Document



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 1-13270
FLOTEK INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
90-0023731
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
10603 W. Sam Houston Parkway N., Suite 300
Houston, TX
 
77064
(Address of principal executive offices)
 
(Zip Code)
(713) 849-9911
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
x
 
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of July 15, 2016, there were 53,909,948 outstanding shares of Flotek Industries, Inc. common stock, $0.0001 par value.




TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2




PART I — FINANCIAL INFORMATION
 
Item 1. Financial Statements
FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

 
June 30, 2016
 
December 31, 2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
3,840

 
$
2,208

Accounts receivable, net of allowance for doubtful accounts of $828 and $1,189 at June 30, 2016 and December 31, 2015, respectively
45,528

 
49,197

Inventories
78,253

 
85,492

Income taxes receivable
15,874

 
4,700

Deferred tax assets, net
3,502

 
2,649

Other current assets
6,602

 
7,496

Total current assets
153,599

 
151,742

Property and equipment, net
80,759

 
91,913

Goodwill
72,820

 
72,820

Deferred tax assets, net
—

 
17,229

Other intangible assets, net
58,166

 
69,386

TOTAL ASSETS
$
365,344

 
$
403,090

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
23,795

 
$
19,444

Accrued liabilities
9,278

 
12,894

Income taxes payable
—

 
2,263

Interest payable
185

 
111

Current portion of long-term debt
50,228

 
32,291

Total current liabilities
83,486

 
67,003

Long-term debt, less current portion
14,684

 
18,255

Deferred tax liabilities, net
526

 
23,823

Total liabilities
98,696

 
109,081

Commitments and contingencies

 

Equity:
 
 
 
Cumulative convertible preferred stock, $0.0001 par value, 100,000 shares authorized; no shares issued and outstanding
—

 
—

Common stock, $0.0001 par value, 80,000,000 shares authorized; 56,839,682 shares issued and 53,906,902 shares outstanding at June 30, 2016; 56,220,214 shares issued and 53,536,101 shares outstanding at December 31, 2015
6

 
6

Additional paid-in capital
278,840

 
273,451

Accumulated other comprehensive income (loss)
(913
)
 
(1,237
)
Retained earnings
6,835

 
39,300

Treasury stock, at cost; 1,881,390 and 1,784,897 shares at June 30, 2016 and December 31, 2015, respectively
(18,478
)
 
(17,869
)
Flotek Industries, Inc. stockholders’ equity
266,290

 
293,651

Noncontrolling interests
358

 
358

Total equity
266,648

 
294,009

TOTAL LIABILITIES AND EQUITY
$
365,344

 
$
403,090


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3



FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
72,319

 
$
87,030

 
$
144,608

 
$
169,404

Cost of revenue
48,398

 
57,778

 
95,759

 
113,625

Gross profit
23,921

 
29,252

 
48,849

 
55,779

Expenses:
 
 
 
 
 
 
 
Selling, general and administrative
21,982

 
23,021

 
47,435

 
46,588

Depreciation and amortization
2,391

 
2,797

 
5,189

 
5,473

Research and development
2,271

 
1,670

 
4,527

 
3,242

Impairment of inventory and long-lived assets
—

 
20,372

 
40,435

 
20,372

Total expenses
26,644

 
47,860

 
97,586

 
75,675

Loss from operations
(2,723
)
 
(18,608
)
 
(48,737
)
 
(19,896
)
Other expense:
 
 
 
 
 
 
 
Interest expense
(701
)
 
(420
)
 
(1,200
)
 
(828
)
Other expense, net
(48
)
 
(2
)
 
(158
)
 
(227
)
Total other expense
(749
)
 
(422
)
 
(1,358
)
 
(1,055
)
Loss before income taxes
(3,472
)
 
(19,030
)
 
(50,095
)
 
(20,951
)
Income tax benefit
1,192

 
6,483

 
17,630

 
6,889

Net loss
$
(2,280
)
 
$
(12,547
)
 
$
(32,465
)
 
$
(14,062
)
 
 
 
 
 
 
 
 
Loss per common share:
 
 
 
 
 
 
 
Basic loss per common share
$
(0.04
)
 
$
(0.23
)
 
$
(0.59
)
 
$
(0.26
)
Diluted loss per common share
$
(0.04
)
 
$
(0.23
)
 
$
(0.59
)
 
$
(0.26
)
Weighted average common shares:
 
 
 
 
 
 
 
Weighted average common shares used in computing basic loss per common share
54,910

 
54,264

 
54,827

 
54,356

Weighted average common shares used in computing diluted loss per common share
54,910

 
54,264

 
54,827

 
54,356



See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4




FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(2,280
)
 
$
(12,547
)
 
$
(32,465
)
 
$
(14,062
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
7

 
76

 
324

 
(164
)
Comprehensive income (loss)
$
(2,273
)
 
$
(12,471
)
 
$
(32,141
)
 
$
(14,226
)


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5



FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 
Six months ended June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(32,465
)
 
$
(14,062
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
 
 
 
Impairment of inventory and long-lived assets
40,435

 
20,372

Depreciation and amortization
7,519

 
9,181

Amortization of deferred financing costs
205

 
173

Gain on sale of assets
(714
)
 
(2,023
)
Stock compensation expense
5,763

 
6,910

Deferred income tax benefit
(8,076
)
 
(9,315
)
Reduction in (excess) tax benefit related to share-based awards
954

 
(2,149
)
Changes in current assets and liabilities:
 
 
 
Accounts receivable, net
3,915

 
22,124

Inventories
(9,139
)
 
(16,496
)
Income taxes receivable
(11,535
)
 
(1,722
)
Other current assets
(543
)
 
1,939

Accounts payable
4,165

 
(6,033
)
Accrued liabilities
(2,153
)
 
159

Income taxes payable
(1,759
)
 
2,232

Interest payable
74

 
13

Net cash (used in) provided by operating activities
(3,354
)
 
11,303

Cash flows from investing activities:
 
 
 
Capital expenditures
(8,956
)
 
(8,963
)
Proceeds from sale of assets
858

 
2,188

Payments for acquisition, net of cash acquired
—

 
(1,250
)
Purchase of patents and other intangible assets
(205
)
 
(292
)
Net cash used in investing activities
(8,303
)
 
(8,317
)
Cash flows from financing activities:
 
 
 
Repayments of indebtedness
(3,571
)
 
(6,571
)
Borrowings on revolving credit facility
171,397

 
204,150

Repayments on revolving credit facility
(153,460
)
 
(189,461
)
Debt issuance costs
(147
)
 
(10
)
(Reduction in) excess tax benefit related to share-based awards
(954
)
 
2,149

Purchase of treasury stock related to share-based awards
(609
)
 
(5,339
)
Proceeds from sale of common stock
446

 
543

Repurchase of common stock
—

 
(7,260
)
Proceeds from exercise of stock options
134

 
22

Proceeds from noncontrolling interest
—

 
7

Net cash provided by (used in) financing activities
13,236

 
(1,770
)
Effect of changes in exchange rates on cash and cash equivalents
53

 
(7
)
Net increase in cash and cash equivalents
1,632

 
1,209

Cash and cash equivalents at the beginning of period
2,208

 
1,266

Cash and cash equivalents at the end of period
$
3,840

 
$
2,475



See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
6



FLOTEK INDUSTRIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(in thousands)
 
Common Stock
 
Treasury Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained Earnings
 
Non-controlling Interests
 
Total Equity
 
Shares
Issued
 
Par
Value
 
Shares
 
Cost
 
Balance, December 31, 2015
56,220

 
$
6

 
1,785

 
$
(17,869
)
 
$
273,451

 
$
(1,237
)
 
$
39,300

 
$
358

 
$
294,009

Net loss
—

 
—

 
—

 
—

 
—

 
—

 
(32,465
)
 
—

 
(32,465
)
Foreign currency translation adjustment
—

 
—

 
—

 
—

 
—

 
324

 
—

 
—

 
324

Stock issued under employee stock purchase plan
—

 
—

 
(55
)
 
—

 
446

 
—

 
—

 
—

 
446

Stock options exercised
86

 
—

 
—

 
—

 
134

 
—

 
—

 
—

 
134

Restricted stock granted
534

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Restricted stock forfeited
—

 
—

 
83

 
—

 
—

 
—

 
—

 
—

 
—

Treasury stock purchased
—

 
—

 
68

 
(609
)
 
