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EX-31.2 - CFO CERTIFICATION - FLOTEK INDUSTRIES INC/CN/exhibit312-10q06302015.htm
EX-31.1 - CEO CERTIFICATION - FLOTEK INDUSTRIES INC/CN/exhibit311-10q06302015.htm
EX-32.1 - CEO 906 CERTIFICATION - FLOTEK INDUSTRIES INC/CN/exhibit321-10q06302015.htm
EX-32.2 - CFO 906 CERTIFICATION - FLOTEK INDUSTRIES INC/CN/exhibit322-10q06302015.htm



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, 2015
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
 
x
  
Accelerated filer
 
¨
 
 
 
 
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, 2015, there were 53,608,401 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 CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
June 30,
2015
 
December 31,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,475

 
$
1,266

Accounts receivable, net of allowance for doubtful accounts of $825 and $847 at June 30, 2015 and December 31, 2014, respectively
56,466

 
78,624

Inventories
84,601

 
85,958

Income taxes receivable
947

 

Deferred tax assets, net
2,602

 
2,696

Other current assets
6,011

 
11,055

Total current assets
153,102

 
179,599

Property and equipment, net
86,996

 
86,111

Goodwill
72,820

 
71,131

Deferred tax assets, net
18,871

 
12,907

Other intangible assets, net
71,604

 
73,528

TOTAL ASSETS
$
403,393

 
$
423,276

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
27,140

 
$
33,185

Accrued liabilities
11,276

 
12,314

Income taxes payable

 
1,307

Interest payable
106

 
93

Current portion of long-term debt
30,332

 
18,643

Total current liabilities
68,854

 
65,542

Long-term debt, less current portion
21,827

 
25,398

Deferred tax liabilities, net
22,537

 
25,982

Total liabilities
113,218

 
116,922

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; 55,917,984 shares issued and 53,608,401 shares outstanding at June 30, 2015; 54,633,726 shares issued and 53,357,811 shares outstanding at December 31, 2014
6

 
5

Additional paid-in capital
265,997

 
254,233

Accumulated other comprehensive income (loss)
(666
)
 
(502
)
Retained earnings
38,700

 
52,762

Treasury stock, at cost; 1,458,061 and 449,397 shares at June 30, 2015 and December 31, 2014, respectively
(14,220
)
 
(495
)
Flotek Industries, Inc. stockholders’ equity
289,817

 
306,003

Noncontrolling interests
358

 
351

Total equity
290,175

 
306,354

TOTAL LIABILITIES AND EQUITY
$
403,393

 
$
423,276


See accompanying Notes to Unaudited Consolidated Financial Statements.
3




FLOTEK INDUSTRIES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
87,030

 
$
105,318

 
$
169,404

 
$
207,893

Cost of revenue
57,778

 
63,008

 
113,625

 
121,903

Gross margin
29,252

 
42,310

 
55,779

 
85,990

Expenses:
 
 
 
 
 
 
 
Selling, general and administrative
23,021

 
20,854

 
46,588

 
42,426

Depreciation and amortization
2,797

 
2,501

 
5,473

 
4,785

Research and development
1,670

 
1,280

 
3,242

 
2,306

Impairment of inventory and rental equipment
20,372

 

 
20,372

 

Total expenses
47,860

 
24,635

 
75,675

 
49,517

Income (loss) from operations
(18,608
)
 
17,675

 
(19,896
)
 
36,473

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(420
)
 
(381
)
 
(828
)
 
(836
)
Other income (expense), net
(2
)
 
(272
)
 
(227
)
 
(218
)
Total other income (expense)
(422
)
 
(653
)
 
(1,055
)
 
(1,054
)
Income (loss) before income taxes
(19,030
)
 
17,022

 
(20,951
)
 
35,419

Income tax benefit (expense)
6,483

 
(5,981
)
 
6,889

 
(12,361
)
Net income (loss)
$
(12,547
)
 
$
11,041

 
$
(14,062
)
 
$
23,058

 
 
 
 
 
 
 
 
Earnings (loss) per common share:
 
 
 
 
 
 
 
Basic earnings (loss) per common share
$
(0.23
)
 
$
0.20

 
$
(0.26
)
 
$
0.42

Diluted earnings (loss) per common share
$
(0.23
)
 
$
0.20

 
$
(0.26
)
 
$
0.42

Weighted average common shares:
 
 
 
 
 
 
 
Weighted average common shares used in computing
    basic earnings (loss) per common share
54,264

 
54,645

 
54,356

 
54,299

Weighted average common shares used in computing diluted earnings (loss) per common share
54,264

 
55,533

 
54,356

 
55,473



See accompanying Notes to Unaudited Consolidated Financial Statements.
4





FLOTEK INDUSTRIES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss)
$
(12,547
)
 
$
11,041

 
$
(14,062
)
 
$
23,058

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
76

 
178

 
(164
)
 
29

Comprehensive income (loss)
$
(12,471
)
 
$
11,219

 
$
(14,226
)
 
$
23,087



See accompanying Notes to Unaudited Consolidated Financial Statements.
5




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

 
Six months ended June 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(14,062
)
 
$
23,058

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Impairment of inventory and rental equipment
20,372

 

Depreciation and amortization
9,181

 
8,814

Amortization of deferred financing costs
173

 
148

Gain on sale of assets
(2,023
)
 
(1,389
)
Stock compensation expense
6,910

 
4,756

Deferred income tax benefit
(9,315
)
 
(446
)
Excess tax benefit related to share-based awards
(2,149
)
 
(3,373
)
Changes in current assets and liabilities:
 
 
 
Accounts receivable, net
22,158

 
(549
)
Inventories
(16,474
)
 
(18,828
)
Income taxes receivable
(947
)
 

Other current assets
3,864

 
(5,323
)
Accounts payable
(6,045
)
 
10,737

Accrued liabilities
(1,038
)
 
(683
)
Income taxes payable
842

 
1,540

Interest payable
13

 
(22
)
Net cash provided by operating activities
11,460

 
18,440

Cash flows from investing activities:
 
 
 
Capital expenditures
(8,963
)
 
