Flotek Industries, Inc. (NYSE:FTK) Q4 2022 Earnings Call Transcript

Flotek Industries, Inc. (NYSE:FTK) Q4 2022 Earnings Call Transcript March 21, 2023

Operator: Good morning, and welcome to the Flotek Industries Fourth Quarter and Full-Year 2022 Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Bernie Colson, Senior Vice President of Corporate Development & Sustainability. Please go ahead.

Bernie Colson: Thank you, and good morning, everyone. We appreciate your participation. Joining me today and participating in the call are Harsha V. Agadi, Interim Chief Executive Officer; Ryan Ezell, President; and Bond Clement, Chief Financial Officer. On today’s call, we will first provide prepared remarks concerning our business and results for the quarter and the full-year. Following that, we will answer any questions you have. We have now released our earnings announcement for the full-year and fourth quarter of 2022, which is available on our website. In addition, today’s call is being webcast and a replay will be available on our website shortly following the conclusion of this call. Please note that comments we make on today’s call regarding projections or our expectations for future events are forward-looking statements.

Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. Also, please refer to the reconciliations provided in our earnings press release as management may discuss non-GAAP metrics on this call. I will now turn it over to Harsha.

Harsha Agadi: Good morning, everyone. Thank you for joining the discussion of our fourth quarter and full-year 2022 financial results. This is my first conference call as Interim CEO, and I’m happy to be here today. I have been a member of the Board of Directors since August 2020 and have never been more encouraged about the present and future outlook of Flotek. Flotek has taken decisive steps to position the company for future growth and profitability with a new Senior Management team in place. As you may recall, Bond Clement was appointed Chief Financial Officer in December of 2022. In January, I was appointed as Interim CEO, we promoted Ryan Ezell to President and David Nierenberg assumed the role of Chairman of the Board.

We believe we have the right management team and Board of Directors to guide Flotek to enhance revenue and profitability. This is my 62nd day since the changes and I’m learning every single day how we can grow this company. What I know so far is that the Flotek team is world-class and has overseen top line growth. Going forward, we have made profitability enhancement the absolute cornerstone of our strategy. Fourth quarter 2022 revenue grew 4 times over the fourth quarter of 2021, this was accomplished while maintaining extremely high service quality, customer satisfaction, and industry leading safety. The effort has been nothing short of herculean. And I would like to congratulate and thank all of our employees, suppliers and customers for the role in our 2022 growth story.

That being said, I’m even more excited about the future runway for our company. I am confident that we will continue to drive peer leading revenue and market share growth and we are approaching an inflection point where the company will shift to generating positive adjusted EBITDA through various cost reduction initiatives that are now in place. Our economies of scale in purchasing raw materials, improved efficiency in freight costs, and introducing just in time labor scheduling will make a significant difference in gross margins over time. Ryan will quantify those later. In addition, reductions in SG&A combined with top line growth will drive us toward positive cash generation. Bond will quantify SG&A savings. All these initiatives are now in place.

It gives me great comfort and pleasure to have a seasoned and experienced oilfield services executive like Dr. Ryan Ezell to lead our company operations towards sustainable top line and bottom line growth. (ph) team have done a tremendous job executing a strategy that has resulted in transformational growth in our chemistry and data analytics business. I do want to state that as the Interim CEO there are significant growing pains as businesses scale up in working capital, gross margins and limited financial staff to execute perfectly. As the new senior team, we recognize the growing pains are investing and investing in resources to correct it. I’m highly confident that revenues in 2023 will be up at least 50% over 2022. Our continued scaling of revenues, increased gross margins combined with tight assisted control on SG&A will lead us to sustainable positive adjusted EBITDA.

The Board, Senior Management, most importantly, all employees are very excited with this positive outlook on our business. In conclusion, as the Interim CEO, when I assume this position in January, I knew I had a learning curve to better understand the culture of the company, the sector and its employees. The people of this company are very impressive and dedicated. There is work to be done on all fronts and we are addressing it confidently. With that, I ask our President, Dr. Ryan Ezell, to discuss our operational results for 2022. Ryan?

