to ramp up oil
production to pre strike levels. We believe the product will eventually be
shipped to PDVSA but we can not predict when. Thus, we have established a
reserve for doubtful accounts for $878.0 thousand, the portion that we believe
to be unrealizable if the product is not ultimately delivered to PDVSA. We fully
expect, once PDVSA accepts the product, that they will pay, as they have in
2002, within their customary payment terms. The delay in collecting this
accounts receivable has had a significant adverse effect on the cash flow of the
Company. Additionally, all invoice amounts, as discussed in Note 8 of the Notes
to Consolidated Financial Statements, which are greater than 90 days old cannot
be included in the borrowing base under our revolving 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 7 of the Notes to Consolidated Financial Statements.
15
The Company has borrowed $3.21 million during 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 $557.5 thousand at December 31, 2002. The lender has
not determined the impact of this on the Company's revolving lines of credit. We
also made total debt service payments of approximately $1.2 million during the
year. The company has estimated minimum debt service obligations in 2003 of $4.7
million. This $4.7 million includes the revolving lines of credit totaling $3.0
million at December 31, 2002, the capital lease obligation incurred during the
first quarter of 2002, and the minimum principal and interest payments on the
new credit agreements mentioned above, and in Notes 8, 9 and 15 of the Notes to
Consolidated Financial Statements.
In December 2002, the Company issued 609,499 shares of its common stock in a
private offering to "accredited investors" in exchange for $609,499 of
subscription proceeds, which was paid by the tender to the Company of $609,499
of cash. These proceeds were used for operating cash flow.
Capital expenditures during 2002 totaled $1.5 million, of which $32.0 thousand
had not been paid in cash at December 31, 2002. The majority of these capital
expenditures relate to a bulk material transload facility which the Company
constructed in Raceland, Louisiana and a paint shop for ES in Duncan, Oklahoma.
The Company has approved a capital expenditure budget for 2003 totaling
approximately $.5 million.
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. 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 political and 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, return our Equipment Manufacturing segment to profitability, grow our
business to the projected 2003 plan levels 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-KSB 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-KSB regarding the
Company's financial position, business strategy, budgets and plans and
objectives of management for future operations are forward-looking statements.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, actual results may differ materially
from those in the forward-looking statements for various reasons including the
effect of competition, the level of petroleum industry exploration and
production expenditures, world economic and political conditions, prices of, and
the demand for crude oil and natural gas, weather, the legislative environment
in the United States and other countries, adverse changes in the capital and
equity markets, and other risk factors identified herein.
16
Item 7. Financial Statements
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.........................................................................18
Consolidated Balance Sheets as of December 31, 2002 and 2001.....................................................19
Consolidated Statements of Operations for the Year Ended December 31, 2002 and
December 31, 2001..........................................................................................20
Consolidated Statements of Changes in Stockholders' Equity for the Year Ended
December 31, 2002 and December 31, 2001.....................................................................21
Consolidated Statements of Cash Flows for the Year Ended December 31, 2002 and
December 31, 2001...........................................................................................22
Notes to Consolidated Financial Statements.......................................................................24
17
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Flotek Industries Inc. and Subsidiaries
Houston, Texas
We have audited the accompanying Consolidated Balance Sheets of Flotek
Industries Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
related Consolidated Statements of Operations, Stockholders' Equity, and Cash
Flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Flotek
Industries Inc. and Subsidiaries as of December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying consolidated financial statements have been prepared assuming
that Flotek Industries Inc. and Subsidiaries will continue as a going concern.
As more fully described in Note 2, the Company has incurred accumulated
operating losses and cash deficits from operations. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 2. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classification of liabilities that may result from the outcome of this
uncertainty.
WEINSTEIN SPIRA & COMPANY, P.C.
Houston, Texas
March 17, 2003
18
FLOTEK INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
2002 2001
----------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ - $ 240,438
Accounts receivable, less allowance of $900,067 and
$208,333 as of December 31, 2002 and 2001, respectively........... 2,034,381 2,189,566
Inventories and work in progress, net.............................. 1,817,717 3,704,153
Other current assets............................................... 198,055 24,735
----------- -----------
Total current assets.......................................... 4,050,153 6,158,892
----------- -----------
Property, plant and equipment, net..................................... 4,386,182 3,671,939
Goodwill, net.......................................................... 12,266,346 13,111,840
Patents and other intangible assets, net............................... 237,421 191,333
Other assets........................................................... - 87,253
----------- -----------
Total assets.................................................. $20,940,102 $23,221,257
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt.................................. $ 977,695 $ 876,737
Capital lease obligations, current portion......................... 66,535 633,894
Accounts payable................................................... 2,464,499 2,225,219
Accrued liabilities................................................ 91,971 722,910
Amounts due to related parties..................................... 100,892 132,855
Notes payable...................................................... 3,532,924 1,282,966
----------- -----------
Total current liabilities..................................... 7,234,516 5,874,581
----------- -----------
Long-term debt........................................................ 3,039,649 3,339,970
Capital lease obligations, long-term.................................. 1,321,726 -
Stockholders' equity:
Preferred stock, $.0001 par value, 100,000 shares authorized, no
shares issued................................................. - -
Common stock, $.0001 par value, 20,000,000 shares authorized,
5,521,670 and 4,850,696 shares issued and outstanding for 2002
and 2001, respectively........................................ 552 485
Additional paid-in capital........................................ 16,373,156 15,572,886
Accumulated deficit............................................... (7,029,497) (1,566,665)
----------- -----------
Total stockholders' equity.................................... 9,344,211 14,006,706
----------- -----------
Total liabilities and stockholders' equity.................... $20,940,102 $23,221,257
=========== ===========
19
The accompanying notes are an integral part of these consolidated financial
statements.