—

 
—

 
—

 
—

 
(609
)
Stock compensation expense
—

 
—

 
—

 
—

 
5,763

 
—

 
—

 
—

 
5,763

Reduction in tax benefit related to share-based awards
—

 
—

 
—

 
—

 
(954
)
 
—

 
—

 
—

 
(954
)
Balance, June 30, 2016
56,840

 
$
6

 
1,881

 
$
(18,478
)
 
$
278,840

 
$
(913
)
 
$
6,835

 
$
358

 
$
266,648


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
7

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note 1 — Organization and Significant Accounting Policies
Organization and Nature of Operations
Flotek Industries, Inc. (“Flotek” or the “Company”) is a global, diversified, technology-driven supplier of energy chemistries and consumer and industrial chemistries and is a global developer and supplier of drilling, completion, and production technologies and related services.
The Company’s strategic focus includes energy related chemistry technologies, drilling and production technologies, and consumer and industrial chemistry technologies. Within its energy related technologies, the Company provides oilfield specialty chemistries and logistics, downhole drilling tools, and production related tools used in the energy and mining industries. Flotek’s products and services enable customers to drill wells more efficiently, to realize increased production from both new and existing wells, and to decrease future well operating costs. Major customers include leading oilfield service providers, pressure-pumping service companies, onshore and offshore drilling contractors, major and independent oil and gas exploration and production companies, national and state-owned oil companies, and international supply chain management companies. Within consumer and industrial chemistry technologies, the Company provides products for the flavor and fragrance industry and the industrial chemical industry. Major customers include food and beverage companies, fragrance companies, and companies providing household and industrial cleaning products.
The Company is headquartered in Houston, Texas, with operating locations in Florida, Louisiana, New Mexico, North Dakota, Oklahoma, Colorado, Pennsylvania, Texas, Utah, Wyoming, Canada, the Netherlands, and the Middle East. Flotek’s products are marketed both domestically and internationally, with international presence and/or representation in over 20 countries.
Flotek was initially incorporated under the laws of the Province of British Columbia on May 17, 1985. On October 23, 2001, Flotek changed its corporate domicile to the state of Delaware.
Basis of Presentation
The accompanying Unaudited Condensed Consolidated Financial Statements and accompanying footnotes (collectively the “Financial Statements”) reflect all adjustments, in the opinion of management, necessary for fair presentation of the financial condition and results of operations for the periods presented. All such adjustments are normal and recurring in nature. The Financial Statements, including selected notes, have been prepared in accordance with applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and do not include all information and disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for comprehensive financial statement reporting. These interim Financial Statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (“Annual Report”). A copy of the Annual Report is available on the SEC’s website, www.sec.gov, under the Company’s ticker symbol (“FTK”) or on Flotek’s website, www.flotekind.com. The results of operations for the three and six months ended June 30, 2016, are not necessarily indicative of the results to be expected for the year ending December 31, 2016.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and reported amounts of revenue and expenses. Actual results could differ from these estimates.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation. The reclassifications did not impact net income (loss).

8

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 — Recent Accounting Pronouncements
Application of New Accounting Standards
Effective January 1, 2016, the Company adopted the accounting guidance in Accounting Standards Update (“ASU”) No. 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” This ASU eliminates from U.S. GAAP the concept of extraordinary items and the need for an entity to separately classify, present, and disclose extraordinary events and transactions, while retaining certain presentation and disclosure guidance for items that are unusual in nature or occur infrequently. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
Effective January 1, 2016, the Company adopted the accounting guidance in ASU No. 2015-02, “Amendments to the Consolidation Analysis.” The amendment eliminates the deferral of certain consolidation standards for entities considered to be investment companies and modifies the consolidation analysis performed on certain types of legal entities. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
Effective January 1, 2016, the Company adopted the accounting guidance in ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” The accounting guidance requires that debt issuance costs related to a recognized debt liability be reported on the Consolidated Statements of Financial Condition as a direct deduction from the carrying amount of that debt liability. In addition, the Company adopted the accounting guidance in ASU No. 2015-15, which provides additional guidance related to the presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. An entity may present debt issuance costs as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings. Implementation of these standards did not have a material effect on the consolidated financial statements and related disclosures.
Effective January 1, 2016, the Company adopted the accounting guidance in ASU No. 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments.” This standard replaces the requirement that an acquirer in a business combination account for measurement period adjustments retrospectively with a requirement that an acquirer recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the guidance. Implementation of this standard did not have a material effect on the consolidated financial statements and related disclosures.
New Accounting Requirements and Disclosures
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers.” The ASU will supersede most of the existing revenue recognition requirements in U.S. GAAP and will require entities to recognize revenue at an amount that reflects the consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer. The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of an entity’s nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date by one year to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted, but not before the original effective date of reporting periods beginning after December 15, 2016. In March 2016, the FASB issued ASU No. 2016-08, which improves the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, which clarifies identifying performance obligations and the licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, effective upon adoption of ASU 2014-09, and ASU No. 2016-12, which reduces the potential for diversity in practice at initial application and reduces the cost and complexity of applying Topic 606 both at transition and on an ongoing basis. The Company is currently evaluating the impact these pronouncements will have on the consolidated financial statements and related disclosures.
In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” This standard requires management to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and should be applied retrospectively, with early application permitted.  The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.

9

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes.” This standard eliminates the current requirement for organizations to present deferred tax assets and liabilities as current and noncurrent in a classified balance sheet. Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent. The pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, “Leases.” This standard requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. The pronouncement is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and should be applied using a modified retrospective transition approach, with early application permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This standard simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The pronouncement is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This standard replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The pronouncement is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption for the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.
Note 3 — Impairment of Inventory and Long-Lived Assets
During the three months ended March 31, 2016, as a result of changes in the oil and gas industry that occurred since the beginning of 2016 and the corresponding impact on the Company’s business outlook, the Company evaluated the direction of its business activities. Crude oil prices, which appeared to have stabilized during the fourth quarter of 2015, fell further during the first quarter of 2016, decreasing approximately 21% from average prices seen in the fourth quarter of 2015. The U.S. drilling rig count declined from 698 at December 31, 2015 to 450 at April 1, 2016, a decline of 35.5%.
Due to the decreased rig activity and its impact on management’s expectations for future market activity, the Company further refocused operations of its Drilling Technologies segment. The Company decided to exit the business of building and repairing motors in all domestic markets. In addition, changes in drilling technique, including further escalation of the move to a dominance of pad drilling, reduced the marketability of certain other inventory items. The focus of the Production Technologies segment is being shifted to its new technologies for electric submersible pumps for the oil and gas industry and for hydraulic pumping units. Inventory associated with older technologies for these items has been evaluated for impairment. As a result of these changes in focus and projected declines in asset utilization, the Company recorded a pre-tax impairment of inventories as noted below.
Changes in the business climate noted above and increasing operating losses experienced within the Drilling Technologies and Production Technologies segments during the three months ended March 31, 2016, caused the Company to test asset groups within these two segments for recoverability. Recoverability of the carrying value of the asset groups was based upon estimated future cash flows while taking into consideration various assumptions and estimates, including future use of the assets, remaining useful life of the assets, and eventual disposition of the assets. Undiscounted estimated cash flows of two asset groups associated with domestic operations in the Drilling Technologies segment did not exceed the carrying value of the respective asset groups. Therefore, the Company performed an analysis of discounted future cash flows to determine the fair value of each of these two asset groups. As a result of this testing, the Company recorded a pre-tax impairment of long-lived assets as noted below.
In addition, during the three months ended June 30, 2015, as a result of decreased rig activity and its impact on management’s expectations for future market activity, the Company refocused the Drilling Technologies segment to businesses and markets that have the best opportunity for profitable growth in the future. In addition, the Company shifted the focus of the Production Technologies segment to oil production markets and away from coal bed methane markets. As a result of these changes in focus and projected declines in asset utilization, the Company recorded pre-tax impairment charges as noted below.