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Ryan Ezell: Thank you, Harsha, and good morning. This quarter represents another progressive step for Flotek as revenue growth in both chemistry and data analytics segments continue to expand, further solidifying that our strategy to be the collaborative partner of choice for sustainable optimized chemistry and data solutions is working. Let’s get right to the fourth quarter operational highlights. Total company revenue increased 300% year-over-year and 6% sequentially equating to our highest quarterly company revenues in over four years. Flotek market share of active U.S. frac fleet served grew to 10.8% at the end of Q4, which marks a 28% increase sequentially and an over 10 times increase year-over-year. We added the full chemistry servicing of five additional ProFrac fleets in Q4, which is a 31% improvement sequentially.

This brings our total to 21 fleets as we continue to ramp to our contractual target of over 30 fleets. Our transactional chemistry technologies revenue growth outpaced the hydraulic fracturing fleet market growth for the sixth straight quarter further indicating that we are gaining market share with our customized chemistry solutions. Our data analytics segment revenue grew 245% versus the prior year and 20% sequentially. Our focus on core applications continues to gain traction coupled with the momentum gained from the successful monitoring of field gas quality by our Verax analyzers. Our industry research shows that maximizing the use of field gas can result in reduction of diesel fuel consumption and the result of greenhouse emissions by over 50%.

Most importantly, the growth milestones presented above were achieved with zero recordable and lost time incidences in the field of operations. I’m pleased with the solid performance Flotek delivered in the fourth quarter of this year and I want to thank all Flotek employees for their hard work and contribution to these outstanding results and the dedication to collaboration, safety and service quality. Now transitioning into a few of the key details for the quarter, I’d like to discuss the status of our mutually beneficial partnership with ProFrac. As a reminder, our contract with ProFrac was effective as of April 1, 2022 and expands 10-years and covers an equivalent volume of our full suite of downhole chemistries to serve 30 of their hydraulic fracturing fleets or 70% of their total fracturing fleets, whichever is greater.

We achieved 21 fleets in December and we remain confident that we will achieve the full contract scope over the coming quarters. In the spirit of our long-term partnership with ProFrac, we executed amendment to the current scope by extending the ramp period by one quarter for ProFrac, while allowing Flotek to receive compensation for billed services for the entire life of the contract. Thus collaboration is further evidence that the mutually beneficial contract and nature of the agreement coupled with Flotek’s focus on service quality and innovative solutions will enhance shareholder value creation for years to come. As we’ve been saying, this agreement is proven to be transformational for Flotek and the industry. As a result of this agreement, E&Ps now have a comprehensive, vertically integrated completion solution that reduces emissions and delivers greener chemistries, thereby protecting air, water, land and people.

Over the next decade, we anticipate the agreement should create a backlog of more than $2 million in revenue for Flotek, including anticipated revenues in excess of $200 million in 2023 for the ProFrac contract alone. And this number does not include any of the impact from ProFrac’s recent acquisitions. I’ll also continue to stress that the contract is not exclusive. Allowing us to add new customers and continue to grow sales volumes to the rest of our energy chemistry customers, which we successfully done for six consecutive quarters. We are laser focused on growing this higher margin, higher value add portion of our business and we continue to make steady progress in growing this market share and outpacing industry activity levels. In the spirit of reducing costs and improving margins, we’ve executed the following actions as part of our multidisciplinary approach to sustainable margin enhancement.

First, we reduced headcount by additional 12% since the end of Q3 2022, while continuing to grow our revenue and market share. We’ve realigned our manufacturing staff, field personnel and 24-hour logistics covers to systematically reduce overtime hours by almost 40%. Our plant utilization is up 50% year-on-year, driving our manufacturing cost per pound of production down 37%. As of February, we have our in-basin support facilities up and running in all major basins, which will drive improvements in freight and material handling for all areas of operation. We also terminated the majority of our dedicated trucking contracts as they were underutilized and we have now transferred to a digitized trucking dispatch and route optimization system. We expect a net improvement of over 20% in logistics.