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year Ended December 31, 2002 and December 31, 2001
2002 2001
------------------ -----------------
Revenues.......................................................... $13,260,503 $12,561,499
Cost of revenues.................................................. 8,711,032 9,078,121
----------- ----------
Gross margin...................................................... 4,549,471 3,483,378
----------- ----------
Expenses:
Selling, general and administrative........................... 7,477,189 3,767,873
Goodwill impairment........................................... 600,000 -
Depreciation and amortization................................. 704,732 744,305
Research and development...................................... 139,371 34,938
----------- ----------
Total expenses............................................. 8,921,292 4,547,116
----------- ----------
Loss from operations.............................................. (4,371,821) (1,063,738)
Other income (expense)
Interest expense.............................................. (639,918) (415,431)
Interest income............................................... 2,217 43,819
Other, net.................................................... (566) 27,415
----------- ----------
Total other income (expense)............................... (638,267) (344,197)
----------- ----------
Loss before cumulative effect of change in
accounting principle ............................................ (5,010,088) (1,407,935)
----------- ----------
Cumulative effect of change in accounting principle net
of income tax benefit............................................ (452,744) -
----------- ----------
Net loss.......................................................... $(5,462,832) $(1,407,935)
=========== ===========
Basic and diluted loss per common share before
cumulative effect of change in accounting
principle........................................................ $ (1.01) $ (0.44)
Cumulative effect of change in accounting principle.............. (.09) -
----------- ----------
Basic and diluted net loss per common share....................... $ (1.10) $ (0.44)
=========== ===========
Weighted average number of common shares
outstanding...................................................... 4,967,658 3,175,449
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
20
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 2002 and December 31, 2001
Common Stock Additional
------------ Paid-in Accumulated
Shares Capital Deficit Total
------------------- --------------- ------------------ ---------------
Balance at December 31, 2000............... 1,425,665 $143 $ 1,383,228 $ (158,730) $ 1,224,641
Common stock issued in 2,326,312
acquisitions.............................. 232 10,077,768 - 10,078,000
Common stock issued for cash............... 1,098,719 110 4,111,890 - 4,112,000
Net loss................................... - - - (1,407,935) (1,407,935)
--------- ------- ----------- ----------- -----------
Balance at December 31, 2001............... 4,850,696 $485 $15,572,886 $(1,566,665) $14,006,706
========= ==== =========== =========== ===========
Common Stock Additional
------------ Paid-in Accumulated
Shares 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
Common stock issued for cash............... 610,858 61 610,810 - 610,871
Net loss................................... - - - (5,462,832) (5,462,832)
--------- ------- ----------- ----------- -----------
Balance at December 31, 2002...................5,521,670 $552 $16,373,156 $(7,029,497) $ 9,344,211
========= ==== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
21
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 2002 and December 31, 2001
(Continued) 2002 2001
------------------ -----------------
Cash flows from operating activities:
Net loss................................................... $(5,462,832) $(1,407,935)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization......................... 704,731 744,305
Imputed interest expense.............................. - 43,095
Gain on sale of assets................................ 15,579 (20,435)
Impairment of goodwill................................ 1,052,744 -
(Increase) decrease in:
Accounts receivable................................. 155,185 (166,464)
Inventories and work in progress.................... 1,886,436 (1,439,324)
Other current assets................................ (173,320) (93,519)
Deposits and other.................................. 87,254 -
Accounts payable and accrued liabilities............ (391,659) 1,177,823
----------- -----------
Net cash used in operating activities.............. (2,125,882) (1,162,454)
----------- -----------
Cash flows from investing activities:
Acquisition of subsidiaries, net.......................... (122,250) (6,066,493)
Capital expenditures...................................... (1,473,521) (1,411,460)
Proceeds from sales of assets............................. 111,312 246,536
----------- -----------
Net cash used in investing activities.............. (1,484,459) (7,231,417)
----------- -----------
Cash flows from financing activities:
Issuance of stock for cash................................ 610,871 4,112,000
Proceeds from borrowings.................................. 3,106,736 3,737,316
Proceeds from sale/leaseback transaction.................. 761,000 -
Repayments of indebtedness................................ (1,056,141) (325,755)
Payments to related parties............................... (31,963) (152,394)
Principal payments on capital leases...................... (20,600) (30,000)
----------- -----------
Net cash provided by financing activities.............. 3,369,903 7,341,167
----------- -----------
Net decrease in cash and cash equivalents...................... (240,438) (1,052,704)
