Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations.
This Quarterly Report on Form 10-Q (this
“Form 10-Q”) is prepared by Coil Tubing Technology, Inc. Unless otherwise indicated or the context otherwise requires,
in this Form 10-Q all references to “Coil Tubing Technology, Inc.” the “Company,” “we,” “our”
and “us” refer to Coil Tubing Technology, Inc. and its subsidiaries on a consolidated basis.
The following discussion and analysis of
our results of operations and financial condition should be read in conjunction with our audited consolidated financial statements
as of December 31, 2012 and 2011, and for the years then ended, included in our Annual Report on Form 10-K for the year ended
December 31, 2012, filed with the Securities and Exchange Commission on March 22, 2013 (the “Form 10-K”) and with
the unaudited condensed consolidated financial statements and related notes thereto presented in this Form 10-Q.
Disclosure Regarding Forward-Looking Statements
Our disclosure and analysis in this Form
10-Q may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended,
or the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Private
Securities Litigation Reform Act of 1995, that are subject to risks and uncertainties. Forward-looking statements give our current
expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance
and business. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These
statements may include words such as “anticipate,” “estimate,” “expect,” “project,”
“intend,” “plan,” “believe” and other words and terms of similar meaning in connection with
any discussion of the timing or nature of future operating or financial performance or other events. All statements other than
statements of historical facts included in this Form 10-Q that address activities, events or developments that we expect, believe
or anticipate will or may occur in the future are forward-looking statements.
These forward-looking statements are largely
based on our expectations and beliefs concerning future events, which reflect estimates and assumptions made by our management.
These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors relating
to our operations and business environment, all of which are difficult to predict and many of which are beyond our control.
Although we believe our estimates and assumptions
to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In
addition, management’s assumptions about future events may prove to be inaccurate. Management cautions all readers that the
forward-looking statements contained in this Form 10-Q are not guarantees of future performance, and we cannot assure any reader
that those statements will be realized or the forward-looking events and circumstances will occur. Actual results may differ materially
from those anticipated or implied in the forward-looking statements due to the factors listed under “Item 1A. Risk Factors”
in our Form 10-K and this “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
section, or MD&A. All forward-looking statements speak only as of the date of this Form 10-Q. We do not intend to publicly
update or revise any forward-looking statements as a result of new information, future events or otherwise, except as required
by law. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.
Our Markets and Business Strategy
Our primary markets for our coil tubing
products are oil and gas companies engaged in horizontal drilling activities located in the United States and Canada. We rent our
products to these oil and gas companies either directly or indirectly through oil service companies. Our revenues are generated
by drilling and well services activities, and therefore, cold weather and holidays and employee vacations during our first and
fourth quarters exert downward pressure on revenues for those quarters, which is usually partially offset by the year-end efforts
on the part of many customers to spend any remaining funds budgeted for services and capital expenditures. During the first quarter
of 2013 oil and gas service companies, which are our clients, have reduced their drilling and work-over operations which in turn
have decreased their demand for, and their use of, our rental tools. Our revenues for the first quarter of 2013 are approximately
$1,804,000 compared to $2,265,000 in the first quarter of 2012, a decrease of $461,000. We expect our revenues to continue to follow
the trends in drilling activities for the second quarter of 2013.
Based on the current trends in drilling
activities we intend to implement the following strategies:
|
—
|
Build profitable sales of existing proprietary products;
|
|
—
|
Accelerate development of new proprietary products for the oil and gas industry;
|
|
—
|
Accelerate growth of new distribution stockpoints worldwide;
|
|
—
|
Expand into other areas of drilling such as conventional drilling tools; and
|
|
—
|
Partner or acquire other coil tubing companies to expand our product sales and service.
|
We believe increasing the availability
of our proprietary product lines to our customers is critical to our profitability. Therefore, we will focus on initiatives to
drive quarter over quarter sales growth for our existing products emphasizing:
|
—
|
Enhanced customer focus through a concerted sales and marketing effort in the following quarters;
|
|
—
|
Increased investment in product lines; and
|
|
—
|
Accelerated growth of new product lines.
|
During the 1
st
quarter of 2013
we became a fully-reporting public company. Our common stock is now quoted on the OTCQB market under the symbol “CTGB”.