(9,245
)
Proceeds from sale of assets
2,188

 
1,982

Payments for acquisitions, net of cash acquired
(1,250
)
 
(5,704
)
Purchase of patents and other intangible assets
(292
)
 
(595
)
Net cash used in investing activities
(8,317
)
 
(13,562
)
Cash flows from financing activities:
 
 
 
Repayments of indebtedness
(6,571
)
 
(6,720
)
Borrowings on revolving credit facility
204,150

 
204,750

Repayments on revolving credit facility
(189,461
)
 
(203,226
)
Debt issuance costs
(10
)
 
(127
)
Excess tax benefit related to share-based awards
2,149

 
3,373

Purchase of treasury stock related to share-based awards
(5,339
)
 
(5,961
)
Proceeds from sale of common stock
543

 
505

Repurchase of common stock
(7,260
)
 

Proceeds from exercise of stock options
22

 
450

       Proceeds from exercise of stock warrants

 
1,545

Proceeds from noncontrolling interest
7

 

Net cash used in financing activities
(1,770
)
 
(5,411
)
Effect of changes in exchange rates on cash and cash equivalents
(164
)
 
29

Net increase (decrease) in cash and cash equivalents
1,209

 
(504
)
Cash and cash equivalents at the beginning of period
1,266

 
2,730

Cash and cash equivalents at the end of period
$
2,475

 
$
2,226



See accompanying Notes to Unaudited Consolidated Financial Statements.
6




FLOTEK INDUSTRIES, INC.
UNAUDITED 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, 2014
54,634

 
$
5

 
449

 
$
(495
)
 
$
254,233

 
$
(502
)
 
$
52,762

 
$
351

 
$
306,354

Net income (loss)

 

 

 

 

 

 
(14,062
)
 

 
(14,062
)
Foreign currency translation adjustment

 

 

 

 

 
(164
)
 

 

 
(164
)
Stock issued under employee stock purchase plan

 

 
(41
)
 

 
543

 

 

 

 
543

Stock options exercised
736

 
1

 

 

 
1,148

 

 

 

 
1,149

Stock surrendered for exercise of stock options

 

 
88

 
(1,126
)
 

 

 

 

 
(1,126
)
Restricted stock granted
488

 

 

 

 

 

 

 

 

Restricted stock forfeited

 

 
20

 

 

 

 

 

 

Treasury stock purchased

 

 
395

 
(5,339
)
 

 

 

 

 
(5,339
)
Stock compensation expense

 

 

 

 
6,910

 

 

 

 
6,910

Excess tax benefit related to share-based awards

 

 

 

 
2,149

 

 

 

 
2,149

Investment in Flotek Gulf, LLC and Flotek Gulf Research, LLC

 

 

 

 

 

 

 
7

 
7

Stock issued in IAL acquisition
60

 

 

 

 
1,014

 

 

 

 
1,014

Repurchase of common stock

 

 
547

 
(7,260
)
 

 

 

 

 
(7,260
)
Balance, June 30, 2015
55,918

 
$
6

 
1,458

 
$
(14,220
)
 
$
265,997

 
$
(666
)
 
$
38,700

 
$
358

 
$
290,175


See accompanying Notes to Unaudited Consolidated Financial Statements.
7


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED 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.
Flotek’s strategic focus, and that of its diversified subsidiaries (collectively referred to as the “Company”), includes energy related chemistry technologies, drilling and production technologies, and consumer and industrial chemistry technologies. Within energy 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, and major and independent oil and gas exploration and production 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 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 (the “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 (“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, 2014 (the “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, 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015.
Use of Estimates
The preparation of financial statements in conformity with 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.

8


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 — Recent Accounting Pronouncements
(a) Application of New Accounting Standards
Effective January 1, 2015, the Company adopted the accounting guidance in Accounting Standards Update (“ASU”) No. 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity,” which amends the definition of a discontinued operation by raising the threshold for a disposal to qualify as discontinued operations. The ASU will also require entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet the discontinued operations criteria. Implementation of this standard did not have a material effect on the consolidated financial statements.
Effective January 1, 2015, the Company adopted the accounting guidance in ASU No. 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” The ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Implementation of this standard did not have a material effect on the consolidated financial statements or the Company’s current awards under its existing stock-based compensation plans.
(b) 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 July 2015, the FASB 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. The Company is currently evaluating the impact the pronouncement will have on the consolidated financial statements and related disclosures.
In January 2015, the FASB issued ASU No. 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” This ASU eliminates from generally accepted accounting principles (“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. The pronouncement is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period and may 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.
In February 2015, the FASB issued 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. The pronouncement is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period and may 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.
In April 2015, the FASB issued 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. The pronouncement is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period with early application permitted for financial statements that have not been previously issued. 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 CONSOLIDATED FINANCIAL STATEMENTS

Note 3 — Impairment of Inventory and Rental Equipment
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 has 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 a pre-tax impairment charge as follows (in thousands):
Drilling Technologies:
 
Inventories
$
17,241

Rental equipment
2,327

Production Technologies:
 
Inventories
804

Total impairment
$
20,372

Note 4 — Acquisitions
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 is a development-stage company that 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.
On April 1, 2014, the Company acquired 100% of the membership interests in SiteLark, LLC (“SiteLark”) for $0.4 million in cash consideration and 5,327 shares of the Company’s common stock. SiteLark provides reservoir engineering and modeling services for a variety of hydrocarbon applications. Its services include proprietary software which assists engineers with reservoir simulation, reservoir engineering and waterflood optimization.
On January 1, 2014, the Company acquired 100% of the membership interests in Eclipse IOR Services, LLC (“EOGA”), a leading Enhanced Oil Recovery (“EOR”) design and injection firm, for $5.3 million in cash consideration, net of cash received, and 94,354 shares of the Company’s Common Stock. EOGA’s enhanced oil recovery processes and its use of polymers to improve the performance of EOR projects has been combined with the Company’s existing EOR products and services.
Note 5 — Supplemental Cash Flow Information
Supplemental cash flow information is as follows (in thousands):
 
Six months ended June 30,
 
2015
 
2014
Supplemental non-cash investing and financing activities:
 
 
 