Cash and cash equivalents at beginning of period............... 240,438 1,293,142
----------- -----------
Cash and cash equivalents at end of period..................... $ - $ 240,438
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
22
FLOTEK INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31, 2002 and December 31, 2001
(Continued)
2002 2001
------------------ ------------------
Supplemental schedule of noncash investing and financing activities:
Land and building acquired under capital lease................ $ - $ 630,794
=========== ===========
Lease obligation incurred...................................... $ 1,408,861 $ -
=========== ===========
Book value of assets sold...................................... $ 633,894 $ -
=========== ===========
Capital expenditures incurred but not paid at year end......... $ 32,000 $ 275,000
=========== ===========
Supplemental disclosures of cash flow information:
Acquisition of subsidiaries:
Assets (liabilities) acquired:
Cash....................................................... $ - $ 1,433,381
Accounts receivable........................................ - 2,023,102
Inventories and work in progress........................... - 2,264,829
Other current assets....................................... - 9,080
Property and equipment..................................... - 1,637,897
Marketable securities...................................... - 204,573
Patents and other intangibles.............................. 104,466 192,541
Goodwill................................................... 207,250 13,394,420
Other assets............................................... - 21,770
Debt....................................................... - (808,951)
Accounts payable and accrued liabilities................... - (1,394,768)
----------- -----------
311,716 18,977,874
Common stock issued.......................................... (189,466) (10,078,000)
Promissory notes issued...................................... - (1,400,000)
Transaction costs paid in cash............................... - (312,274)
----------- -----------
Net cash paid to sellers................................... $ 122,250 $ 7,187,600
=========== ===========
Cash paid for interest......................................... $ 639,918 $ 415,431
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
23
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization and Summary of Significant Accounting Policies
Flotek Industries, Inc. and subsidiaries (the "Company" or "Flotek") was
originally incorporated under the laws of the Province of British Columbia on
May 17, 1985. On October 23, 2001, the Company moved its corporate domicile to
Delaware and completed a reverse stock split of 120 to 1. On October 31, 2001,
the Company completed a merger ("the 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 for the year ended December 31, 2001 are the
historical financial statements of CESI. All of the assets and liabilities of
Flotek were recorded at fair value on 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.
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
cementing, stimulation 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.
Principles of Consolidation
The consolidated financial statements consist of Flotek Industries, Inc. and its
subsidiaries, all of which are wholly owned. All significant intercompany
transactions and balances have been eliminated in consolidation.
Revenue Recognition
The Specialty Chemical and Downhole Equipment segments recognize revenues when
products have been delivered and all significant risks and rewards of ownership
have passed to customers. Accounts receivable are recorded at that time.
Earnings are charged with a provision for doubtful accounts based on a current
review of collectibility of accounts. Accounts deemed uncollectible are applied
against the allowance for doubtful accounts. Deposits and other funds received
in advance of delivery are deferred until the transfer of ownership is complete.
The Equipment Manufacturing segment, except for the bulk material transload
operation, recognizes revenues from manufacturing and construction contracts
under the percentage-of-completion method of accounting, generally in the ratio
of costs incurred to total estimated costs of completion. Contract costs include
all direct labor and material costs and those indirect costs related to
manufacturing and construction operations. General and administrative costs are
charged to expense as incurred. Changes in job performance and estimated
profitability, including those arising from contract bonus or penalty provisions
and final contract settlements, may result in revisions to costs and income and
are recognized in the period in which such revisions appear probable. All known
or anticipated losses on contracts are recognized in full when such amounts
become apparent. Bulk material transload revenue is recognized as services are
performed for the customer.
24
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Customers are invoiced under the terms of manufacturing or construction
contracts and accounts receivable are recorded at that time. Collection of
revenues invoiced on large heavy equipment builds or refurbishments are
collected upon delivery of the completed unit. Progress billings are made on
large construction projects, usually resulting in only a small fraction of the
total project revenue in accounts receivable at the completion of the project.
Revenues recognized in excess of customer billings are reflected in current
assets as work in progress. Deposits and billings in excess of revenues on
specific contracts are recognized as a reduction of work in progress.
Cash and Cash Equivalents
The Company considers all short-term investments with an original maturity of
three months or less to be cash equivalents.