We intend to seek funding through public or other equity based offerings to support future acquisition and growth plans.
Critical Accounting Policies
Revenue Recognition.
The Company's
revenue is generated primarily from the rental and sales of its tools used for oilfield services primarily in Texas, Louisiana
and Pennsylvania in the U.S. and in Alberta, Canada. Rental income is recognized over the rental periods, which are generally from
one to thirty days. The estimated amounts of sales discounts, returns and allowances are accounted for as reductions of sales when
the sale occurs and the realization of collectability is reasonably assured. These estimates are based on historical amounts and
adjusted periodically based on changes in facts and circumstances when the changes become known to the Company. The Company also
recognizes rental revenue for the full sales price of any tools which are lost and/or damaged in use (and billed to the customer)
and recognizes the net carrying cost of such tool (“
manufacturers cost
” less depreciation) as cost of product
of rental revenue.
Sales of coil tubing related products are
primarily derived from instances where a customer has a specific need for a particular coil tubing related product and desires
to have the Company obtain and/or manufacture the particular product. These sales may include replacement parts, as well as proprietary
tools which are manufactured to the customer’s specification, but which are not part of the Company’s tool line. The
Company generally recognizes product revenue at the time the product is shipped. Concurrent with the recognition of revenue, the
Company provides for the estimated cost of product returns. Sales incentives are generally classified as a reduction of revenue
and are recognized at the later of when revenue is recognized or when the incentive is offered. Shipping and handling costs are
included in cost of goods sold.
Rental Tool Assets.
Approximately
98% of the Company’s revenues are generated from the rental of its coil tubing products. Rental tools are recorded on the
Company’s books as rental equipment at “
manufacturers cost.
” Depreciation is calculated using the straight
line method over the useful lives of the assets of five years. Lost or destroyed tools are not a significant source of rental tools
revenue for the Company. The Company bills customers for the sales price of any tools which are lost and/or damaged in use and
the cost and related accumulated depreciation are removed from the accounts and any resulting revenue or expense is recognized.
Lost tools are recognized as product rental revenue and cost of products of rental revenue, respectively.
Intangible Assets.
The Company’s
intangible assets, which are recorded at cost, consist primarily of the unamortized cost basis of issued and pending patents. These
assets are being amortized on a straight line basis over the estimated useful lives of 15 years. The Company continually evaluates
the amortization period and carrying basis of intangible assets to determine whether subsequent events and circumstances warrant
a revised estimated useful life or impairment in value. To date, no such impairment has occurred. To the extent such events or
circumstances occur that could affect the recoverability of our Intangible assets, we may incur charges for impairment in the future.
Stock-Based Compensation.
The Company accounts for stock-based employee compensation arrangements using the fair value method that requires that the
fair value of employees awards issued, modified, repurchased or cancelled after implementation, under share-based payment arrangements,
be measured as of the date the award is issued, modified, repurchased or cancelled. The resulting cost is then recognized in the
statement of earnings over the service period.
The Company periodically issues common
stock for services rendered and may issue common stock for acquisitions in the future. Common stock issued is valued at fair market
value. Management and the board of directors consider market price quotations, recent stock offering prices and other factors in
determining fair market value for purposes of valuing the common stock. The fair value of each option granted is estimated on the
date of grant using the Black-Scholes option-pricing model with the various weighted average assumptions, including dividend yield,
expected volatility, average risk-free interest rate and expected lives.
Income Taxes.
The Company
uses the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined
based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted
tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation
allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in the consolidated statements of operations in the period that includes the enactment date.