Value of common stock issued in acquisitions
$
1,014

 
$
1,900

Value of common stock issued in payment of accrued liability

 
600

Exercise of stock options by common stock surrender
1,126

 
1,005

Supplemental cash payment information:
 
 
 
Interest paid
$
641

 
$
710

Income taxes paid
2,549

 
13,884


10


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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,
 
2015
 
2014
 
2015
 
2014
Revenue:
 
 
 
 
 
 
 
Products
$
74,522

 
$
82,302

 
$
140,682

 
$
164,707

Rentals
8,747

 
15,065

 
20,571

 
28,989

Services
3,761

 
7,951

 
8,151

 
14,197

 
$
87,030

 
$
105,318

 
$
169,404

 
$
207,893

Cost of revenue:
 
 
 
 
 
 
 
Products
$
50,189

 
$
49,995

 
$
95,850

 
$
97,731

Rentals
3,687

 
7,654

 
9,943

 
14,165

Services
2,089

 
3,265

 
4,124

 
5,978

Depreciation
1,813

 
2,094

 
3,708

 
4,029

 
$
57,778

 
$
63,008

 
$
113,625

 
$
121,903

Note 7 — Inventories
Inventories are as follows (in thousands):
 
June 30, 2015
 
December 31, 2014
Raw materials
$
46,149

 
$
50,195

Work-in-process
3,043

 
3,129

Finished goods
35,409

 
32,634

Inventories
$
84,601

 
$
85,958

Note 8 — Property and Equipment
Property and equipment are as follows (in thousands):
 
 
June 30, 2015
 
December 31, 2014
Land
 
$
7,140

 
$
6,780

Buildings and leasehold improvements
 
34,332

 
33,765

Machinery, equipment and rental tools
 
83,997

 
80,731

Equipment in progress
 
4,467

 
7,299

Furniture and fixtures
 
2,658

 
2,528

Transportation equipment
 
7,509

 
6,566

Computer equipment and software
 
10,519

 
7,605

Property and equipment
 
150,622

 
145,274

Less accumulated depreciation
 
(63,626
)
 
(59,163
)
Property and equipment, net
 
$
86,996

 
$
86,111


Depreciation expense, including expense recorded in cost of revenue, totaled $3.4 million and $3.4 million for the three months ended June 30, 2015 and 2014, respectively, and $6.8 million and $6.4 million for the six months ended June 30, 2015, and 2014, respectively.

11


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 9 — Goodwill and Other Intangible Assets
During the six months ended June 30, 2015, the Company recognized $1.7 million of goodwill within the Production Technologies reporting unit in connection with the acquisition of IAL. There were no impairments of goodwill recognized during the three and six months ended June 30, 2015 and 2014.
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, 2014
$
36,318

 
$
19,480

 
$
15,333

 
$

 
$
71,131

Addition upon acquisition of IAL

 

 

 
1,689

 
1,689

Balance at June 30, 2015
$
36,318

 
$
19,480

 
$
15,333

 
$
1,689

 
$
72,820

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 $1.2 million and $1.2 million for the three months ended June 30, 2015 and 2014, respectively, and $2.4 million and $2.4 million for the six months ended June 30, 2015, and 2014, respectively.
Amortization of deferred financing costs was $0.1 million for the three months ended June 30, 2015, and $0.2 million and $0.1 million for the six months ended June 30, 2015, and 2014, respectively. Amortization of deferred financing costs was not significant for the three months ended June 30, 2014.
Note 10 — Long-Term Debt and Credit Facility
Long-term debt is as follows (in thousands):
 
June 30, 2015
 
December 31, 2014
Long-term debt:
 
 
 
Borrowings under revolving credit facility
$
23,189

 
$
8,500

Term loan
28,970

 
35,541

Total long-term debt
52,159

 
44,041

Less current portion of long-term debt
(30,332
)
 
(18,643
)
Long-term debt, less current portion
$
21,827

 
$
25,398

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 includes a financial covenant to maintain a fixed charge coverage ratio of 1.10 to 1.00. The numerator of the ratio includes (a) Adjusted EBITDA (consolidated earnings before interest, taxes, depreciation and amortization adjusted to exclude stock compensation expense and impairment expense of up to $23 million in 2015) minus (b) unfunded capital expenditures (excluding up to $7.5 million in 2015 and $5.0 million in 2016 associated with the construction of the Company’s Global Research and Innovation facility) and (c) cash taxes paid. The Credit Facility also includes a financial covenant to maintain a ratio of funded debt to Adjusted EBITDA of not greater than 4.0 to 1.0, and an annual limit on capital expenditures of approximately $35 million. The Credit Facility restricts the payment of cash dividends on common stock. In the event of default, PNC Bank may accelerate the maturity date of any outstanding amounts borrowed under the Credit Facility.
The Credit Facility includes a provision 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

12


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2014, the excess cash flow exceeded $3.0 million. Consequently, the Company paid $3.0 million on its term loan balance to PNC Bank on March 2, 2015. This amount was classified as current debt at December 31, 2014.
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, 2015, eligible accounts receivable and inventory securing the revolving credit facility provided availability of $72.9 million under the revolving credit facility. Available borrowing capacity, net of outstanding borrowings, was $49.7 million at June 30, 2015.
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 0.5% to 1.0% or (b) between the London Interbank Offered Rate (LIBOR) plus 1.5% to 2.0%. PNC Bank’s base lending rate was 3.25% at June 30, 2015. 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, 2015, $23.2 million was outstanding under the revolving credit facility, with $3.2 million borrowed as base rate loans at an interest rate of 3.75% and $20.0 million borrowed as LIBOR loans at an interest rate of 1.69%.
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 1.25% to 1.75% or (b) between LIBOR plus 2.25% to 2.75%. At June 30, 2015, $29.0 million was outstanding under the term loan, with $1.0 million borrowed as base rate loans at an interest rate of 4.50% and $28.0 million borrowed as LIBOR loans at an interest rate of 2.44%.
Note 11 — Earnings (Loss) Per Share
Basic earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per common share is calculated by dividing net income (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 earnings (loss) per share for the three and six months ended June 30, 2015, since including them would have an anti-dilutive effect on earnings (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 earnings (loss) per share calculation were 0.8 million stock options and 0.4 million restricted stock units for the three months ended June 30, 2015, and were 0.8 million stock options and 0.4 million restricted stock units for the six months ended June 30, 2015.