10

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company recorded impairment charges during the three months ended March 31, 2016 and June 30, 2015, as follows (in thousands):
 
Three months ended
 
March 31, 2016
 
June 30, 2015
Drilling Technologies:
 
 
 
Inventories
$
12,653

 
$
17,241

Long-lived assets:


 
 
Property and equipment
14,642

 
2,327

Intangible assets other than goodwill
9,227

 
—

Production Technologies:
 
 
 
Inventories
3,913

 
804

Total Impairment
$
40,435

 
$
20,372

Based on the changes in the business climate discussed above and increasing operating losses experienced during the three months ended March 31, 2016 and June 30, 2016, goodwill within the Teledrift and Production Technologies reporting units was tested for impairment. However, no impairments of goodwill were recorded based upon this testing.
Note 4 — Acquisition
On January 27, 2015, the Company acquired 100% of the assets of International Artificial Lift, LLC (“IAL”) for $1.3 million in cash consideration and 60,024 shares of the Company’s common stock. IAL specializes in the design, manufacturing and service of next-generation hydraulic pumping units that serve to increase and maximize production for oil and natural gas wells.
Note 5 — Supplemental Cash Flow Information
Supplemental cash flow information is as follows (in thousands):
 
Six months ended June 30,
 
2016
 
2015
Supplemental non-cash investing and financing activities:
 
 
 
Value of common stock issued in acquisitions
$
—

 
$
1,014

Exercise of stock options by common stock surrender
—

 
1,126

Supplemental cash payment information:
 
 
 
Interest paid
$
921

 
$
641

Income taxes paid, net of refunds
3,429

 
2,549

Note 6 — Revenue
The Company differentiates revenue and cost of revenue based on whether the source of revenue is attributable to products, rentals, or services. Revenue and cost of revenue by source are as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue:
 
 
 
 
 
 
 
Products
$
67,155

 
$
74,522

 
$
133,030

 
$
140,682

Rentals
3,146

 
8,747

 
7,198

 
20,571

Services
2,018

 
3,761

 
4,380

 
8,151

 
$
72,319

 
$
87,030

 
$
144,608

 
$
169,404

Cost of revenue:
 
 
 
 
 
 
 
Products
$
44,919

 
$
50,189

 
$
87,391

 
$
95,850

Rentals
1,026

 
3,687

 
2,326

 
9,943

Services
1,615

 
2,089

 
3,712

 
4,124

Depreciation
838

 
1,813

 
2,330

 
3,708

 
$
48,398

 
$
57,778

 
$
95,759

 
$
113,625


11

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 7 — Inventories
Inventories are as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Raw materials
$
37,998

 
$
44,997

Work-in-process
3,482

 
3,069

Finished goods
36,773

 
37,426

Inventories
$
78,253

 
$
85,492

During the three months ended March 31, 2016 and June 30, 2015, the Company recorded an inventory impairment of $16.6 million and $18.0 million, respectively (see Note 3).
Note 8 — Property and Equipment
Property and equipment are as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Land
$
6,896

 
$
7,145

Buildings and leasehold improvements
34,290

 
34,351

Machinery, equipment and rental tools
62,775

 
85,611

Equipment in progress
15,963

 
12,304

Furniture and fixtures
2,635

 
2,749

Transportation equipment
6,740

 
7,462

Computer equipment and software
12,016

 
11,382

Property and equipment
141,315

 
161,004

Less accumulated depreciation
(60,556
)
 
(69,091
)
Property and equipment, net
$
80,759

 
$
91,913

During the three months ended March 31, 2016 and June 30, 2015, the Company recorded a fixed asset impairment of $14.6 million and $2.3 million, respectively (see Note 3).
Depreciation expense, including expense recorded in cost of revenue, totaled $2.3 million and $3.4 million for the three months ended June 30, 2016 and 2015, respectively, and $5.4 million and $6.8 million for the six months ended June 30, 2016 and 2015, respectively.
Note 9 — Goodwill
Changes in the carrying value of goodwill for each reporting unit are as follows (in thousands):
 
Energy Chemistry Technologies
 
Consumer and Industrial Chemistry Technologies
 
 Teledrift
 
Production Technologies
 
Total
Balance at December 31, 2015
$
36,318

 
$
19,480

 
$
15,333

 
$
1,689

 
$
72,820

Goodwill impairment recognized
—

 
—

 
—

 
—

 
—

Balance at June 30, 2016
$
36,318

 
$
19,480

 
$
15,333

 
$
1,689

 
$
72,820

Goodwill within the Teledrift and Production Technologies reporting units was tested for impairment during the three months ended March 31, 2016 and June 30, 2016. No impairments of goodwill were recognized during the three and six months ended June 30, 2016 and 2015 (see Note 3).

12

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 10 — Other Intangible Assets
Other intangible assets are as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
 
Cost
 
Accumulated Amortization
 
Cost
 
Accumulated Amortization
Finite-lived intangible assets:
 
 
 
 
 
 
 
Patents and technology
$
19,229

 
$
5,398

 
$
20,960

 
$
5,809

Customer lists
41,877

 
11,626

 
52,607

 
14,640

Trademarks and brand names
3,947

 
2,242

 
7,191

 
3,360

Total finite-lived intangible assets acquired
65,053

 
19,266

 
80,758

 
23,809

Deferred financing costs
1,812

 
1,063

 
1,665

 
858

Total amortizable intangible assets
66,865

 
$
20,329

 
82,423

 
$
24,667

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
Trademarks and brand names
11,630

 
 
 
11,630

 
 
Total other intangible assets
$
78,495

 
 
 
$
94,053

 
 
 
 
 
 
 
 
 
 
Carrying value:
 
 
 
 
 
 
 
Other intangible assets, net
$
58,166

 
 
 
$
69,386

 
 
Finite-lived intangible assets acquired are amortized on a straight-line basis over two to 20 years. Amortization of finite-lived intangible assets acquired totaled $0.9 million and $1.2 million for the three months ended June 30, 2016 and 2015, respectively, and $2.1 million and $2.4 million for the six months ended June 30, 2016 and 2015, respectively.
During the three months ended March 31, 2016, the Company recorded an impairment of finite-lived intangible assets of $9.2 million (see Note 3).
Amortization of deferred financing costs was $0.1 million and $0.1 million for the three months ended June 30, 2016 and 2015, respectively, and $0.2 million and $0.2 million for the six months ended June 30, 2016 and 2015, respectively.
Note 11 — Long-Term Debt and Credit Facility
Long-term debt is as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Long-term debt:
 
 
 
Borrowings under revolving credit facility
$
43,085

 
$
25,148

Term loan
21,827

 
25,398

Total long-term debt
64,912

 
50,546

Less current portion of long-term debt
(50,228
)
 
(32,291
)
Long-term debt, less current portion
$
14,684

 
$
18,255

Credit Facility
On May 10, 2013, the Company and certain of its subsidiaries (the “Borrowers”) entered into an Amended and Restated Revolving Credit, Term Loan and Security Agreement (the “Credit Facility”) with PNC Bank, National Association (“PNC Bank”). The Company may borrow under the Credit Facility for working capital, permitted acquisitions, capital expenditures and other corporate purposes. Under terms of the Credit Facility, as amended, the Company (a) may borrow up to $75 million under a revolving credit facility and (b) has borrowed $50 million under a term loan.
The Credit Facility is secured by substantially all of the Company’s domestic real and personal property, including accounts receivable, inventory, land, buildings, equipment and other intangible assets. The Credit Facility contains customary representations, warranties, and both affirmative and negative covenants. The Credit Facility restricts the payment of cash dividends on common stock and limits the amount that may be used to repurchase common stock and preferred stock. In the event of default, PNC Bank may accelerate the maturity date of any outstanding amounts borrowed under the Credit Facility.