We continue to leverage our growing economies of scale to re-tender and drive overall materials cost improvements. Additionally, we’re currently undergoing a continuous improvement exercise of our entire chemicals portfolio validating our sourcing strategies and identifying vertical integration possibilities to improve capital management. We’ve also executed a supply agreement in our data analytics segment that will not only improve our manufacturing costs, but it will also generate security supply for our proprietary JP3 sensors for real time monitoring of hydrocarbons. And finally, we’ve outlined an exit plan from our current corporate office footprint in Houston to a more fit for purpose facility that will take place in the second-half of 2023.

In total, these actions are expected to deliver approximately $18 million in cost reductions. And despite seasonal disruption in December, as extended in the start of Q1 of 2023, we continue to believe that the underlying market fundamentals stay strong as the supply of hydrocarbons remains tight to under — due to under investment in infrastructure and new sources of oil and gas production. Additionally, E&Ps have remained focused on capital discipline, despite healthy oil prices and increased demand projections in 2023. The industry’s demand for services, returns focus and capital discipline plays well to our strategy of being the collaborative partner of choice to producers as our solution solve for maximizing total well production, while reducing the overall carbon footprint and not simply just minimizing costs.

Our producer customers report achieving better well performance with Flotek, chemistry and data analytics when all else being equal. I continue to be optimistic about the future and I’m excited about our mission to provide differentiated solutions that maximize value to our customers. Simply speaking, we’re focused on protecting water quality, minimizing formation damage and improving the estimated ultimate recovery of every completion, while maintaining our commitment to corporate responsibility, market share growth and SG&A discipline. Now, I’ll turn the call over to Bond to provide key financial highlights.

Bond Clement: Thanks, Ryan. Good morning, everyone, it’s great to be with you from our first conference call at Flotek. It’s really exciting to be part of a company that is essentially no leverage, a backlog of revenue roughly 20 times the current market cap and an outstanding team of professionals with deep expertise in logistics, supply chain management, data analytics and of course chemistry. I echo Ryan’s comments on the fourth quarter achievements and I’m very excited about the direction we’re now heading. As it relates to getting to positive adjusted EBITDA, I want to focus my comments this morning on SG&A and professional fee cost reductions. Ryan and his team have made great progress moving us toward profitability at the gross margin level and concurrent with this work will focus on attacking the SG&A of this company to ensure that we achieve bottom line profitability this year.

You may have noticed we included a new metric in the press release called adjusted gross profit. Non-cash amortization of our contract asset reduces both revenue and gross profit. We believe the new metric provides a more accurate representation of the performance of the business. While reported gross margin for the quarter was negative $2.1 million on a cash basis, we were 75% better than that at negative $500,000. Certainly more work to do, but we are getting close. Fourth quarter adjusted EBITDA improved 40% sequentially as we continue to march toward turning that metric positive during 2023. This marked the sixth consecutive quarter of improvement in adjusted EBITDA as a percentage of revenue. Again, more work to do, but we’re moving in the right direction.

SG&A during the fourth quarter also showed improvement as it declined 36% sequentially. It’s worth highlighting that third quarter 2022 SG&A included about $900,000 in non-recurring professional fees, roughly half of which were related to evaluating an ABL structure that the company ultimately decided not to pursue. Third quarter 2022 SG&A also included a $1.9 million accrual related to potential year-end performance bonuses. To add a component of protection to our resources, we decided to reduce and restructure this bonus to focus on retaining key employees that are necessary to create shareholder value and achieve profitability. As a result, we reversed the $1.9 million performance bonus accrual during the fourth quarter. During March, we plan to pay $1.2 million of retention bonuses with the condition that recipients are required to remain with a company through the end of 2023 or be subject to a prorated clawback.