13


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Basic and diluted earnings (loss) per common share are as follows (in thousands, except per share data):
 
Three months ended June 30,
 
Six months ended June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss) - Basic and Diluted
$
(12,547
)
 
$
11,041

 
$
(14,062
)
 
$
23,058

 
 
 
 
 
 
 
 
Weighted average common shares outstanding - Basic
54,264

 
54,645

 
54,356

 
54,299

Assumed conversions:
 
 
 
 
 
 
 
Incremental common shares from warrants

 

 

 
243

Incremental common shares from stock options

 
878

 

 
916

Incremental common shares from restricted stock units

 
10

 

 
15

Weighted average common shares outstanding - Diluted
54,264

 
55,533

 
54,356

 
55,473

 
 
 
 
 
 
 
 
Basic earnings (loss) per common share
$
(0.23
)
 
$
0.20

 
$
(0.26
)
 
$
0.42

Diluted earnings (loss) per common share
$
(0.23
)
 
$
0.20

 
$
(0.26
)
 
$
0.42

Note 12 — 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, 2015, or December 31, 2014.
The carrying value and estimated fair value of the Company’s long-term debt are as follows (in thousands):
 
June 30, 2015
 
December 31, 2014
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Term loan
$
28,970

 
$
28,970

 
$
35,541

 
$
35,541

Borrowings under revolving credit facility
23,189

 
23,189

 
8,500

 
8,500

 
The carrying value of the term loan and borrowings under the revolving credit facility approximate their fair value because the interest rates are variable.

14


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 June 30, 2015, the Company recorded an impairment of $2.3 million relating to rental equipment held and used. Loss on impairment is reported in operating expenses. No impairments of goodwill or other intangible assets were recognized during the three and six months ended June 30, 2015, and 2014.
Note 13 — Income Taxes
The Company’s corporate organizational structure requires the filing of two separate consolidated U.S. Federal income tax returns. Taxable income of one group cannot 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,
 
2015
 
2014
 
2015
 
2014
Federal statutory tax rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
State income taxes, net of federal benefit
(0.5
)
 
2.2

 
0.1

 
2.2

Non-US income taxed at different rates
2.9

 

 
0.4

 

Non-deductible expenses
(2.9
)
 
0.6

 
(2.1
)
 
0.4

Domestic production activities deduction
0.6

 
(2.7
)
 
0.4

 
(2.7
)
Other
(1.0
)
 

 
(0.9
)
 

Effective income tax rate
34.1
 %
 
35.1
 %
 
32.9
 %
 
34.9
 %
The change in the effective income tax rate for the three and six months ended June 30, 2015, compared to the three and six months ended June 30, 2014, was primarily due to the mix of pre-tax profit and loss between domestic and international taxing jurisdictions and the impact of non-deductible expenses and the domestic production activities deduction. The Company plans to permanently reinvest profits from international operations into opportunities to expand the Company’s international presence.
Deferred taxes are presented in the balance sheets as follows (in thousands):
 
 
June 30, 2015
 
December 31, 2014
Current deferred tax assets
 
$
2,602

 
$
2,696

Non-current deferred tax assets
 
18,871

 
12,907

Non-current deferred tax liabilities
 
(22,537
)
 
(25,982
)
Net deferred tax assets (liabilities)
 
$
(1,064
)
 
$
(10,379
)
Note 14 — Convertible Preferred Stock and Stock Warrants
In August 2009, the Company sold convertible preferred stock with detachable warrants to purchase shares of the Company’s common stock. In February 2011, the Company exercised its contractual right to mandatorily convert all outstanding shares of convertible preferred stock into shares of common stock. Currently, the Company has no issued or outstanding shares of preferred stock.

On February 7, 2014, warrants were exercised to purchase 1,277,250 shares of the Company’s common stock at $1.21 per share. The Company received cash proceeds of $1.5 million in connection with the warrants exercised. Following the exercise, the Company no longer has any outstanding warrants.

15


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 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 open market or through privately negotiated transactions. Through June 30, 2015, the Company has not repurchased any of its common stock under this authorization.
As of June 30, 2015, the Company has $57.3 million remaining and available to to repurchase shares under its share repurchase programs.
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 (previously referred to as Energy Chemical Technologies), Consumer and Industrial Chemistry Technologies (previously referred to as Consumer and Industrial Chemical 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, water well and industrial drilling activities.
Production Technologies assembles and markets production-related equipment, including the PetrovalveTM product line of rod pump components, 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.

16


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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
2015
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
56,472

 
$
15,477

 
$
12,334

 
$
2,747

 
$

 
$
87,030

Gross margin
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

 
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
62,589

 
$
12,607

 
$
27,241

 
$
2,881

 
$

 
$
105,318

Gross margin
27,432

 
2,893

 
10,762

 
1,223

 

 
42,310

Income (loss) from operations
19,162

 
972

 
4,200

 
421

 
(7,080
)
 
17,675

Depreciation and amortization
1,095

 
549

 
2,493

 
92

 
366

 
4,595

Total assets
140,028

 
97,935

 
139,095

 
15,922

 
15,241

 
408,221

Capital expenditures
1,418

 
17

 
2,025

 
50

 
747

 
4,257

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
2015
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
103,115

 
$
28,940

 
$
31,028

 
$
6,321

 
$

 
$
169,404

Gross margin
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

 
 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
 
Net revenue from external customers
$
124,966

 
$
25,638

 
$
52,142

 
$
5,147

 
$

 
$
207,893

Gross margin
56,650

 
6,927

 
20,550

 
1,863

 

 
85,990

Income (loss) from operations
40,785

 
3,307

 
7,517

 
343

 
(15,479
)
 
36,473

Depreciation and amortization
2,162

 
982

 
4,930

 
163

 
577

 
8,814

Total assets
140,028

 
97,935

 
139,095

 
15,922

 
15,241

 
408,221

Capital expenditures
2,804

 
30

 
5,321

 
110

 
980

 
9,245

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,
 
2015
 
2014
 
2015
 
2014
U.S.
$
73,250

 
$
91,691

 
$
137,446

 
$
179,022

Other countries
13,780

 
13,627

 
31,958

 
28,871

Total
$
87,030

 
$
105,318

 
$
169,404

 
$
207,893

Long-lived assets held in countries other than the U.S. are not considered material to the consolidated financial statements.