13

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Effective March 31, 2016, the Company entered into a Fifth Amendment to the Credit Facility under which the financial covenants to maintain a fixed charge coverage ratio and a ratio of funded debt to adjusted EBITDA were suspended until June 30, 2017. These financial covenants will be reinstated to require compliance with these ratios for the twelve-month period ending June 30, 2017, and continuing as of the last day of each fiscal quarter. The Fifth Amendment established a requirement to maintain certain minimum adjusted EBITDA levels for the periods ending September 30, 2016, December 31, 2016, and March 31, 2017. In addition, the Company is required to maintain under its revolving credit facility, a minimum monthly average undrawn availability of $10 million, including a requirement to continuously maintain $5 million of undrawn availability until June 30, 2017. The Fifth Amendment contains an annual limit on capital expenditures for 2016 of approximately $25 million. The annual capital expenditure limit returns to approximately $32 million beginning in the fiscal year 2017.
Effective March 31, 2016, the interest rate on all advances under the revolving credit facility and the term loan was increased by 1.0%. The interest rates disclosed below reflect the new rates.
The Credit Facility includes a provision on the term loan that 25% of EBITDA minus cash paid for taxes, dividends, debt payments, and unfunded capital expenditures, not to exceed $3.0 million for any year, be paid within 60 days of the fiscal year end. For the year ended December 31, 2015, there was no additional payment required based on this provision.
Each of the Company’s domestic subsidiaries is fully obligated for Credit Facility indebtedness as a Borrower or as a guarantor.
(a) Revolving Credit Facility
Under the revolving credit facility, the Company may borrow up to $75 million through May 10, 2018. This includes a sublimit of $10 million that may be used for letters of credit. The revolving credit facility is secured by substantially all the Company’s domestic accounts receivable and inventory.
At June 30, 2016, eligible accounts receivable and inventory securing the revolving credit facility provided total borrowing capacity of $61.0 million under the revolving credit facility before $5 million of availability that must remain undrawn through June 30, 2017. Available borrowing capacity, net of outstanding borrowings and the $5 million of availability that must remain undrawn, was $12.9 million at June 30, 2016.
The interest rate on advances under the revolving credit facility varies based on the level of borrowing under the Credit Facility. Rates range (a) between PNC Bank’s base lending rate plus 1.5% to 2.0% or (b) between the London Interbank Offered Rate (LIBOR) plus 2.5% to 3.0%. PNC Bank’s base lending rate was 3.50% at June 30, 2016. The Company is required to pay a monthly facility fee of 0.25% per annum, on any unused amount under the commitment based on daily averages. At June 30, 2016, $43.1 million was outstanding under the revolving credit facility, with $0.1 million borrowed as base rate loans at an interest rate of 5.00% and $43.0 million borrowed as LIBOR loans at an interest rate of 2.96%.
Borrowing under the revolving credit agreement is classified as current debt as a result of the required lockbox arrangement and the subjective acceleration clause.
(b) Term Loan
The Company increased borrowing to $50 million under the term loan on May 10, 2013. Monthly principal payments of $0.6 million are required. The unpaid balance of the term loan is due May 10, 2018. Prepayments are permitted, and may be required in certain circumstances. Amounts repaid under the term loan may not be reborrowed. The term loan is secured by substantially all of the Company’s domestic land, buildings, equipment and other intangible assets.
The interest rate on the term loan varies based on the level of borrowing under the Credit Facility. Rates range (a) between PNC Bank’s base lending rate plus 2.25% to 2.75% or (b) between LIBOR plus 3.25% to 3.75%. At June 30, 2016, $21.8 million was outstanding under the term loan, with $0.8 million borrowed as base rate loans at an interest rate of 5.75% and $21.0 million borrowed as LIBOR loans at an interest rate of 3.71%.
Note 12 — Loss Per Share
Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding combined with dilutive common share equivalents outstanding, if the effect is dilutive.
Potentially dilutive securities were excluded from the calculation of diluted loss per share for the three and six months ended June 30, 2016 and 2015, since including them would have an anti-dilutive effect on loss per share due to the net loss incurred during the period. Securities convertible into shares of common stock that were not considered in the diluted loss per share

14

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

calculations were 0.7 million stock options and 0.8 million restricted stock units for the three and six months ended June 30, 2016 and 0.8 million stock options and 0.4 million restricted stock units for the three and six months ended June 30, 2015.
Basic and diluted loss per common share are as follows (in thousands, except per share data):
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Net loss - Basic and Diluted
$
(2,280
)
 
$
(12,547
)
 
$
(32,465
)
 
$
(14,062
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
54,910

 
54,264

 
54,827

 
54,356

Assumed conversions:
 
 
 
 
 
 
 
Incremental common shares from stock options
—

 
—

 
—

 
—

Incremental common shares from restricted stock units
—

 
—

 
—

 
—

Weighted average common shares outstanding - Diluted
54,910

 
54,264

 
54,827

 
54,356

 
 
 
 
 
 
 
 
Basic loss per common share
$
(0.04
)
 
$
(0.23
)
 
$
(0.59
)
 
$
(0.26
)
Diluted loss per common share
$
(0.04
)
 
$
(0.23
)
 
$
(0.59
)
 
$
(0.26
)
Note 13 — Fair Value Measurements
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company categorizes financial assets and liabilities into the three levels of the fair value hierarchy. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value and bases categorization within the hierarchy on the lowest level of input that is available and significant to the fair value measurement.
•
Level 1 — Quoted prices in active markets for identical assets or liabilities;
•
Level 2 — Observable inputs other than Level 1, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
•
Level 3 — Significant unobservable inputs that are supported by little or no market activity or that are based on the reporting entity’s assumptions about the inputs.
Fair Value of Other Financial Instruments
The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximate fair value due to the short-term nature of these accounts. The Company had no cash equivalents at June 30, 2016, or December 31, 2015.
The carrying value and estimated fair value of the Company’s long-term debt are as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Term loan
$
21,827

 
$
21,827

 
$
25,398

 
$
25,398

Borrowings under revolving credit facility
43,085

 
43,085

 
25,148

 
25,148

 
The carrying value of the term loan and borrowings under the revolving credit facility approximate their fair value because the interest rates are variable.
Assets Measured at Fair Value on a Nonrecurring Basis
The Company’s non-financial assets, including property and equipment, goodwill, and other intangible assets are measured at fair value on a non-recurring basis and are subject to fair value adjustment in certain circumstances. During the three months ended March 31, 2016, the Company recorded an impairment of $14.6 million for property and equipment and $9.2 million for other intangible assets (see Note 3). During the three months ended June 30, 2015, the Company recorded an impairment of $2.3 million for property and equipment (see Note 3). Loss on impairment is reported in operating expenses. No impairments of property and equipment or other intangible assets were recognized during the three months ended June 30, 2016, and no impairments of other

15

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

intangible assets were recognized during the three and six months ended June 30, 2015. No impairments of goodwill were recognized during the three and six months ended June 30, 2016 and 2015.
Note 14 — Income Taxes
During the year ended December 31, 2015, the Company restructured its legal entities such that there will be only one U.S. tax filing group filing a single U.S. consolidated federal income tax return beginning in 2016. Prior to 2016, the Company’s corporate organizational structure required the filing of two separate consolidated U.S. Federal income tax returns. Taxable income of one group could not be offset by tax attributes, including net operating losses, of the other group.
A reconciliation of the U.S. federal statutory tax rate to the Company’s effective income tax rate is as follows:
 
Three months ended June 30,

Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
U.S. federal statutory tax rate
(35.0
)%
 
(35.0
)%
 
(35.0
)%
 
(35.0
)%
State income taxes, net of federal benefit
(1.0
)
 
0.5

 
(1.1
)
 
(0.1
)
Non-U.S. income taxed at different rates
(5.5
)
 
(2.9
)
 
(0.1
)
 
(0.4
)
Non-deductible expenses
6.9

 
2.9

 
0.6

 
2.1

Domestic production activities deduction
—

 
(0.6
)
 
—

 
(0.4
)
Other
0.3

 
1.0

 
0.4

 
0.9

Effective income tax rate
(34.3
)%
 
(34.1
)%
 
(35.2
)%
 
(32.9
)%
Fluctuations in effective tax rates have historically been impacted by permanent tax differences with no associated income tax impact, changes in state apportionment factors, including the effect on state deferred tax assets and liabilities, and benefits of non-U.S. income taxed at lower rates. Changes in the effective tax rate during the three and six months ended June 30, 2016, included the Company not qualifying for the domestic production activities deduction.
Deferred taxes are presented in the balance sheets as follows (in thousands):
 
 
June 30, 2016
 
December 31, 2015
Current deferred tax assets
 
$
3,502

 
$
2,649

Non-current deferred tax assets
 
—

 
17,229

Non-current deferred tax liabilities
 
(526
)
 
(23,823
)
Net deferred tax assets (liabilities)
 
$
2,976

 
$
(3,945
)
Note 15 — Stock Repurchase Program
In November 2012, the Company’s Board of Directors authorized the repurchase of up to $25 million of the Company’s common stock. Repurchases may be made in the open market or through privately negotiated transactions. During the three and six months ended June 30, 2016, the Company did not repurchase any shares of its outstanding common stock. During the three months ended June 30, 2015, the Company repurchased 367,129 shares of its outstanding common stock on the open market at a cost of $4.6 million, inclusive of transaction costs, or an average price of $12.55 per share. During the six months ended June 30, 2015, the Company repurchased a total of 547,319 shares of its outstanding common stock on the open market at a cost of $7.3 million, inclusive of transaction costs, or an average price of $13.26 per share.
In June 2015, the Company’s Board of Directors authorized the repurchase of up to an additional $50 million of the Company’s common stock. Repurchases may be made in the open market or through privately negotiated transactions. Through June 30, 2016, the Company has not repurchased any of its common stock under this authorization.
As of June 30, 2016, the Company has $54.9 million remaining under its share repurchase programs. A covenant under the Company’s Credit Facility limits the amount that may be used to repurchase the Company’s common stock. As of June 30, 2016, this covenant limits additional share repurchases to $4.9 million.