As a result of this service condition the $1.2 million will be expensed evenly throughout the final three quarters of 2023. We believe having a more narrowly focused retention bonus is far better for shareholders than an organizationally broad performance bonus with no clawback protections. As it relates to the annual increase in SG&A in 2021, versus 2021, keep in mind, last year’s number included a $2.9 million credit for a COVID-related ERC payroll credit. So to bridge the 2022 full-year SG&A increase versus 2021, we had the payroll tax credit in €˜21 plus $3 million in non-recurring fees in 2022 directly related to the ProFrac agreement, which I’ll discuss further in a moment. The combination of just these two items accounts for nearly $6 million of the SG&A variance between €˜22 and ’21.

As it relates to €˜23 SG&A, since the third quarter, we’ve executed on headcount reductions as Ryan mentioned, dropping full time employees by 12%. These headcount reductions include numerous management level positions. In connection with these staffing reductions, we expect to expense approximately $2.9 million in separation costs during the first quarter of 2023. This amount includes $1.5 million related to the former CEO that was previously disclosed, the bulk of the remaining $1.4 million of non-CEO related separation cost will be paid evenly over the next 12-months as stipulated in the governing agreements. Excluding separation costs, annual salary and benefits savings from headcount reductions are expected to total approximately $5 million.

In addition to reevaluating corporate staffing, we are aggressively pursuing ways to reduce professional fees that have historically been too high at this company. As mentioned earlier, during 2022, there were nearly $3 million professional fees, primarily banking, legal and accounting directly associated with the ProFrac supply agreement that will not be duplicated this year. While expensive on an absolute basis when you consider the cost in light of securing a $2 billion contract, those transactions fees equate to only about 15 basis points before discounting the contract value. The elimination of just the non-recurring ProFrac contract costs represents a roughly 30% reduction in 2022 professional fees. In terms of professional fees moving forward, we have implemented enhanced monitoring and approval processes to ensure that future engagements of any professionals require executive level approval.

Finally, we are working to reduce our wedge of consultant costs by bringing certain full time roles in-house and realizing overhead savings. By the fourth quarter of this year, we expect SG&A including professional fees to be less than 10% of revenues. While that level is generally accepted on a relative basis, we endeavor to continue looking for ways to reduce the absolute dollars of SG&A. Quickly moving to the balance sheet. As noted during the quarter, we closed on the sale of our Monahans, Texas facility, resulting in net proceeds of $1.5 million. We continue to execute well during the quarter in terms of converting orders to cash. Our cash balance at year-end increased to about $12.3 million versus cash at the end of the third quarter of $8.5 million.

Cash balances of course will fluctuate with the ebbs and flows of working capital. As activity and related revenues increase with additional fleets added to our chemistry delivery, we will continue to focus on managing working capital by timing our collections inside of the favorable pay terms we’ve negotiated with our suppliers. To augment our working capital management, we have renewed our efforts to attain an ABL, supported by our receivables and/or our inventory to provide additional liquidity. Initial discussions with lenders have been positive and we’re currently working through various creditor diligence requests. We’ll update the market and have further updates as this process progresses. On the debt front, as mentioned in the release, we were notified during January that all, but approximately $400,000 of our PPP loan was forgiven.

The balance of loan carries a 1% interest rate and will be amortized over the next 24-months. In yesterday’s release, we provided an update regarding our certain items associated with our year-end audit in 10-K. We did identify material weakness in our internal controls over financial reporting as of year-end. Unfortunately, the 300% growth in our business from a year ago has had some unintended consequences in terms of the stress placed on our back office staff charged with managing the increased operational activity. We are implementing enhanced processes to shore up internal communications and augment our staff in certain areas to provide additional resources to ensure that our controls are operating effectively. We believe this issue will be quickly remediated.

As it relates to the going concern of qualification and the related disclosures we expect to make in our 10-K, we’re working to secure additional sources of liquidity as we just discussed in terms of an ABL. Additionally, as stated throughout today’s call, we’re taking positive steps toward profitability. We expect to achieve positive adjusted EBITDA during 2023 as opposed to continuing our historical trend of operating losses. We believe our efforts to manage cash and working capital combined with an improving cash flow outlook provides us with sufficient financial resources to continue to operate the business. With that, I’ll turn it over to Harsha for closing comments.