17


FLOTEK INDUSTRIES, INC.
NOTES TO UNAUDITED 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,
 
2015
 
2014
 
2015
 
2014
Customer A
19.5
%
 
*

 
15.8
%
 
*

Customer B
12.1
%
 
17.7
%
 
11.2
%
 
19.2
%
* This customer did not account for more than 10% of revenue during the period.
Over 96% of the revenue from these customers were for sales in the Energy Chemistry Technologies segment.
Note 17 — Commitments and Contingencies
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.
EPA Environmental Proceeding
On January 9, 2015, FC Pro, LLC (“FC Pro”), a wholly-owned subsidiary of the Company, received a letter and proposed consent agreement and final order from the United States Environmental Protection Agency (“EPA”) concerning alleged violations of the federal hazardous waste regulations at FC Pro’s specialty chemical blending facility in Waller, Texas. Specifically, EPA alleged that FC Pro failed to comply with certain notification, operating, and reporting requirements applicable to generators or large quantity generators of hazardous waste. FC Pro has resolved the alleged violations pursuant to a consent agreement and final order dated effective as of April 22, 2015, under which it did not admit or deny the allegations and has paid an administrative penalty of $410,868, obtained an EPA identification number, and developed certain specified operating procedures. Since this enforcement case was initiated, FC Pro has made changes to its operating practices at its Waller facility that it believes has resulted in it no longer generating hazardous waste at that facility.
The amount of the civil penalty was recorded as selling, general and administrative expense during the three months ended March 31, 2015.
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.

18




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q (the “Quarterly Report”), and in particular, Part I, Item 2 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains “forward-looking statements” within the meaning of the safe harbor provisions, 15 U.S.C. § 78u-5, of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Forward-looking statements are not historical facts, but instead represent the Company’s current assumptions and beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside the Company’s control. Such statements include estimates, projections, and statements related to Flotek Industries, Inc.’s (“Flotek” or the “Company”) business plan, objectives, 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, 2014 (the “Annual Report”) and periodically in subsequent reports filed with the Securities and Exchange Commission (the “SEC”). The Company has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events, except as required by law.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited consolidated financial statements and the related notes thereto, 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 chemicals and logistics, down-hole 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, specifically 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 (the “U.S.”), Canada, Mexico, Central America, South America, Europe, Africa, Middle East, Australia 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.



19




The operations of the Company are categorized into four reportable segments: Energy Chemistry Technologies (previously referred to as Energy Chemical Technologies), Consumer and Industrial Chemistry Technologies (previously referred to as Consumer and Industrial Chemical 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 the specialty chemistry industry. These technologies are used by beverage and food companies, fragrance companies, and companies providing household and industrial cleaning products.

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

Production Technologies assembles and markets production-related equipment, including the PetrovalveTM product line of rod pump components, electric submersible pumps, 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.



20




TABLE A
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2015
 
2014
 
% Change

 
2015
 
2014
 
% Change
North American Average Active Drilling Rigs
 
 
 
 
 
 
 
 
 
 
 
U.S.
907

 
1,852

 
(51.0
)%
 
1,155

 
1,816

 
(36.4
)%
Canada
98

 
199

 
(50.8
)%
 
206

 
362

 
(43.1
)%
Total Average North American Drilling Rigs
1,005

 
2,051

 
(51.0
)%
 
1,361

 
2,178

 
(37.5
)%
U.S. Average Active Drilling Rigs by Type
 
 
 
 
 
 
 
 
 
 
 
Vertical
114

 
395

 
(71.1
)%
 
166

 
391

 
(57.5
)%
Horizontal
701

 
1,243

 
(43.6
)%
 
878

 
1,213

 
(27.6
)%
Directional
92

 
214

 
(57.0
)%
 
111

 
212

 
(47.6
)%
Total Average U.S. Drilling Rigs by Type
907

 
1,852

 
(51.0
)%
 
1,155

 
1,816

 
(36.4
)%
Oil vs. Natural Gas Average North American Drilling Rigs
 
 
 
 
 
 
 
 
 
 
 
Oil
718

 
1,629

 
(55.9
)%
 
988

 
1,697

 
(41.8
)%
Natural Gas
287

 
422

 
(32.0
)%
 
373

 
481

 
(22.5
)%
Total North America
1,005

 
2,051

 
(51.0
)%
 
1,361

 
2,178

 
(37.5
)%
Source: Rig counts are per Baker Hughes, Inc. (www.bakerhughes.com). Rig counts are the averages of the weekly rig count activity.

As crude oil prices peaked at approximately $106/barrel in June 2014 and began the descent to the current levels ranging between $50 to $60 per barrel, total US rig count decreased from 1,929 rigs on November 21, 2014, to 859 rigs as of June 26, 2015, representing a 55.5% drop. As the total US rig count dropped, the horizontal rig count declined 52.3%, the directional rig count decreased by 52.2%, and the vertical rig count fell by 69.6%. Horizontal rigs now represent 76.1% of the total working US rig count, versus 71.1% at the peak US drilling activity level in November 2014.
The Canadian rig count, while still following its normal seasonal pattern, has had a similar response. Canadian rigs failed 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. The Canadian rig count peaked on January 16, 2015, at 440 rigs, fell to 72 rigs for the week ending May 22, 2015, and has improved to 135 rigs on June 26, 2015. However, Canadian rig activity is still lagging normal activity levels by more than 100 rigs.
During the three and six months ended June 30, 2015, total North American active drilling rig count significantly decreased when compared to the comparable periods of 2014, primarily in oil drilling rigs. Average North American oil drilling rig activity decreased by 55.9% and 41.8% for the three and six months ended June 30, 2015, respectively, when compared to the same periods of 2014.