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 and
deposits and billings in excess of revenues on specific contracts. The
components of inventories and work in progress at December 31, 2002 were as
follows:
December 31, December 31,
2002 2001
------------------- ------------------
Raw materials....................... $ 409,806 $ 496,332
Finished goods...................... 1,534,387 1,856,011
Manufacturing parts and materials... 272,048 708,036
Work in progress.................... 110,539 1,000,799
Inventory obsolescence reserve...... (509,063) (357,025)
---------- ----------
$1,817,717 $3,704,153
========== ==========
Property and Equipment
Property and equipment are stated at cost. The cost of ordinary maintenance and
repairs is charged to operations, while replacements and major improvements are
capitalized. Depreciation is provided at rates considered sufficient to amortize
the cost of the assets using the straight-line method over the following
estimated useful lives:
Buildings and leasehold improvements........... 20 years
Machinery and equipment........................ 5-8 years
Furniture and fixtures......................... 5 years
Transportation equipment....................... 3 years
Computer equipment............................. 3 years
25
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company reviews long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to sell.
Goodwill
Goodwill represents the excess of cost over the fair value of net assets of
companies acquired in business combinations accounted for using the purchase
method. Goodwill acquired in business combinations prior to June 30, 2001 had
been amortized using the straight-line method over an estimated useful life of
20 years. In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS No. 142 requires that goodwill
no longer be amortized but instead be reviewed periodically for possible
impairment. The Company adopted SFAS No. 142 effective January 1, 2002 and will
no longer amortize goodwill. The goodwill amortization expense during the year
ended December 31, 2001, was $378,040.
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, Inc. ("ES") 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, ES
and Material Translogistics, Inc. ("MTI"). As a result, the Company recognized a
charge to income of $452,744 ($.09 loss per share) for the ES 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.
In addition to the transitional year impairment test mentioned above, we also
conducted a goodwill impairment assessment during the fourth quarter of 2002 for
the Petrovalve reporting unit within the Downhole Equipment Segment. There was
approximately $5.5 million of goodwill attributable to this segment, all
relating to the Petrovalve reporting unit. Our test concluded that $600.0
thousand of goodwill was impaired. Consequently, we have recognized this
impairment loss in Results of Operations in the fourth quarter of 2002.
We concluded, for the other reporting units of the Company, that their assets
and liabilities had not changed significantly since the transition test and thus
they were not tested during the impairment assessment in the fourth quarter of
2002. See Note 10 of the Notes to Consolidated Financial Statements.
Income Taxes
Income taxes are computed under the liability method based upon rates prevailing
at the end of the period. The Company provides deferred income tax assets and
liabilities for the expected future tax consequences attributable to differences
between the financial statement carrying amounts and the respective tax basis of
assets and liabilities. These deferred assets and liabilities are based on
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to amounts which are more likely than not to be
realized.
26
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Loss Per Share
Loss per common share is calculated by dividing net loss attributable to common
shareholders by the weighted average number of common shares outstanding.
Dilutive loss per share is calculated by dividing net loss attributable to
common shareholders by the weighted average number of common shares and dilutive
potential common shares outstanding. There were no potentially dilutive common
shares as of December 31, 2002 or 2001.
Stock-Based Compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic method, as prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the fair market value of the Company's stock at the date of the grant
over the amount the employee must pay to acquire the stock, and is recognized
over the related vesting period. The Company provides supplemental disclosure of
the effect on net income and earnings per share as if the provisions of SFAS No.
123, Accounting for Stock-Based Compensation, had been applied in measuring
compensation expense.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and certain
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Note 2 - Going Concern
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern.
However, the Company has sustained accumulated operating losses since inception.
In addition, the Company has used substantial amounts of working capital in
their operations. These conditions raise substantial doubt about the Company's
ability to continue as a going concern.
In view of these matters, realization of a major portion of the assets in the
accompanying consolidated balance sheets is dependent upon continued operations
of the Company, which in turn is dependent upon the Company's ability to meet
its financing requirements, and the success of its future operations.
27
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Management believes that actions taken to revise the Company's operating and
financial requirements provide the opportunity for the Company to continue as a
going concern. Management has taken the following steps to revise its operating
and financial requirements, which it believes are sufficient to provide the
Company with adequate working capital:
o The Company believes that revenues will increase in fiscal 2003.
o Management continues to actively seek potential acquisition or merger
candidates to either decrease costs of providing products or add new products
and customer base to diversify the Company's market.
o The Company is expanding its Specialty Chemicals business segment in Canada
and Mexico and expects these markets to yield significant revenue and profit
in 2003.
o Management is working with its primary lender to restructure its revolving
lines of credit to add more flexibility in accessing working capital.
o Management fully expects PDVSA to use the $1.2 million in product,
currently under the control of our agent, and to order additional product
in 2003.
o New management at ES, a reporting unit within the Equipment Manufacturing
Segment, have significantly improved operating controls and work processes
resulting in improved efficiencies, lower costs and increased quality.