Comparison of Results of Operations
Three Months Ended March 31, 2013,
Compared To Three Months Ended March 31, 2012
The following tables set forth summarized
consolidated financial information for the three months ended March 31, 2013 and 2012:
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2013
|
|
|
2012
|
|
|
$ Change
|
|
|
% Change
|
|
Total sales
|
|
$
|
1,804
|
|
|
$
|
2,265
|
|
|
$
|
(461
|
)
|
|
|
20%
|
|
Cost of goods sold
|
|
|
854
|
|
|
|
876
|
|
|
|
(22
|
)
|
|
|
3%
|
|
Gross profit
|
|
|
950
|
|
|
|
1,389
|
|
|
|
(439
|
)
|
|
|
32%
|
|
Gross profit as a percent of total sales
|
|
|
53%
|
|
|
|
61%
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
1,019
|
|
|
|
962
|
|
|
|
57
|
|
|
|
6%
|
|
Income (loss) from operations
|
|
|
(69
|
)
|
|
|
427
|
|
|
|
(496
|
)
|
|
|
116%
|
|
Other income (expense)
|
|
|
3
|
|
|
|
(4
|
)
|
|
|
7
|
|
|
|
175%
|
|
Net income (loss)
|
|
$
|
(66
|
)
|
|
$
|
423
|
|
|
$
|
(489
|
)
|
|
|
116%
|
|
For the three months ended March 31, 2013,
the Company's business operations reflected a decrease in sales for Coiled Tubing Technology, Inc. and subsidiaries (“CTT”).
For the three months ended March 31, 2013, the Company's consolidated operations generated revenues of approximately $1,804,000
compared to prior-year revenues of $2,265,000 for the quarter ended March 31, 2012. The $461,000 decrease in net sales is primarily
attributable to a decline in rental orders for coil tubing products. This decline is a result of our customers postponing drilling
operations until later in the 2013 budget year. We expect to increase our revenues to reflect the current trends in the drilling
industry based on sales information provided by our largest customers. For the three months ended March 31, 2013, the Company had
a gross profit margin of 53%, compared to a gross profit margin 61% for three months ended March 31, 2012. The $439,000 decrease
in gross profit for the three months ended March 31, 2013, compared to the prior period, is primarily attributed to the slowdown
in orders for our rental products by our largest customers.
Revenue Information
The following tables set forth summarized
consolidated sales information for the three months ended March 31, 2013 and 2012:
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2013
|
|
|
2012
|
|
|
$ Change
|
|
|
% Change
|
|
Rentals
|
|
$
|
1,760
|
|
|
$
|
2,215
|
|
|
$
|
(455
|
)
|
|
|
21%
|
|
Products
|
|
|
44
|
|
|
|
50
|
|
|
|
(6
|
)
|
|
|
12%
|
|
Total revenue
|
|
$
|
1,804
|
|
|
$
|
2,265
|
|
|
$
|
(461
|
)
|
|
|
20%
|
|
We had total revenues of approximately
$1,804,000 for the three months ended March 31, 2013, compared to total revenues of $2,265,000 for the three months ended March
31, 2012, a decrease in total revenues of $461,000 or 20% from the prior period. Total revenues included $1,760,000
of rental revenue for the three months ended March 31, 2013, compared to $2,215,000 for the three months ended March 31, 2012,
a decrease in rental revenue of $455,000 or 21% from the prior period. The decrease in rental revenue was mainly due to a decrease
in customer demand. We anticipate that the demand for our rental tools will be less for the next quarter based on current
oil and gas drilling data in our service areas and an increase in competitive pricing to maintain our market share.
Cost of Revenue
The following table sets forth summarized
cost of revenue information for the three months ended March 31, 2013 and 2012:
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2013
|
|
|
2012
|
|
|
$ Change
|
|
|
% Change
|
|
Depreciation of rental tools
|
|
$
|
268
|
|
|
$
|
224
|
|
|
$
|
44
|
|
|
|
20%
|
|
Facilities and support expenses
|
|
|
61
|
|
|
|
98
|
|
|
|
(37
|
)
|
|
|
38%
|
|
Compensation and benefits
|
|
|
234
|
|
|
|
254
|
|
|
|
(20
|
)
|
|
|
8%
|
|
Material, supplies and support service
|
|
|
291
|
|
|
|
300
|
|
|
|
(9
|
)
|
|
|
3%
|
|
Total cost of revenue
|
|
$
|
854
|
|
|
$
|
876
|
|
|
$
|
(22
|
)
|
|
|
3%
|
|
Cost of revenue includes costs associated
with products and rental sales and depreciation of capitalized rental tool assets that are rented to oil field service companies.