21




North American natural gas drilling rig count decreased by 32.0% and 22.5% for the three and six months ended June 30, 2015, respectively, compared to the same periods of 2014.
Company Outlook
Beginning in the second half of 2014 and continuing through the first quarter of 2015, the price of crude oil declined dramatically followed by slight improvement in the second quarter of 2015. As a result, most North American exploration and production companies - many of which are Flotek clients - have significantly reduced their exploration and drilling activity in 2015. 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. 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, recently introduced Stemulator® product line and the growing line of production technologies. While international markets may react differently than North American markets to the decline in crude prices, the Company expects similar market challenges around the globe.
The Company’s continued emphasis on promotion of its CnF® chemistries produced significant results in the second quarter despite the continued decline in overall market activity levels. CnF® volumes increased 76% compared to the first quarter of 2015 and 34% compared to the second quarter of 2014. The Company expects CnF® volumes to continue to outpace the overall industry activity level due to the distinctive advantage demonstrated by the patent pending FracMax™ analytical platform which provides quantitative validation of the improved well economics achieved by utilizing CnF® as part of well completions.
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. Cost reductions to date include headcount reductions and hiring restrictions that have not impacted customer service or production output; vendor price reductions that have partially mitigated gross margin erosion; the consolidation of certain operating bases which reduced lease and other expenses; and other cost controls that have reduced overall operating costs of our business. Capital spending has largely been limited to completion of existing projects with a focus on revenue-generating expenditures. The Company regularly evaluates its cost structure based on market conditions with a focus on continuous efficiency improvements.  
Capital expenditures, exclusive of acquisitions, totaled $9.0 million and $9.2 million for the six months ended June 30, 2015 and 2014, respectively. Of the $9.0 million spent to date in 2015, 78% has been for the completion of projects started in 2014. The Company expects capital spending to be approximately $25 million in 2015, inclusive of approximately $10 million for construction of laboratory facilities, including the Company’s previously announced Global Research & Innovation Headquarters in Houston. The Company believes construction of this facility should generate substantial value in 2016 and beyond. The Company will remain nimble in its core capital expenditure plans, adjusting as market conditions warrant.
The Company’s planned Global Research & Innovation Headquarters in Houston will allow for the development of new energy chemistries as well as expand collaboration between clients, leaders from academia and Company scientists. The Company believes these collaborative opportunities will become an important and distinguishing capability within the industry. The Company also plans to continue to expand the capabilities and use of its patent pending FracMaxTM software which will continue to enhance the Company’s sales and marketing efforts by validating the production and economic benefits of the Company’s core Complex nano-Fluid® chemistries.
The patent pending FracMax™ analytical platform is an innovative software technology that allows the Company to quantitatively demonstrate the benefits associated with the use of the Company’s patented and proprietary Complex nano-Fluid® chemistries. The patent pending FracMax™ application has been integrated into the Company’s sales and marketing process leading to new sales opportunities. In October 2014, the Company announced the formation of FracMax Analytics, LLC, a wholly owned subsidiary that will use the patent pending FracMax™ analytical platform to provide customized data analysis to oil and gas operators, investors and other companies.
During the second quarter of 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. Additionally, the Company has shifted the focus of the Production Technologies segment towards oil production markets and away from the less opportunistic coal bed methane (“CBM”) markets.

22




The Company continues to pursue selected strategic relationships, both domestically and internationally, to expand its business:
In March 2015, the Company entered into agreements with Solazyme, Inc (“Solazyme”) to globally commercialize Flocapso™, an innovative, advanced drilling fluid additive that combines Flotek’s patented Complex nano-Fluid® chemistries with Solazyme’s proprietary EncapsoTM technology. FlocapsoTM will allow the use of water-based fluids in wells that previously required more expensive and invasive oil-based products, providing an environmentally superior, more efficient solution to drilling challenges. In addition, Flotek will market Solazyme’s Encapso™ lubricant - the first commercially available, biodegradable encapsulated lubricant for drilling fluids - in certain Middle Eastern markets.
In January 2015, the Company acquired 100% of the assets from International Artificial Lift, LLC (“IAL”), a development-stage company that 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.
The outlook for the Company’s consumer and industrial chemistries will be driven by the availability and demand for citrus oils and other bio-based raw materials. Current inventory and crop expectations are sufficient to meet the Company’s needs to supply its flavor and fragrance business as well as the industrial markets. However, market price volatility may result in revenue and margin fluctuations from quarter-to-quarter.
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 adequate liquidity to withstand the impact of such changes while continuing to make strategic capital investments and acquisitions if and when 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.
The Company expects that competition for contracts and margins will remain intense but that product innovation, service improvements and data from its patent pending FracMax™ analytical platform should enable the Company to realize relative market share gains during the remainder of 2015 and into 2016.

23




Consolidated Results of Operations (in thousands):
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
$
87,030

 
$
105,318

 
$
169,404

 
$
207,893

Cost of revenue
 
57,778

 
63,008

 
113,625

 
121,903

Gross margin
 
29,252

 
42,310

 
55,779

 
85,990

    Gross margin %
 
33.6
 %
 
40.2
%
 
32.9
 %
 
41.4
%
Selling, general and administrative costs
 
23,021

 
20,854

 
46,588

 
42,426

    Selling, general and administrative costs %
 
26.5
 %
 
19.8
%
 
27.5
 %
 
20.4
%
Depreciation and amortization
 
2,797

 
2,501

 
5,473

 
4,785

Research and innovation costs
 
1,670

 
1,280

 
3,242

 
2,306

Impairment of inventory and rental equipment
 
20,372

 

 
20,372

 

Income (loss) from operations
 
(18,608
)
 
17,675

 
(19,896
)
 
36,473

    Income (loss) from operations %
 
(21.4
)%
 
16.8
%
 
(11.7
)%
 
17.5
%
Interest and other expense, net
 
(422
)
 
(653
)
 
(1,055
)
 
(1,054
)
Income (loss) before income taxes
 
(19,030
)
 
17,022

 
(20,951
)
 