Note 3 - Acquisitions
In January 2002, the Company issued 26,116 shares of common stock valued at
$82,309 to the former shareholders of 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 December 31, 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 4 - 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.
28
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 5 - Accounts Receivable
At December 31, 2002, the Company had approximately $1,227.0 thousand 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 due to the recent political unrest and oil and gas industry work
curtailment in Venezuela. Currently, we are waiting on payment for approximately
$27 thousand of product shipped to and accepted by PDVSA. The remaining $1.2
million has not been shipped to the end customer (PDVSA). Our contacts within
PDVSA inform us that our product will be needed as they begin to ramp up oil
production to pre-strike levels. We believe the product will eventually be
shipped to PDVSA but we cannot predict when. Thus, we have established a reserve
for doubtful accounts for $878.0 thousand, the portion that we believe to be
unrealizable if the product is not ultimately delivered to PDVSA. We fully
expect, once PDVSA accepts the product, that they will pay, as they have in
2002, within their customary payment terms.
Note 6 - Property, Plant and Equipment
At December 31, 2002 and December 31, 2001, property, plant and equipment were
comprised of the following:
December 31, December 31,
2002 2001
------------------ ------------------
Land $ 118,700 $ 145,000
Buildings and leasehold improvements............... 3,274,799 2,115,078
Machinery and equipment............................ 1,129,223 1,195,632
Furniture and fixtures............................. 67,236 67,936
Transportation..................................... 570,407 456,690
Computer equipment................................. 156,156 76,497
----------- ------------
Total property and equipment.................... 5,316,519 4,056,833
Less accumulated depreciation..................... (930,337) (384,894)
----------- ------------
Net property and equipment...................... $ 4,386,182 $ 3,671,939
=========== ============
Note 7 - 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 $750.0 thousand 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 $1.4 million with net cash proceeds to the Company of $761.0
thousand. 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
29
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the first two years of the lease for a fixed price of $1.4 million. The Company
also has the option to purchase the building for a fixed price of $420.0
thousand at the end of the ten-year lease term.
The following is a schedule of future minimum lease payments under the capital
lease, together with net lease payments as of December 31, 2002:
For the Year Ending December 31,
---------------------------------------------------------------
2003.......................................... 226,500
2004.......................................... 237,000
2005.......................................... 219,500
2006.......................................... 216,000
2007.......................................... 216,000
Thereafter.................................... 1,339,122
---------
Total 2,454,123
---------
Less amount representing interest............. 1,065,862
---------
Present value of net minimum lease payments... 1,388,261
Less current portion.......................... 66,535
---------
Long-term portion of present value of net
minimum lease payments....................... 1,321,726
=========
Note 8 - Notes Payable
Notes payable at December 31, 2002 and December 31, 2001 consisted of the
following:
December 31, 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) (see Note 15) ......................... 1,593,109 -
Note payable, secured by accounts receivable, bearing interest
at the prime rate, 4.25% at December 31, 2002, 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. 495,780 -
Other notes payable........................................................... 30,000 30,000
----------- -----------
Total notes payable......................................................... $ 3,532,924 $ 1,282,966
=========== ===========
30
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 were used to meet general corporate purposes.
At December 31, 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 $1,227.0 thousand, of the over 90 day accounts
receivable relates to amounts due from a customer in Venezuela as
further explained in Note 5 of the Notes to the Consolidated Financial
Statements. On January 31, 2003, the Lender for the revolving lines of
credit granted the Company a 90 day waiver from excluding over 90 day
accounts receivable in the borrowing base calculation. The waiver
expires on April 1, 2003. With the waiver the Company is in compliance
with its revolving line credit agreements; however,
2. Even with the over 90 day accounts receivable waiver mentioned above,
the Company's borrowings against its revolving lines of credit
exceeded the eligible asset base by approximately $559.7 thousand at
December 31, 2002. The Lender has not determined the impact of this 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.
31
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 9 - Long-Term Debt
Long-term debt at December 31, 2002 and December 31, 2001, consisted of the
following:
December 31, 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... 2,025,119 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. 307,375 464,538
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 (see Note 15) ............................................... 594,740 -
Mortgage note on property, bearing interest at 10%, payable in monthly
installments of $1,470 including interest, due in December 2012........... 111,228 115,877
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................................................. 68,182 87,620
Secured vehicle and other equipment loans...................................... 110,700 109,140
------------- -------------
Total..................................................................... 4,017,344 4,216,707
Less current maturities................................................... 977,695 876,737
------------- -----------
Long-term debt........................................................ $ 3,039,649 $ 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.