16

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 16 — Business Segment, Geographic and Major Customer Information
Segment Information
Operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by chief operating decision-makers in deciding how to allocate resources and assess performance. The operations of the Company are categorized into four reportable segments: Energy Chemistry Technologies, Consumer and Industrial Chemistry Technologies, Drilling Technologies, and Production Technologies.
•
Energy Chemistry Technologies designs, develops, manufactures, packages, and markets specialty chemistries used in oil and natural gas well drilling, cementing, completion, stimulation, and production. In addition, the Company’s chemistries are used in specialized enhanced and improved oil recovery markets. Activities in this segment also include construction and management of automated material handling facilities and management of loading facilities and blending operations for oilfield services companies.
•
Consumer and Industrial Chemistry Technologies designs, develops, and manufactures products that are sold to companies in the flavor and fragrance industries and the specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.
•
Drilling Technologies rents, sells, inspects, manufactures, and markets downhole drilling equipment used in energy, mining, and industrial drilling activities.
•
Production Technologies assembles and markets production-related equipment, including the Petrovalve® product line of rod pump components, hydraulic pumping units, electric submersible pumps, gas separators, valves, and services that support natural gas and oil production activities.
The Company evaluates performance based upon a variety of criteria. The primary financial measure is segment operating income. Various functions, including certain sales and marketing activities and general and administrative activities, are provided centrally by the corporate office. Costs associated with corporate office functions, other corporate income and expense items, and income taxes are not allocated to reportable segments.
Summarized financial information of the reportable segments is as follows (in thousands):
As of and for the three months ended June 30,
Energy Chemistry Technologies
 
Consumer and Industrial Chemistry Technologies
 
Drilling Technologies
 
Production Technologies
 
Corporate and Other
 
Total
2016
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
43,385

 
$
20,694

 
$
6,372

 
$
1,868

 
$
—

 
$
72,319

Gross profit
17,660

 
4,058

 
2,217

 
(14
)
 
—

 
23,921

Income (loss) from operations
7,584

 
2,686

 
(1,618
)
 
(1,261
)
 
(10,114
)
 
(2,723
)
Depreciation and amortization
1,237

 
608

 
607

 
221

 
557

 
3,230

Total assets
151,117

 
108,935

 
67,815

 
23,612

 
13,865

 
365,344

Capital expenditures
3,685

 
204

 
245

 
50

 
559

 
4,743

 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
56,472

 
$
15,477

 
$
12,334

 
$
2,747

 
$
—

 
$
87,030

Gross profit
20,426

 
4,126

 
4,103

 
597

 
—

 
29,252

Income (loss) from operations
11,892

 
2,683

 
(21,300
)
 
(1,596
)
 
(10,287
)
 
(18,608
)
Depreciation and amortization
1,174

 
549

 
2,218

 
198

 
471

 
4,610

Total assets
149,767

 
98,251

 
114,481

 
25,544

 
15,350

 
403,393

Capital expenditures
2,075

 
6

 
620

 
138

 
527

 
3,366


17

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of and for the six months ended June 30,
Energy Chemistry Technologies
 
Consumer and Industrial Chemistry Technologies
 
Drilling Technologies
 
Production Technologies
 
Corporate and Other
 
Total
2016
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
88,064

 
$
39,827

 
$
12,828

 
$
3,889

 
$
—

 
$
144,608

Gross profit
36,429

 
9,082

 
3,242

 
96

 
—

 
48,849

Income (loss) from operations
15,597

 
6,075

 
(42,569
)
 
(6,691
)
 
(21,149
)
 
(48,737
)
Depreciation and amortization
2,480

 
1,118

 
2,428

 
440

 
1,053

 
7,519

Total assets
151,117

 
108,935

 
67,815

 
23,612

 
13,865

 
365,344

Capital expenditures
6,699

 
346

 
483

 
235

 
1,193

 
8,956

 
 
 
 
 
 
 
 
 
 
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
103,115

 
$
28,940

 
$
31,028

 
$
6,321

 
$
—

 
$
169,404

Gross profit
36,526

 
7,833

 
10,094

 
1,326

 
—

 
55,779

Income (loss) from operations
18,713

 
5,064

 
(21,937
)
 
(2,135
)
 
(19,601
)
 
(19,896
)
Depreciation and amortization
2,378

 
1,102

 
4,537

 
323

 
841

 
9,181

Total assets
149,767

 
98,251

 
114,481

 
25,544

 
15,350

 
403,393

Capital expenditures
4,443

 
28

 
2,744

 
776

 
972

 
8,963

Geographic Information
Revenue by country is based on the location where services are provided and products are used. No individual country other than the United States (“U.S.”) accounted for more than 10% of revenue. Revenue by geographic location is as follows (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
U.S.
$
54,014

 
$
73,250

 
$
111,808

 
$
137,446

Other countries
18,305

 
13,780

 
32,800

 
31,958

Total
$
72,319

 
$
87,030

 
$
144,608

 
$
169,404

Long-lived assets held in countries other than the U.S. are not considered material to the consolidated financial statements.
Major Customers
Revenue from major customers, as a percentage of consolidated revenue, is as follows:
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Customer A
15.5
%
 
19.5
%
 
18.3
%
 
15.8
%
Customer B
11.8
%
 
12.1
%
 
11.3
%
 
11.2
%
Over 95% of the revenue from these customers was for sales in the Energy Chemistry Technologies segment.
Note 17 — Commitments and Contingencies
Class Action Litigation
In November 2015, four putative securities class action lawsuits were filed in the United States District Court for the Southern District of Texas against the Company and certain of its officers. The lawsuits have been consolidated into a single case, and an amended complaint has been filed. The amended complaint asserts that the Company made false and/or misleading statements, as well as failed to disclose material adverse facts about the Company’s business, operations, and prospects. The complaint seeks an award of damages in an unspecified amount on behalf of a putative class consisting of persons who purchased the Company’s common stock between October 23, 2014 and November 9, 2015, inclusive.

18

FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In January 2016, three derivative lawsuits were filed, two in the District Court of Harris County, Texas (which have since been consolidated into one case) and one in the United States District Court for the Southern District of Texas, on behalf of the Company against certain of its officers and its current directors. The lawsuits allege violations of law, breaches of fiduciary duty, and unjust enrichment against the defendants.
The Company believes the class action lawsuit and the derivative lawsuits are without merit, and it intends to vigorously defend against all claims asserted. Discovery has not yet commenced. At this time, the Company is unable to reasonably estimate the outcome of this litigation.
In addition, the Company has received notice from the U.S. Securities and Exchange Commission that it has opened an inquiry related to similar issues to those raised in the above-described litigation.
Other Litigation
The Company is subject to routine litigation and other claims that arise in the normal course of business. Management is not aware of any pending or threatened lawsuits or proceedings that are expected to have a material effect on the Company’s financial position, results of operations or liquidity.
Concentrations and Credit Risk
The majority of the Company’s revenue is derived from the oil and gas industry. Customers include major oilfield services companies, major integrated oil and natural gas companies, independent oil and natural gas companies, pressure pumping service companies and state-owned national oil companies. This concentration of customers in one industry increases credit and business risks.
The Company is subject to concentrations of credit risk within trade accounts receivable, as the Company does not generally require collateral as support for trade receivables. In addition, the majority of the Company’s cash is maintained at a major financial institution and balances often exceed insurable amounts.