35,419

Income tax benefit (expense)
 
6,483

 
(5,981
)
 
6,889

 
(12,361
)
Net income (loss)
 
$
(12,547
)
 
$
11,041

 
$
(14,062
)
 
$
23,058

    Net income (loss) %
 
(14.4
)%
 
10.5
%
 
(8.3
)%
 
11.1
%

Consolidated Results of Operations: Three and Six Months Ended June 30, 2015, Compared to the Three and Six Months Ended June 30, 2014
Consolidated revenue for the three and six months ended June 30, 2015, decreased $18.3 million, or 17.4%, and $38.5 million, or 18.5%, respectively, relative to the comparable periods of 2014. The decrease in revenue was driven by the continued decline in drilling activity throughout the first half of 2015 as indicated by the 51.0% and 37.5% reduction in average North American rig count for the three and six months ended June 30, 2015, respectively, versus the same periods in 2014, which affected the Energy Chemistry Technologies and Drilling Technologies segments.
Consolidated gross margin for the three and six months ended June 30, 2015, decreased $13.1 million, or 30.9%, and $30.2 million, or 35.1%, respectively, relative to the comparable periods of 2014. Gross margin as a percentage of revenue decreased to 33.6% for the three months ended June 30, 2015, from 40.2% in the same period of 2014, and decreased to 32.9% for the six months ended June 30, 2015, from 41.4% in the same period of 2014. These reductions were primarily attributable to new incentive pricing structures for strategic relationships, product mix and price concessions.
Selling, general and administrative (“SG&A”) expenses are not directly attributable to products sold or services provided. SG&A costs increased $2.2 million, or 10.4%, and $4.2 million, or 9.8%, for the three and six months ended June 30, 2015, respectively, compared to the same periods of 2014. The increases were primarily due to higher stock compensation expense and professional fees, increased head count in the Energy Chemistry Technologies sales staff during late 2014 and the first half of 2015, and a civil penalty related to an environmental matter assessed in the first quarter of 2015, partially offset by cost reduction actions taken throughout the organization during the first half of 2015. The company regularly evaluates its SG&A cost structure as market conditions warrant.
Depreciation and amortization expense for the three and six months ended June 30, 2015, increased by $0.3 million, or 11.8%, and $0.7 million, or 14.4%, respectively, relative to the comparable periods of 2014. The increase was primarily attributable to the depreciation and amortization of improvements to facilities and equipment that were added during the later portion of 2014.
Research and Innovation (“R&I”) expense increased $0.4 million, or 30.5%, and $0.9 million, or 40.6%, for the three and six months ended June 30, 2015, respectively, as compared to the same periods in 2014. The increase in R&I is primarily attributable to new product development and Flotek’s commitment to remaining responsive to customer needs, increased demand and continued growth of our existing product lines.

24




During the second quarter of 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.  Additionally, the Company has shifted the focus of the Production Technologies segment towards oil production markets and away from the less opportunistic CBM markets. As a result of these changes in focus and projected declines in asset utilization, the Company recorded an impairment charge of $20.4 million in the second quarter of 2015.
Interest and other expense decreased $0.2 million for the three months ended June 30, 2015, but remained flat for the six months ended June 30, 2015, as compared to the same periods of 2014.
The Company recorded income tax benefits of $6.5 million and $6.9 million, yielding effective tax rates of 34.1% and 32.9% for the three and six months ended June 30, 2015, respectively, compared to income tax provisions of $6.0 million and $12.4 million reflecting effective tax rates of 35.1% and 34.9% for the comparable periods in 2014.
Results by Segment
Energy Chemistry Technologies
(previously referred to as Energy Chemical Technologies)
(dollars in thousands)
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
$
56,472

 
$
62,589

 
$
103,115

 
$
124,966

Gross margin
 
20,426

 
27,432

 
36,526

 
56,650

Gross margin %
 
36.2
%
 
43.8
%
 
35.4
%
 
45.3
%
Income from operations
 
11,892

 
19,162

 
18,713

 
40,785

Income from operations %
 
21.1
%
 
30.6
%
 
18.1
%
 
32.6
%
Energy Chemistry Technologies Results of Operations: Three and Six Months Ended June 30, 2015, Compared to the Three and Six Months Ended June 30, 2014
Energy Chemistry Technologies revenue for the three months ended June 30, 2015, decreased $6.1 million, or 9.8%, relative to the comparable period of 2014, compared to a 51.0% decline in market activity as measured by average North American rig count. Revenue for the six months ended June 30, 2015, decreased $21.9 million, or 17.5%, relative to the comparable period of 2014, compared to a 37.5% decline in market activity. The Energy Chemistry Technologies segment substantially outperformed market activity indicators due to substantial increases in CnF® sales volumes during the quarter. CnF® sales volumes increased 76% for the three months ended June 30, 2015 compared to the three months ended March 31, 2015, and increased 34% compared to the three months ended June 30, 2014. The increased sales of CnF® during the second quarter of 2015 were due to Flotek’s aggressive promotion of the benefits of CnF® in completions and re-stimulation efforts by leveraging the quantitative evidence provided through the patent pending FracMax™ analytical platform. These strategic sales and marketing efforts are ensuring that Flotek remains a leader in the energy chemistry industry and is poised to take even greater advantage of any market recovery.
Energy Chemistry Technologies gross margin decreased $7.0 million, or 25.5%, and $20.1 million, or 35.5%, for the three and six months ended June 30, 2015, respectively, compared to the same periods of 2014. Gross margin as a percentage of revenue decreased to 36.2% for the three months ended June 30, 2015, from 43.8% in the same period of 2014. Gross margin as a percentage of revenue decreased to 35.4% for the six months ended June 30, 2015, from 45.3% in the same period of 2014. The decline in gross margin as a percentage of revenue over the periods was primarily due to new incentive pricing structures associated with new strategic relationships and product mix.
Income from operations for the Energy Chemistry Technologies segment decreased $7.3 million, or 37.9%, for the three months ended June 30, 2015, and decreased $22.1 million, or 54.1%, for the six months ended June 30, 2015, relative to the comparable periods of 2014. The decrease in income from operations for both periods is primarily attributable to the decrease in gross margin and increased headcount during late 2014 and in the first half of 2015. Headcount has increased in the sales organization in pursuit of growth opportunities, and in R&I, related to new product development and increased demand for existing product support as the segment continues to refocus and reposition for growth in the market.