The following is a schedule of future maturities of long-term debt:
Years ending
December 31,
------------------------
2003............... 1,078,589
2004............... 965,931
2005............... 852,904
2006............... 764,912
2007............... 386,249
Thereafter......... 69,652
32
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 10 - Goodwill and Other Intangible Assets
Following is a reconciliation of goodwill:
Beginning balance, December 31, 2001............... $ 13,111,840
Acquisitions....................................... 207,250
Goodwill impairment, January 1, 2002
associated with the ES reporting unit............ (452,744)
Goodwill impairment, December 31, 2002
associated with the Petrovalve reporting
unit............................................ (600,000)
------------
Ending balance, December 31, 2002................. $ 12,266,346
============
Following is a reconciliation of the reported net loss to the adjusted net loss
reflecting the impact of the adoption of SFAS No. 142 on all periods presented:
Year Ended
December 31,
--------------------------------------
2002 2001
------------------ ------------------
Reported net loss:
Reported net loss............... $(5,462,832) $(1,407,935)
Add back: Cumulative effect of
accounting change for
impairment of goodwill......... 452,744 -
Goodwill amortization........... 378,040
----------- -----------
Adjusted net loss............... $(5,010,088) $(1,029,895)
=========== ===========
Year Ended
December 31,
--------------------------------------
2002 2001
------------------- -----------------
Basic and diluted earnings per
share:
Reported net loss............... $ (1.10) $ (0.44)
Add back: Cumulative effect of
accounting change for
impairment of goodwill......... (.09) -
Goodwill amortization........... - .12
----------- -----------
Adjusted net loss............... $ (1.01) $ (0.36)
=========== ===========
33
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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 December 31, 2002, the Company did not recognize any
impairment associated with its long-lived assets.
Other intangible assets are comprised of the following:
December 31, 2002 December 31, 2001
-------------------------------------- -------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
----------------- ------------------- ------------------ -----------------
Patents................................... $ 266,148 $ 102,099 $ 266,148 $ 74,815
Other Intangibles......................... 104,464 31,092 - -
--------- ------------ ----------- ----------
Total................................... $ 370,612 $ 133,191 $ 266,148 $ 74,815
========= ============ =========== ==========
Aggregate Expense for the Three Aggregate Expense for the
Months Ended Year Ended
-------------------------------------- -------------------------------------
December 31, December 31, December 31, December 31,
2002 2001 2002 2001
----------------- ------------------ ------------------ ------------------
Patents................................... $ 7,779 $ 118 $ 27,264 $ 118
Other Intangibles......................... 10,466 - 31,339 -
--------- ------------ ----------- ----------
Total................................... $ 18,161 $ 118 $ 58,603 $ 118
========= ============ =========== ==========
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 11 - Stock Options and Warrants
The Company and its predecessors have issued non-qualified employee stock
options to employees, officers, directors and consultants from time to time as
approved by the Board of Directors. The exercise price has been equal to the
fair market value at the date of grant. The shares covered by the option
agreements are not registered with the Securities and Exchange Commission.
34
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents stock options issued and outstanding during the
period:
Weighted
Range of Exercise Prices Average
Exercise
---------------------------
Shares Low High Price
------------- ------------- ------------- -------------
Balance at December 31, 2001.............. 166,790 $ 3.60 $ 12.96 $5.03
Options granted........................... - - - -
Stock Dividend Adjustment (a)............. 16,172 3.49 11.77 4.82
Options exercised......................... - - - -
Options cancelled......................... (6,215) 11.77 11.77 11.77
------ ----- ------- -----
Balance at December 31, 2002.............. 176,747 $ 3.49 $11.77 $4.70
======= ====== ======= =====
(a) See Note 4 of the Notes to Consolidated Financial Statements which
discusses the stock adjustment as a result of the merger between Flotek
Industries, Inc. and CESI.
The weighted average contractual life remaining on outstanding stock options was
approximately 1.5 years at December 31, 2002.
Prior to the Merger, Flotek had outstanding warrants to purchase 56,030 shares
of common stock, adjusted for the stock settlement as described in Note 4 of the
Notes to Consolidated Financial Statements, at an exercise price of $14.40 per
share, which expire in October 2006. These warrants were assumed by the combined
company. The expiration date of these warrants can be accelerated in the event
that the closing price of the common stock of the Company is in excess of $21.60
for a period of 60 consecutive trading days.