We had cost of products and rental revenue of approximately $854,000 for the three months ended March 31, 2013, compared to a cost
of $876,000 for the three months ended March 31, 2012, a decrease of $22,000 or 3% from the prior period. This decrease is mainly
attributable to lower overtime and reduced travel and related expenses.
Gross Profit
We had gross profit of $950,000
for the three months ended March 31, 2013, compared to gross profit of $1,389,000 for the three months ended March 31, 2012, a
decrease in gross profit of $439,000 or 32% from the prior period. Our gross profit was 53% of revenue for the three months ended
March 31, 2013, compared to 61% for the three months ended March 31, 2012.
Operating Expenses
General and Administrative
The following table sets forth summarized
operating expense information for the three months ended March 31, 2013 and 2012:
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2013
|
|
|
2013
|
|
|
$ Change
|
|
|
% Change
|
|
Depreciation and amortization
|
|
$
|
67
|
|
|
$
|
58
|
|
|
$
|
9
|
|
|
|
16%
|
|
Compensation and benefits
|
|
|
268
|
|
|
|
136
|
|
|
|
132
|
|
|
|
97%
|
|
General and administrative- Professional
services
|
|
|
157
|
|
|
|
173
|
|
|
|
(16
|
)
|
|
|
9%
|
|
General and administrative
expenses- Other
|
|
|
72
|
|
|
|
76
|
|
|
|
(4
|
)
|
|
|
5%
|
|
Total general operating expenses
|
|
$
|
564
|
|
|
$
|
443
|
|
|
$
|
121
|
|
|
|
27%
|
|
We had total general and administrative
expenses of $564,000 for the three months ended March 31, 2013, compared to total general and administrative expenses
of $443,000 for the three months ended March 31, 2012, an increase in general and administrative expenses of $121,000 or 27% from
the prior period. The increase in general and administrative expenses was primarily due to the increase in compensation expense
of $113,000 for the extending the life of the stock options for key management personnel.
Selling and Marketing
The following table sets forth summarized
selling and marketing expense information for the three months ended March 31, 2013 and 2012:
|
|
Three Months Ended March 31,
|
|
(in thousands)
|
|
2013
|
|
|
2012
|
|
|
$ Change
|
|
|
% Change
|
|
Auto
|
|
$
|
79
|
|
|
$
|
76
|
|
|
$
|
3
|
|
|
|
4%
|
|
Commissions
|
|
|
191
|
|
|
|
232
|
|
|
|
(41
|
)
|
|
|
18%
|
|
Compensation and benefits
|
|
|
110
|
|
|
|
145
|
|
|
|
(35
|
)
|
|
|
24%
|
|
Other selling and marketing
|
|
|
93
|
|
|
|
66
|
|
|
|
27
|
|
|
|
41%
|
|
Total selling and marketing expenses
|
|
$
|
473
|
|
|
$
|
519
|
|
|
$
|
(46
|
)
|
|
|
9%
|
|
We had total selling and marketing expenses
of $473,000 for the
three months ended March 31, 2013
, compared to $519,000 for
the
three months ended March 31, 2012
, a decrease of $46,000 or 9% from the prior period, which
decrease was mainly due to decreases in sales commissions, automobile expenses and travel.
Depreciation and Amortization
Total depreciation and amortization expense
increased by $53,000 or 19%, to $335,000 for the
three months ended March 31, 2013
,
compared to $282,000 for the
three months ended March 31, 2012
. The increase was
primarily due to the addition of shop equipment and automobiles.
Income (Loss) from Operations
We had a loss from operations of $69,000 for the
three months ended March 31, 2013
, compared to income of $427,000 for the
three
months ended March 31, 2012
, a decrease of $496,000 or 116% from the prior period.
Net Income (Loss)
We had a net loss of $66,000 for the
three
months ended March 31, 2013
, compared to net income of $423,000 for the
three months ended
March 31, 2012
, a decrease in net income of $489,000 or 116% from the prior period. The decrease in
net income was attributable to a decrease in total revenue and an increase in certain operating expenses, principally a
$114,000 increase in stock option expense, for the
three months ended March 31, 2013
,
compared to the
three months ended March 31, 2012
.