25




Consumer and Industrial Chemistry Technologies
(previously referred to as Consumer and Industrial Chemical Technologies)
(dollars in thousands)
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
$
15,477

 
$
12,607

 
$
28,940

 
$
25,638

Gross margin
 
4,126

 
2,893

 
7,833

 
6,927

Gross margin %
 
26.7
%
 
22.9
%
 
27.1
%
 
27.0
%
Income from operations
 
2,683

 
972

 
5,064

 
3,307

Income from operations %
 
17.3
%
 
7.7
%
 
17.5
%
 
12.9
%

CICT Results of Operations: Three and Six Months Ended June 30, 2015, Compared to the Three and Six Months Ended June 30, 2014
CICT revenue increased $2.9 million, or 22.8%, and $3.3 million, or 12.9%, for the three and six months ended June 30, 2015, respectively, versus the comparable periods of 2014, primarily due to increased flavor and fragrance and terpene sales.
CICT gross margin for the three and six months ended June 30, 2015, increased $1.2 million, or 42.6%, and $0.9 million, or 13.1%, from the comparable periods of 2014, primarily due to increased flavor and fragrance sales and terpene sales between the periods. Gross margin as a percentage of revenue increased to 26.7% for the three months ended June 30, 2015, from 22.9% in the same period of 2014, primarily due to increased sales of higher margin flavor and fragrance products. Gross margin as a percentage of revenue remained relatively consistent for the six months ended June 30, 2015, as compared to the same period of 2014.
Income from operations for the CICT segment increased $1.7 million, or 176.0%, for the three months ended June 30, 2015, and increased $1.8 million, or 53.1%, for the six months ended June 30, 2015, compared to the same periods of 2014. The increases in income from operations were primarily due to the revenue and gross margin factors described above and reductions in SG&A expenses resulting from cost control measures.
Drilling Technologies (dollars in thousands)
 
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue
 
$
12,334

 
$
27,241

 
$
31,028

 
$
52,142

Gross margin
 
4,103

 
10,762

 
10,094

 
20,550

Gross margin %
 
33.3
 %
 
39.5
%
 
32.5
 %
 
39.4
%
Income from operations
 
(21,300
)
 
4,200

 
(21,937
)
 
7,517

Income from operations - excluding impairment
 
(1,732
)
 
4,200

 
(2,369
)
 
7,517

Income from operations % - excluding impairment
 
(14.0
)%
 
15.4
%
 
(7.6
)%
 
14.4
%
Drilling Technologies Results of Operations: Three and Six Months Ended June 30, 2015, Compared to the Three and Six Months Ended June 30, 2014
Drilling Technologies revenue for the three months ended June 30, 2015, decreased $14.9 million, or 54.7%, relative to the same period in 2014, primarily due to decreased actuated tool rentals, Teledrift® tool rentals, and product sales. Revenue for the six months ended June 30, 2015, decreased $21.1 million, or 40.5%, relative to the same period in 2014, primarily due to a decrease in Teledrift® domestic rental revenue, decreased product sales, and decreased actuated tool rentals. The revenue declines were in line with the decrease in drilling rig activity for the three and six months ended June 30, 2015.

Rental revenue for the three months ended June 30, 2015, decreased $6.2 million, or 41.7%, compared to the same period of 2014. This decrease can be attributed to a sales volume decrease in actuated tool rental revenue, particularly in the competitive motor rental market, and decreased Teledrift® tool rental revenue domestically. Rental revenue for the six months ended June 30, 2015, decreased by $8.3 million, or 28.7%, compared to the same period of 2014. This decline in revenue is due to a decrease in Teledrift® domestic tool rentals, motor rentals and other tool rentals which can be

26




attributed to competitive pricing pressure and decreasing rig counts. This decrease is partially offset by an increase in Teledrift® international revenue.

Product sales revenue for the three months ended June 30, 2015, compared to the same periods of 2014 decreased by $6.1 million, or 69.0%, and also decreased for the six months ended June 30, 2015, by $8.9 million, or 53.6%. This is primarily due to decreased float, centralizer and motor equipment sales in domestic locations.

Service revenue for the three and six months ended June 30, 2015, decreased $2.5 million, or 75.0%, and $4.0 million, or 58.8%, respectively, relative to comparable periods of 2014. This was primarily related to a decline in Teledrift® domestic service revenue as the volume of jobs and service pricing both declined in 2015.

Drilling Technologies gross margin for the three months ended June 30, 2015, decreased $6.7 million, or 61.9%, and decreased $10.5 million, or 50.9%, for the six months ended June 30, 2015, from the comparable periods of 2014, primarily due to the lower sales volumes in 2015 mentioned above and increased pricing pressure for product and rental sales. Direct costs decreased by 30.0% and 24.2% for the three and six months ended June 30, 2015, respectively, due to decreased employee related costs, materials and supplies, and freight costs.

During the second quarter of 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. As a result, an impairment charge of $19.6 million was recorded to reflect the reduced value of inventory and rental equipment associated with product lines and markets the Company plans to exit or de-emphasize in the future.

Income from operations for the three months and six months ended June 30, 2015, respectively, decreased by $25.5 million and $29.5 million primarily resulting from the impairment charge. Income from operations excluding the impairment charge for the three months ended June 30, 2015, decreased by $5.9 million, or 141.2%, compared to the same period of 2014. Drilling Technologies income from operations excluding the impairment charge for the six months ended June 30, 2015, decreased by $9.9 million, or 131.5%, over the same period of 2014. The decreases in income from operations for the three and six month periods ending June 30, 2015, were primarily due to reductions in revenue and pricing pressure that resulted in customer price reductions, partially offset by reductions in direct and indirect costs resulting primarily from head count reductions and other cost reduction measures.
Production Technologies (dollars in thousands)
 
 
 
 
 
 
 
 
 
 
Three months ended June 30,