Harsha Agadi: Thank you, Bond. I have never been so positive on Flotek. I am encouraged by the robust revenue backlog and I’m optimistic about our ability to convert revenue growth into earnings going forward. In conclusion, on the revenue front, our anchor customer ProFrac is continuing to ramp up and giving us increasing business. Our transactional business pipeline is now over $100 million and JP3 has robust demand in 2023 and beyond. Regarding margins, we are aggressively moving towards profitability on four fronts in 2023. Revenue optimization of $8 million; headcount reduction of $5 million; professional fees savings of $3 million; supply chain efficiencies of $13 million all of which has been detailed by Ryan and Bond. I want to thank all of the employees of Flotek for having a fanatically focus on execution and cost management in 2023 and beyond. We are now open to your questions or comments. Thank you.

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Q&A Session

Operator: We will now begin the question-and-answer session. And our first question will come from Don Crist of Johnson Rice. Please go ahead.

Don Crist: Good morning, gentlemen.

Harsha Agadi: Good morning.

Ryan Ezell: Good morning, Don?

Don Crist: It is truly commendable, which I’ll have done, and I appreciate all the color that you all provide on this call so far. Maybe my first one for Ryan, as you have ramped up supply in the ACDC fleets or the ProFrac fleets, you’ve had to do a lot of in-basin work to streamline operations and get everything operating properly? Where are you in that process? And number two, when do you think that you’ll get to the contracted 30 fleets?

Ryan Ezell: So I’ll take those, kind of, break them apart in a way as you presented it. So when we look at it, at the mobilization components. In Q4 because we’re getting solid traction on the way that we’re ramping. We’ve now fully executed delivery points in the Northeast, West Texas, South Texas and the Permian Basin, particularly focused in Cambridge, Ohio, Kilgore, Texas, Corpus Christi and in Midland. And so that’s going to help accelerate, we took a little extra cost in Q4, because we were really happy with how fast we’re ramping and we brought those costs into Q4, so that we have a clean run in 2020 through the mobilizations. We also went ahead and completed the mobilization of the additional tanks required to service the 30 fleets and brought those into play at the end of December and carried that cost as well in Q4.

So when I look at where we want to be ramped out and getting to that contractual 30 fleets, we expect to be there around mid-year, maybe a little earlier. And I think we’re in a very good position to service all 30. And from that point on, I hope we’re not limited by 30 and we grow past that. But I think we’re in a great position now and we’ve taken the burden of the cost on the mobilization. And we said we’re leaning up at this point forward.

Harsha Agadi: And I think Don as ProFrac moves into number one position, because they’re continuing to acquire, continuing to ramp up. I will not be shy in picking up the phone just like Ryan does and asking for much more than 30. Nothing stops us from doing more.

Don Crist: I agree with that. And as far as JP3 is concerned, I know your comments were a little bit limited in your prepared remarks. Where do we stand in relation to the ProFrac contract supplying 20 fleets? And know you all were exploring some opportunities outside of traditional completions activity towards the compression industry et cetera. Where are we in those efforts?

Ryan Ezell: So looking at the ProFrac initial supply agreement of the 20 units, we’re three quarters of the way through that and we have 12 in operations and we’ll be delivering the other ones around mid-year timeframe. And for that, it’s doing really well. You can start to see now even on ProFrac site, there’s a discussion of the activity of the JP3 units on their F3 and their performance and how it impacts the dual fuel fleets. So we’re very happy with the traction that’s ongoing there. And we expect those to continue to grow in terms of field gas monitoring as we have some additional opportunities to deploy units with other hydraulic fracturing fleets. And we look at the compressed gas, we have some targeted field trials without being specific to the operators there, but we do have targeted field trials for applications of those in 1H of this year and continue to gain traction on that side with JP3.

And most importantly, what I want to point out for that is we are transitioning into us like data as a service more than we are capital sales, which is phenomenal improvements for us in terms of profitability and revenue backlog in that part of the business.