19



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q (“Quarterly Report”), and in particular, Part I, Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains “forward-looking statements” within the meaning of the safe harbor provisions, 15 U.S.C. § 78u-5, of the Private Securities Litigation Reform Act of 1995 (“Reform Act”). Forward-looking statements are not historical facts, but instead represent Flotek Industries, Inc.’s (“Flotek” or “Company”) current assumptions and beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside the Company’s control. Such statements include estimates, projections, and statements related to the Company’s business plan, objectives, expected operating results, and assumptions upon which those statements are based. The forward-looking statements contained in this Quarterly Report are based on information available as of the date of this Quarterly Report.
The forward-looking statements relate to future industry trends and economic conditions, forecast performance or results of current and future initiatives and the outcome of contingencies and other uncertainties that may have a significant impact on the Company’s business, future operating results and liquidity. These forward-looking statements generally are identified by words including, but not limited to, “anticipate,” “believe,” “estimate,” “continue,” “intend,” “expect,” “plan,” “forecast,” “project,” and similar expressions, or future-tense or conditional constructions such as “will,” “may,” “should,” “could,” etc. The Company cautions that these statements are merely predictions and are not to be considered guarantees of future performance. Forward-looking statements are based upon current expectations and assumptions that are subject to risks and uncertainties that can cause actual results to differ materially from those projected, anticipated, or implied.
A detailed discussion of potential risks and uncertainties that could cause actual results and events to differ materially from forward-looking statements is included in Part I, Item 1A — “Risk Factors” of the Annual Report on Form 10-K for the year ended December 31, 2015 (“Annual Report”) and periodically in subsequent reports filed with the Securities and Exchange Commission (“SEC”). The Company has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events, except as required by law.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto of this Quarterly Report, as well as the Annual Report. Phrases such as “Company,” “we,” “our,” and “us” refer to Flotek Industries, Inc. and its subsidiaries.
Executive Summary
Flotek is a global diversified, technology-driven company that develops and supplies oilfield products, services, and equipment to the oil, gas, and mining industries, and high value compounds to companies that make cleaning products, cosmetics, food and beverages, and other products that are sold in the consumer and industrial markets.
The Company’s oilfield businesses include specialty chemistries and logistics, downhole drilling tools, and production-related tools. Flotek’s technologies enable customers to drill wells more efficiently, increase well production, and decrease well operating costs. The Company also provides automated bulk material handling, loading facilities, and blending capabilities. The Company sources citrus oil domestically and internationally and is one of the largest processors of citrus oil in the world. Products produced from processed citrus oil include (1) high value compounds used as additives by companies in the flavors and fragrances markets and (2) environmentally friendly chemistries for use in numerous industries around the world, including the oil and gas (“O&G”) industry.
Flotek operates in over 20 domestic and international markets, including the Gulf Coast, Southwest, West Coast, Rocky Mountains, Northeastern, and Mid-Continental regions of the United States (“U.S.”), Canada, Mexico, Central America, South America, Europe, Africa, Middle East, and Asia-Pacific. Customers include major integrated O&G companies, oilfield services companies, independent O&G companies, pressure-pumping service companies, national and state-owned oil companies, and international supply chain management companies. The Company also serves customers who purchase non-energy-related citrus oil and related products, including household and commercial cleaning product companies, fragrance and cosmetic companies, and food manufacturing companies.

20



The operations of the Company are categorized into four reportable segments: Energy Chemistry Technologies, Consumer and Industrial Chemistry Technologies, Drilling Technologies, and Production Technologies.
•
Energy Chemistry Technologies designs, develops, manufactures, packages, and markets specialty chemistries used in O&G well drilling, cementing, completion, stimulation, and production. In addition, the Company’s chemistries are used in specialized enhanced and improved oil recovery markets (“EOR” or “IOR”). Activities in this segment also include construction and management of automated material handling facilities and management of loading facilities and blending operations for oilfield services companies.
•
Consumer and Industrial Chemistry Technologies designs, develops, and manufactures products that are sold to companies in the flavor and fragrance industries and specialty chemical industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.
•
Drilling Technologies rents, sells, inspects, manufactures, and markets downhole drilling equipment used in energy, mining, and industrial drilling activities.
•
Production Technologies assembles and markets production-related equipment, including the Petrovalve® product line of rod pump components, hydraulic pumping units (“HPU”), electric submersible pumps (“ESP”), gas separators, valves, and services that support natural gas and oil production activities.
Market Conditions
The Company’s success is sensitive to a number of factors, which include, but are not limited to, drilling activity, customer demand for its advanced technology products, market prices for raw materials, and governmental actions.
Drilling activity levels are influenced by a number of factors, including the number of rigs in operation, the geographical areas of rig activity, and drill rig efficiency (rig days required per well). Additional factors that influence the level of drilling activity include:
•
Historical, current, and anticipated future O&G prices,
•
Federal, state, and local governmental actions that may encourage or discourage drilling activity,
•
Customers’ strategies relative to capital funds allocations,
•
Weather conditions, and
•
Technological changes to drilling methods and economics.
Historical North American drilling activity is reflected in “TABLE A” on the following page.
Customers’ demand for advanced technology products and services provided by the Company are dependent on their recognition of the value of:
•
Chemistries that improve the economics of their O&G operations,
•
Drilling products that improve drilling operations and efficiencies,
•
Chemistries that are economically viable, socially responsible, and ecologically sound, and
•
Production technologies that improve production and production efficiencies in maturing wells.
Market prices for citrus oils can be influenced by:
•
Historical, current, and anticipated future production levels of the global citrus (primarily orange) crop,
•
Weather related risks,
•
Health and condition of citrus trees (e.g., disease and pests), and
•
International competition and pricing pressures resulting from natural and artificial pricing influences.
Governmental actions may restrict the future use of hazardous chemicals, including, but not limited to, the following industrial applications:
•
O&G drilling and completion operations,
•
O&G production operations, and
•
Non-O&G industrial solvents.



21



TABLE A
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
% Change

 
2016
 
2015
 
% Change
Average North American Active Drilling Rigs
 
 
 
 
 
 
 
 
 
 
 
U.S.
422

 
907

 
(53.5
)%
 
483

 
1,155

 
(58.2
)%
Canada
48

 
98

 
(51.0
)%
 
108

 
206

 
(47.6
)%
Total
470

 
1,005

 
(53.2
)%
 
591

 
1,361

 
(56.6
)%
Average U.S. Active Drilling Rigs by Type
 
 
 
 
 
 
 
 
 
 
 
Vertical
51

 
114

 
(55.3
)%
 
57

 
166

 
(65.7
)%
Horizontal
326

 
701

 
(53.5
)%
 
377

 
878

 
(57.1
)%
Directional
45

 
92

 
(51.1
)%
 
49

 
111

 
(55.9
)%
Total
422

 
907

 
(53.5
)%
 
483

 
1,155

 
(58.2
)%
Average North American Drilling Rigs by Product
 
 
 
 
 
 
 
 
 
 
 
Oil
350

 
718

 
(51.3
)%
 
433

 
988

 
(56.2
)%
Natural Gas
120

 
287

 
(58.2
)%
 
158

 
373

 
(57.6
)%
Total
470

 
1,005

 
(53.2
)%
 
591

 
1,361

 
(56.6
)%
Source: Rig counts are per Baker Hughes, Inc. (www.bakerhughes.com). Rig counts are the averages of the weekly rig count activity.

During the three and six months ended June 30, 2016, total average North American active drilling rig count decreased 53.2% and 56.6%, respectively, when compared to the same periods of 2015. Average North American oil drilling rig activity decreased by 51.3% and 56.2% for the three and six months ended June 30, 2016, respectively, when compared to the same periods of 2015. Average North American natural gas drilling rig count decreased by 58.2% and 57.6% for the three and six months ended June 30, 2016, respectively, compared to the same periods of 2015. Sequentially, total average North American active drilling rig count decreased by 35.1% when compared to the first quarter of 2016.
Average U.S. rig activity decreased by 53.5% and 58.2% for the three and six months ended June 30, 2016, respectively, compared to the same periods of 2015, and sequentially, decreased by 23.4% when compared to the first quarter of 2016.
Average Canadian rig count decreased by 51.0% and 47.6% for the three and six months ended June 30, 2016, respectively, compared to the same periods of 2015, while failing for the second consecutive year to reach the 600 - 700 rig range normally achieved from mid-January through early March before the spring thaw resulted in significantly reduced drilling activity. Canadian rig activity is still lagging normal activity levels by more than 100 rigs.