Note 12 - Federal Income Tax
A reconciliation of the statutory federal income tax rate to the effective
income tax rate is as follows:
December 31, December 31,
2002 2001
------------------ -----------------
Federal income tax (benefit) at 34%... $ (1,857,362) $ (478,696)
Nondeductible items................... 14,850 4,833
Other................................. (1,404,488) (108,137)
Change in valuation allowance......... 3,274,000 582,000
------------ ----------
$ - $ -
============ ==========
35
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The components of deferred taxes are as follows:
Allowance for doubtful accounts........ $ 306,000 $ 71,000
Inventory reserves..................... 173,000 121,000
Net operating loss carryforward........ 3,283,000 440,000
Goodwill impairment.................... 358,000 -
Accumulated depreciation............... (238,000) 3,000
---------- ----------
3,882,000 635,000
Valuation allowance.................... (3,882,000) (635,000)
---------- ----------
$ - $ -
========== ==========
At December 31, 2002, the Company had estimated net operating loss carryforwards
which may be available to offset future taxable income of approximately $9.65
million, expiring in 2021. Under federal tax law, the amount and availability of
Flotek's loss carryforwards are subject to complex tax regulations and
restrictive tests. The utilization of such carryforwards can be severely limited
or effectively lost upon certain changes in ownership, such as the Merger. The
utilization of any of these net operating loss carryforwards is dependent on the
future profitability of the Company. Accordingly, no assurance can be given
regarding the ultimate realization of such loss carryforwards. An allowance has
been recorded to fully offset the net deferred tax asset.
Note 13 - Operating Leases
The Company has entered into operating leases for office space, vehicles and
equipment. Future minimum lease payments under these leases are as follows:
Years ending
December 31,
---------------------
2003.......... $151,177
2004.......... 129,183
2005.......... 44,163
2006.......... 29,966
2007.......... 31,472
--------
$385,961
========
Total rent expense under these operating leases totaled approximately $170,334
during the year ended December 31, 2002.
Note 14 - Segment Information
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
cementing, stimulation and production.
36
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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
or 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 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. The Company evaluates the performance of its
operating segments based on operating income, net of depreciation expense and
goodwill amortization, but excluding other income and unusual charges.
Intersegment sales and transfers are not material.
Essentially all of the Company's revenues are derived from the oil and gas
industry. This concentration of customers in one industry increases the credit
and business risks of the Company, particularly given the volatility of activity
levels in the industry. The majority of the Company's sales are to major or
large independent oilfield service companies with established credit histories
and actual credit losses have been insignificant. Four customers accounted for
44.2% of our consolidated revenues for the year ended December 31, 2002. Three
of these customers were in the Specialty Chemicals segment of our business and
they collectively accounted for 65.2% of the revenues in this segment. The
remaining customer was in the downhole equipment segment of our business and it
accounted for 52.1% of the revenues in this segment.
The Company operates primarily in the United States. The Company derived more
than 10% of its revenues from international customers during the year ended
December 31, 2002, and expects to increase the level of these sales in the
future. International customers can pose additional credit risks to the Company.
As of December 31, 2002, the Company had approximately $1,227.0 thousand in
accounts receivable from a customer located in Venezuela. All of these sales
were recorded in 2002. As a result of recent political unrest and oil and gas
industry work curtailment in Venezuela, the Company has experienced significant
delays in receiving payment for the items sold in 2002. The Company has an
established long-term relationship with the customer and fully expects the
ultimate customer to consume the remaining product as Venezuela ramps up oil
production. The Company expects that these accounts receivable will ultimately
be paid, but cannot predict the timing of collection. Consequently, the Company
has provided a reserve for doubtful accounts associated with this balance.
The following table presents the revenues, operating income, total assets and
other information for each reportable segment as of and for the year ended
December 31, 2002 ($ in thousands):
Specialty Equipment Downhole Corporate
Chemicals Manufacturing Equipment and Other Total
Net sales to external customers $ 6,845 $ 3,721 $ 2,694 $ - $ 13,261
Income (loss) from operations $ 854 $(1,647) $(1,688) $ (1,891) $ (4,372)
Depreciation and amortization $ 273 $ 292 $ 80 $ 60 $ 705
Total assets $ 9,379 $ 4,383 $ 6,886 $ 292 $ 20,940
Goodwill, net $ 6,550 $ 795 $ 4,921 $ - $ 12,266
Capital expenditures $ - $ 1,465 $ 8 $ - $ 1,473
37
FLOTEK INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 15 - Subsequent Events (Unaudited)
On January 9, 2003 ES, a Flotek Industries, Inc. company, entered into
agreements with Stimulation Instruments, Inc. to refurbish four Nitrogen Skid
Units at a total sales price of $412,000 and broker the sale of these units for
a commission of $5,000 per unit plus 50% of the sales proceeds in excess of
$160,000 per skid. Stimulation Instruments, Inc. is owned solely by Dr. Penny,
an officer and director of Flotek Industries, Inc.
On January 13, 2003, the construction loan for the MTI Transload facility in
Raceland, Louisiana was refinanced on a short-term loan to December 31, 2003
with a 54 month amortization. This note bears interest at prime plus 2%, payable
in monthly installments of $16,958. Reference Note 9 of the Notes to
Consolidated Financial Statements.
On January 30, 2003, CESI Chemical ("CESI"), a Flotek Industries, Inc. company,
entered into an agreement with Stimulation Chemicals, LLC ("SCL") for the
purchase of various raw materials from CESI Chemical suppliers under deferred
payment terms. SCL will procure the raw materials as ordered by CESI granting
CESI 120 day payment terms for a percent markup on established supplier prices
up to a purchase value of $330,000. SCL invoices not paid by CESI within 120
days will bear interest at 1% per month. SCL is owned jointly by Dr. Penny and
Mr. Beall, whom are both directors of Flotek Industries, Inc.