Liquidity and Capital Resources
We had $2,545,000 of working
capital as of March 31, 2013. We believe we are sufficiently capitalized to continue our growth and are in a position to develop
financing alternatives that will enable us to take advantage of growth opportunities in the future.
As of March 31, 2013, we had total assets
of $8,454,000, which included total current assets of $3,365,000, consisting of $1,142,000 of cash, $2,157,000 of
accounts receivable, net, and $66,000 of other current assets; and long term assets including $3,541,000 of rental tools, net;
$535,000 of property and equipment, net; and $1,013,000 of intangible assets, net, consisting of our rights to the patents purchased
from Jerry Swinford pursuant to the IP Agreement described in greater detail in Note 4 to the unaudited consolidated financial
statements included herein.
We had total liabilities of $1,202,000 as of March 31, 2013, which included total current liabilities of $820,000, consisting of accounts payable of $485,000;
accrued liabilities of $128,000; current portion of related party notes payable of $156,000 relating to amounts owed to Jerry Swinford
in connection with the IP Purchase Agreement, and current portion of notes payable of $51,000, relating to the amount due on loans
associated with equipment financing; and long term liabilities consisting of $207,000 of related party notes payable relating to
amounts owed to Jerry Swinford in connection with the IP Purchase Agreement, and $175,000 of notes payable, net of current portion
relating to equipment financing.
We had net cash provided by operating activities
of $101,000 for the
three months ended March 31, 2013
, which consisted of non-cash
items including $335,000 of depreciation and amortization, $114,000 of stock based compensation, and ($18,000) gain on sale of equipment;
offset by $66,000 of net loss, $388,000 of increase in accounts receivable, $9,000 of increase in other current assets, $78,000
of increase in accounts payable and $55,000 of increase in accrued liabilities.
We had $94,000 of net cash used in investing
activities for the
three months ended March 31, 2013
, which included the purchase of $102,000
of rental tools and $50,000 of property and equipment; offset by $58,000 in proceeds from the sale of lost tools. Our principal
recurring investing activity was the funding of capital expenditures to ensure that we have the appropriate levels and types of
equipment in place to generate revenue from operations.
We had $18,000 of net cash used in financing
activities for the
three months ended March 31, 2013
, which included $21,000 of proceeds from
notes payable offset by $39,000 of payments on related party notes payable.
The Company has historically been funded
through loans provided by, and through the sale of common stock and warrants to, the Company’s largest shareholder and former
director, Herbert C. Pohlmann, provided that Mr. Pohlmann is not required to provide us any additional funding and/or to purchase
any securities from us in the future.
Our immediate plans are to continue our
growth by meeting expected demand for our rental tool products in our current geographic markets and further expanding into international
markets similar to what we accomplished in Canada during 2012. We anticipate entering markets in Mexico, the Middle East and Southeast
Asia in 2013 and 2014. We plan to supplement our cash flow with typical bank debt or similar financing which will enable us to
meet larger demand on bigger projects, enter new markets and improve our network for servicing our customers.
Moving forward, we anticipate increased
spending on research and development activities, which we believe will be required to provide technological advancement to our
coiled tubing technologies and workover product lines. We are currently working on a new generation of coil tubing tools to aid
in and facilitate horizontal drilling. We expect the market for new applications of coiled tubing to continue to expand our operations
throughout fiscal 2013 and 2014, especially in the horizontal drilling and workover applications.
In addition to debt financing and our organic
growth as discussed above, we may raise funds for further expansion of our tool fleet, development of new tools or to make strategic
acquisitions through the sale or exchange of equity securities. Our common stock is now quoted on the OTCQB market, provided that
we may choose to list our common stock on the NYSE MKT or NASDAQ Capital Market in the future. As a result of becoming a fully-reporting
public company, we believe investors may be more willing to purchase our common stock in private offerings allowing us to raise
funding to use for the items described above. The sale of additional equity or debt securities, if accomplished, may result in
dilution to our shareholders.
Off Balance Sheet Arrangements:
None.