22



Company Outlook
In line with the continuing decline in North American drilling rig activity, many of Flotek’s clients have significantly reduced their exploration and drilling activity. The reduction in activity has created a more challenging environment in which to market the Company’s broad range of energy technologies, from chemistry to drilling and production technologies. Further decreases in exploration and drilling activity and in North American rig counts could cause further reductions in revenue and income from operations. Although the Company has seen demand for its oil and gas related products and services in North America impacted by these industry conditions, the Company continues to aggressively market its oil and gas based products and services including its Complex nano-Fluid® (“CnF®”) chemistries, Teledrift® product line, Stemulator® product line, and the growing line of production technologies, and the Company expects to see increased market acceptance of these product lines.
Although oilfield activity, as measured by active rig count, has increased recently, based on current market dynamics, the Company expects North American oilfield activity to remain depressed throughout the remainder of 2016 and potentially beyond.
During the second quarter of 2016, the Company continued to successfully promote the efficacy of its CnF® chemistries resulting in a 16% increase in CnF® sales volumes compared to the second quarter of 2015, despite a 53% year over year decline in North American general oilfield activity. Second quarter 2016 CnF® volumes declined only 13% compared to the first quarter of 2016, despite a 35% sequential quarter decline in North American general oilfield activity as measured by active rig count. The Company expects to continue this strong performance relative to market activity by continuing to demonstrate the efficacy of its CnF® chemistries through comparative analysis of wells with and without CnF® chemistries, field validation results conducted by E&P companies, and the continuation of its direct-to-operator sales program known as the Flotek Store™. Whether operators purchase directly from Flotek or continue to purchase from oilfield distribution and service companies, E&P operators are benefiting from increased price transparency and a more direct relationship with Flotek’s technical expertise and supply chain.
The Company’s success in promoting CnF® chemistries is supported through its industry leading research and innovation staff who provide customer responsive product innovation, as well as development of new products which are expected to expand the Company’s future product lines. During the third quarter of 2016, the Company expects to complete its new Global Research & Innovation Center in Houston. This state-of-the-art facility will allow for the development of next-generation innovative energy chemistries, as well as expand collaboration between clients, leaders from academia, and Company scientists. These collaborative opportunities will become an important and distinguishing capability within the industry and should generate value in 2016 and beyond.
As a result of the significant and continued reduction in drilling activity and the Company’s expectations for the future market for the Company’s drilling tools, during the first quarter of 2016, the Company refocused the Drilling Technologies segment by closing locations, reducing staff, and eliminating product lines. At current activity levels, the Company expects continued, intense competition for jobs and significant pressure on margins until market conditions stabilize and begin to improve. Throughout 2015 and continuing in to 2016, some of the Company’s smaller competitors left the market, and the Company believes, based on its improved cost structure and market position, it is well positioned to benefit from improved pricing and market growth opportunities when the market begins to recover.
During 2015, the Company strategically repositioned the focus of the Production Technologies segment towards oil production markets and away from the less opportunistic coal bed methane (“CBM”) markets. As part of this strategic repositioning, in January 2015, the Company acquired 100% of the assets from International Artificial Lift, LLC (“IAL”), a company that specializes in the design, manufacturing, and service of next-generation HPUs that serve to increase and maximize production for oil and natural gas wells. Additionally, the Company is developing a new line of ESPs. The Company is currently commercializing its new HPU and ESP product lines.
The outlook for the Company’s consumer and industrial chemistries will be driven by the availability and demand for citrus oils, industrial solvents, and flavor and fragrance ingredients. Although current inventory and crop expectations are sufficient to meet the Company’s needs to supply its flavor and fragrance business, as well as both internal and external industrial markets, the market supply of citrus terpenes has declined in recent years due to the reduction in citrus crops caused by the citrus greening disease. This reduced supply has resulted in higher citrus terpene prices and increased price volatility. The Company expects terpene prices to remain elevated for the remainder of 2016. In addition, the Company expects its strong market position to enable it to maintain a stable supply of citrus terpenes for internal use and external sales.
In response to the current market environment, the Company has been proactive in reducing costs to reflect current market conditions while, at the same time, remaining focused on preserving appropriate functions and capacity, which allows the Company to be opportunistic as market conditions improve. The Company expects to continue to focus on supply chain optimizations and, when needed, adjustments to staffing levels, facility consolidations, and other cost adjustments. The Company regularly evaluates its cost structure based on market conditions with a focus on continuous efficiency improvements.

23



Capital expenditures, exclusive of acquisitions, totaled $9.0 million for each of the six months ended June 30, 2016 and 2015. The Company now expects capital spending to be between $14 million and $16 million in 2016, inclusive of approximately $7 million for completion of its Global Research & Innovation Center. The Company will remain nimble in its core capital expenditure plans, adjusting as market conditions warrant.
Changes to geopolitical, global economic, and industry trends could have an impact, either positive or negative, on the Company’s business. In the event of significant adverse changes to the demand for oil and gas production and/or the market price for oil and gas, the market conditions affecting the Company could change rapidly and materially. Should such adverse changes to market conditions occur, management believes the Company has access to adequate liquidity to withstand the impact of such changes while continuing to make strategic capital investments and acquisitions, if opportunities arise. In addition, management believes the Company is well-positioned to take advantage of significant increases in demand for its products should market conditions improve dramatically in the near term.
Consolidated Results of Operations (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
72,319

 
$
87,030

 
$
144,608

 
$
169,404

Cost of revenue
48,398

 
57,778

 
95,759

 
113,625

Gross profit
23,921

 
29,252

 
48,849

 
55,779

    Gross margin %
33.1
 %
 
33.6
 %
 
33.8
 %
 
32.9
 %
Selling, general and administrative costs
21,982

 
23,021

 
47,435

 
46,588

    Selling, general and administrative costs %
30.4
 %
 
26.5
 %
 
32.8
 %
 
27.5
 %
Depreciation and amortization
2,391

 
2,797

 
5,189

 
5,473

Research and innovation costs
2,271

 
1,670

 
4,527

 
3,242

Impairment of inventory and long-lived assets
—

 
20,372

 
40,435

 
20,372

Loss from operations
(2,723
)
 
(18,608
)
 
(48,737
)
 
(19,896
)
    Operating margin %
(3.8
)%
 
(21.4
)%
 
(33.7
)%
 
(11.7
)%
Interest and other expense, net
(749
)
 
(422
)
 
(1,358
)
 
(1,055
)
Loss before income taxes
(3,472
)
 
(19,030
)
 
(50,095
)
 
(20,951
)
Income tax benefit
1,192

 
6,483

 
17,630

 
6,889

Net loss
$
(2,280
)
 
$
(12,547
)
 
$
(32,465
)
 
$
(14,062
)
    Net loss %
(3.2
)%
 
(14.4
)%
 
(22.5
)%
 
(8.3
)%
Consolidated Results of Operations: Three and Six Months Ended June 30, 2016, Compared to the Three and Six Months Ended June 30, 2015
Consolidated revenue for the three and six months ended June 30, 2016, decreased $14.7 million, or 16.9%, and $24.8 million, or 14.6%, respectively, versus the same periods of 2015. The decrease in revenue for both periods was driven by the continued decline in drilling activity throughout 2015 and 2016, as indicated by the 53.2% and 56.6% reduction in average North American rig count for the three and six months ended June 30, 2016, versus the same periods of 2015. This resulted in significant reductions in customer demand and price concessions in our Drilling Technologies segment. Our Energy Chemistry Technologies segment experienced a less significant decline in revenues due to increased CnF® sales volumes and revenues. Additionally, our Consumer and Industrial Chemistry Technologies segment saw a significant increase in revenues due to higher sales prices and volume increases.
Consolidated gross profit for the three and six months ended June 30, 2016, decreased $5.3 million, or 18.2%, and $6.9 million, or 12.4%, respectively, compared to the same periods of 2015. Gross margin decreased to 33.1% for the three months ended June 30, 2016, from 33.6% in the same period of 2015, primarily due to increased raw material costs and liquidation of lower margin materials in our Consumer and Industrial Chemistry Technologies segment and declining sales volumes and product pricing pressure in our Production Technologies segment. Gross margin increased to 33.8% for the six months ended June 30, 2016, from 32.9% in the same period of 2015, primarily attributable to the increase in CnF® sales volumes which have a higher margin than other products, partially offset by lower sales and pricing pressures in both Drilling Technologies and Production Technologies.