The revolving line of credit, totaling $1,608,100 and secured by accounts
receivable and inventory due January 6, 2003 was refinanced on January 31, 2003
for 66 days to April 7, 2003 at prime plus 1.25%. Reference Note 8 of the Notes
to Consolidated Financial Statements.
On February 11, 2003, Mr. Dumas, Chairman of the Board and Chief Executive
Officer, made a short-term loan to the Company for $135,000 to cover operating
cash flow requirements. This note bears interest at 6%.
On February 24, 2003, the Company entered into a forbearance agreement with two
shareholders of acquired business extending $100,000 each of principal payments
due, under the original promissory note, on January 22, 2003 until June 30, 2003
and September 30, 2003. Interest at 9% under the terms of the original note
continues to be payable quarterly. In the event that principal payments are not
made when due, a penalty of 5.25% of the outstanding unpaid principal will be
assessed. In addition, interest will default to a rate of 12% per annum, until
past due amounts are paid.
38
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Items 9 to 12 Inclusive.
These items have been omitted in accordance with the general instructions to
Form 10-KSB Annual Report. The Registrant intends to file with the Securities
and Exchange Commission prior to April 30, 2003, pursuant to Regulation 14A, a
definitive proxy statement that will involve the election of directors. The
information required by these items will be included in such proxy statement and
are incorporated herein by reference.
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits:
Index to Exhibits
Exhibit
Number Description of Exhibit
------------- ---------------------------------------------------------------
3.1 * Articles of Incorporation of Flotek Industries, Inc.
(incorporated by reference to Appendix E of the Company's
Definitive Proxy Statement filed with the Commission on
September 27, 2001).
3.2 * By-laws of Flotek Industries, Inc. (incorporated by reference
to Appendix F of the Company's Definitive Proxy Statement
filed with the Commission on September 27, 2001).
4.1 * Registration Right Agreement, effective as of April 30,
2000, signed in August 2000 (incorporated by reference to
Exhibit 4.3 of the Company's Form 10-QSB for the quarter ended
August 31, 2000).
10.1 * Promissory Note, Loan Agreement and Security Agreement dated
January 7, 2002 by and between Legacy Bank and Flotek
Industries, Inc. (incorporated by reference to the Company's
Form 10-QSB filed with the Commission on August 14, 2002).
10.2 * Promissory Note, Loan Agreement and Security Agreement dated
January 4, 2002 by and between Legacy Bank and Flotek
Industries, Inc. (incorporated by reference to the Company's
Form 10-QSB filed with the Commission on August 14, 2002).
10.3 * Lease Agreement with Option to Purchase, dated February 28,
2002, by and between Oklahoma Facilities, L.L.C. and Neal's
Technology Company, Inc. (incorporated by reference to the
Company's Form 10-QSB filed with the Commission on May 20,
2002).
10.4 * Promissory Note and Collateral Assignment Agreement dated
July 25, 2002 by and between Oklahoma Facilities, L.L.C. and
Flotek Industries, Inc. (incorporated by reference to the
Company's Form 10-QSB filed with the Commission on August 14,
2002).
10.5 * Change in Terms Agreement dated September 16, 2002 by and
between Legacy Bank and Flotek Industries, Inc. (incorporated
by reference to the Company's Form 10-QSB filed with the
Commission on November 12, 2002).
21.1 List of Subsidiaries.
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.
*Previously Filed
(b) Reports on Form 8-K:
None.
39
Item 14. 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.
Previously noted weaknesses have been corrected.
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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:March 31, 2003
By:/s/ Jerry D. Dumas, Sr.
---------------------------
Jerry D. Dumas, Sr.
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date Signature Title(s)
March 31, 2003 /s/ Jerry D. Dumas, Sr. Chairman and Chief Executive Officer
--------------------------------------
Jerry D. Dumas, Sr.
March 31, 2003 /s/ Glenn S. Penny President, Chief Technical Officer and
-------------------------------------- Director
Glenn S. Penny
March 31, 2003 /s/ Mark D. Kehnemund Chief Financial Officer
--------------------------------------
Mark D. Kehnemund
March 31, 2003 /s/ Robert S. Beall Director
--------------------------------------
Robert S. Beall
March 31, 2003 /s/ John W. Chisholm Director
--------------------------------------
John W. Chisholm
March 31, 2003 /s/ Gary M. Pittman Director
--------------------------------------
Gary M. Pittman
March 31, 2003 /s/ Barry E. Stewart Director
--------------------------------------
Barry E. Stewart
March 31, 2003 /s/ William R. Ziegler Director
--------------------------------------
William R. Ziegler
41