24



Selling, general and administrative (“SG&A”) expenses are not directly attributable to products sold or services provided. SG&A costs decreased $1.0 million, or 4.5%, and increased $0.8 million, or 1.8%, for the three and six months ended June 30, 2016, respectively, versus the same period of 2015. The decrease during the second quarter was primarily due to lower incentive compensation, while the increase during the six months ended June 30, 2016 was primarily due to higher legal and professional fees. The Company regularly evaluates its SG&A cost structure as market conditions warrant.
Depreciation and amortization expense decreased $0.4 million, or 14.5%, and $0.3 million, or 5.2%, for the three and six months ended June 30, 2016, versus the same periods of 2015, primarily due to the long-lived asset impairment in the first quarter of 2016.
Research and Innovation (“R&I”) expense increased $0.6 million, or 36.0%, and $1.3 million, or 39.6%, for the three and six months ended June 30, 2016, respectively, compared to the same periods of 2015. The increase in R&I is primarily attributable to new product development and Flotek’s commitment to remaining responsive to customer needs, increased demand, continued growth and refining of our existing product lines, and the development of new products which are expected to expand the Company’s future product lines.
During the three months ended March 31, 2016, as a result of changes in the oil and gas industry that have occurred since the beginning of 2016 and its corresponding impact on the Company’s business outlook, the Company determined that within its Drilling Technologies segment the carrying amount of certain long-lived assets exceeded their respective fair values and that some inventory was either not usable in future operations or the carrying value exceeded its market value. In addition, as a result of the introduction of newer and proprietary technology, as well as lower demand for older technologies, the Company also evaluated its Production Technologies inventory for impairment during the three months ended March 31, 2016. As a result of these evaluations, the Company recorded impairment charges of $40.4 million in the first quarter of 2016.
Interest and other expense increased $0.3 million, or 77.5%, and $0.3 million, or 28.7%, for the three and six months ended June 30, 2016, versus the same periods of 2015, primarily due to the interest rate increase on the term loan and revolving credit facility effective March 31, 2016.
The Company recorded income tax benefits of $1.2 million and $17.6 million, yielding effective tax benefit rates of 34.3% and 35.2% for the three and six months ended June 30, 2016, respectively, compared to income tax benefits of $6.5 million and $6.9 million yielding effective tax benefit rates of 34.1% and 32.9% for the comparable periods in 2015.
Results by Segment
Energy Chemistry Technologies
 
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
43,385

 
$
56,472

 
$
88,064

 
$
103,115

Gross profit
17,660

 
20,426

 
36,429

 
36,526

Gross margin %
40.7
%
 
36.2
%
 
41.4
%
 
35.4
%
Income from operations
7,584

 
11,892

 
15,597

 
18,713

Operating margin %
17.5
%
 
21.1
%
 
17.7
%
 
18.1
%
Energy Chemistry Technologies Results of Operations: Three and Six Months Ended June 30, 2016, Compared to the Three and Six Months Ended June 30, 2015
Energy Chemistry Technologies revenue for the three and six months ended June 30, 2016, decreased $13.1 million, or 23.2%, and $15.1 million, or 14.6%, respectively, versus the same periods of 2015, compared to a 53.2% and 56.6% decline in market activity as measured by average North American rig count. Flotek’s Energy Chemistry Technologies segment outperformed these market indicators by continuing to aggressively promote the benefits of CnF® chemistries. CnF® sales volumes increased 16.2% (revenues increased 7.9%), compared to the three months ended June 30, 2015. The increased sales of CnF® chemistries during the second quarter of 2016 was achieved by continuing to demonstrate the efficacy of its CnF® chemistries through comparative analysis of wells with and without CnF® chemistries, field validation results conducted by E&P companies, and its direct-to-operator sales program known as the Flotek Store™. Non-CnF revenues declined approximately 54.4%, compared to the three months ended June 30, 2015, due to reduced customer demand as a result of oilfield market conditions.

25



Sequentially, revenues decreased $1.3 million, or 2.9%, versus the first quarter of 2016, compared to a 35.1% decline in market activity as measured by average North American rig count. CnF® sales volumes decreased 12.5% (revenues decreased 13.6%) on a sequential basis due to decreased completions activity by customers. Non-CnF revenues increased $2.9 million due to increased activity with a service company and increased international sales.
Energy Chemistry Technologies gross profit decreased $2.8 million, or 13.5%, and $0.1 million, or 0.3%, for the three and six months ended June 30, 2016, respectively, versus the same periods of 2015. Gross margin increased to 40.7% and 41.4% for the three and six months ended June 30, 2016, respectively, from 36.2% and 35.4% in the same periods of 2015. The gross margin increases over the periods were primarily due to product mix resulting from relatively higher sales of CnF® chemistries.
Income from operations for the Energy Chemistry Technologies segment decreased $4.3 million, or 36.2%, and $3.1 million, or 16.7%, for the three and six months ended June 30, 2016, respectively, versus the same periods of 2015. These decreases are primarily attributable to the decrease in gross profit, increased costs associated with sales and marketing efforts in pursuit of growth opportunities, and increased costs associated with the Company’s continued commitment to its research and innovation efforts within Energy Chemistry Technologies.
Consumer and Industrial Chemistry Technologies
 
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
20,694

 
$
15,477

 
$
39,827

 
$
28,940

Gross profit
4,058

 
4,126

 
9,082

 
7,833

Gross margin %
19.6
%
 
26.7
%
 
22.8
%
 
27.1
%
Income from operations
2,686

 
2,683

 
6,075

 
5,064

Operating margin %
13.0
%
 
17.3
%
 
15.3
%
 
17.5
%

CICT Results of Operations: Three and Six Months Ended June 30, 2016, Compared to the Three and Six Months Ended June 30, 2015
CICT revenue increased $5.2 million, or 33.7%, and $10.9 million, or 37.6%, for the three and six months ended June 30, 2016, respectively, versus the same periods of 2015. Sequentially, revenues increased $1.6 million, or 8.2%, versus the first quarter of 2016. Increases in all comparison periods were due to higher prices and volume increases in all product lines.
CICT gross profit for the three and six months ended June 30, 2016, decreased $0.1 million, or 1.6%, and increased $1.2 million, or 15.9%, versus the same periods of 2015. Gross margin decreased to 19.6% and 22.8% for the three and six months ended June 30, 2016, respectively, from 26.7% and 27.1% in the same periods of 2015. Sequentially, gross profits decreased by $1.0 million, and gross margins declined to 19.6% from 26.3% from the first quarter of 2016. Higher sales were offset by increased raw material costs and liquidation of lower margin materials.
Income from operations for the CICT segment was essentially flat for the three months ended June 30, 2016 and increased $1.0 million, or 20.0%, for the six months ended June 30, 2016, versus the same periods of 2015. Operating margin decreased to 13.0% and 15.3% for the three and six months ended June 30, 2016, respectively, from 17.3% and 17.5% in the same periods of 2015. Sequentially, operating profits decreased by $0.7 million, and operating margins decreased by 4.7% compared to the first quarter of 2016. Lower gross margins were partially offset by reduced SG&A costs of $0.3 million.

26



Drilling Technologies (dollars in thousands)
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
6,372

 
$
12,334

 
$
12,828

 
$
31,028

Gross profit
2,217

 
4,103

 
3,242

 
10,094

Gross margin %
34.8
 %
 
33.3
 %
 
25.3
 %
 
32.5
 %
Loss from operations
(1,618
)
 
(21,300
)
 
(42,569
)
 
(21,937
)
Loss from operations - excluding impairment
(1,618
)
 
(1,732
)
 
(6,047
)
 
(2,369
)
Operating margin % - excluding impairment
(25.4
)%
 
(14.0
)%
 
(47.1
)%
 
(7.6
)%
Drilling Technologies Results of Operations: Three and Six Months Ended June 30, 2016, Compared to the Three and Six Months Ended June 30, 2015
Drilling Technologies revenue decreased $6.0 million, or 48.3%, and $18.2 million, or 58.7%, for the three and six months ended June 30, 2016, respectively, relative to the same periods of 2015. The decline in both comparison periods was primarily due to decreased actuated and other tool rentals, decreased Teledrift®