Flotek Industries, Inc. (FTK) Earnings Call Transcript & Summary

Thank you for joining us today. Good morning. My name is Jeff Robertson. I'm the Managing Director for Natural Resources at Water Tower Research. It's a pleasure today to welcome Flotek Industries for a fireside chat. With us for today's chat, we have Ryan Ezell, Flotek's President; and Bond Clement, Flotek's Chief -- I'm sorry -- Chief Financial Officer, Bond having just joined the company in December of 2022. Before we get into the conversation, I would like to remind participants that today's discussion could include forward-looking statements. Flotek's disclosures regarding such statements can be found in the company's corporate presentation under the Investor Relations tab of its website.

Let's kind of go back to the beginning of the year, Ryan. In January, Flotek announced a management transition that included the departure of John Gibson, who, at that time, was Chairman and CEO. And existing Director, Harsha Agadi, became interim CEO. And then existing Director -- Lead Director, actually, David Nierenberg, was appointed Chairman of the Board. And you were appointed President. As I said a minute ago, Bond joined the company in December as Chief Financial Officer. Can you provide an update for people on the transition process? And I know there was a -- I think there was a search for a permanent CEO. What can you share about that process?

And so, Jeff, our mission here at Flotek is to be the collaborative partner of choice for sustainable chemistry and data analytics with chemistry being the core value creation component. And the organizational changes that we outlined in Q1 are just an evolution of our internal structure to deliver on this mission to not only our customers but also our shareholders. And we want to be lean, efficient, innovative and industry leaders in safety and service quality. And these changes 100% help us do that in terms of creating value for everyone involved and all our stakeholders. And in terms of the current CEO search, what I'll say is we are involved in a process that's moved quite a bit along since we had our earnings call. And I will suspect we'll be making an announcement here probably in the Q2 time frame on that part on the CEO search.

So just at a high level, Ryan, the transition that's underway at the company, both from a managerial standpoint and an operation standpoint is to execute on the supply agreement with ProFrac, execute on attracting additional third-party business and do it in a way that converts the revenue ramp you all have to adjusted EBITDA.

100%. And all those things are just part of the things we've had laid out to really, again, lean up the organization to deliver on those exact points.

Several events, including the management transition and the conversion of the PIK notes that were issued when the original float -- sorry, ProFrac agreement was put in place in February last year and the filing of the 10-K have contributed to some volatility in Flotek's share price. On the earnings call a couple of weeks back, Ryan, management talked about buying shares in the open market. I know you've had a lot of things going on and probably a lot of closed periods, where under SEC rules you wouldn't have been able to participate in the market. But can you talk about management's appetite to acquire shares in the company at its current valuation?

Yes. So you're 100% correct. Our insider trading policy didn't allow an open window for us when we closed the year for 2022 in that period. We do expect it to be open for us here around the May 10 time frame post our Q1 earnings release. And I can't speak for all the rest of the insiders in the organization, but I can tell you I do plan to buy shares at that particular point on our next window opening.

Let's talk about some of the steps you all are taking to streamline the organization and make it more efficient and manage cost, but also manage serving your customers. It's clear that the ProFrac agreement set Flotek up with a significant revenue ramp that will play out over the next 10 years for the life of the agreement. In the fourth quarter of 2022, you all provided chemistry solutions to 21 ProFrac crews and are continuing to build out to get to the minimum contract service of 30. Ryan, as a bit of background, can you talk about why Flotek's chemistry is seen by ProFrac and others as an integral part of what they want to offer their customers?

Yes. The spirit of this mutual beneficial contract for both ProFrac and Flotek is to create a vertical integration between an industry leader in hydraulic fracturing that has a multitude of Tier 4 dual fuel fleets as well as one of the largest electric fleets in the market that leads to improvements in greenhouse gas emissions and overall operational efficiency, and then bring a chemical delivery system that we have at Flotek that is leading in intellectual property, patent applications of renewable green source chemistries that creates a wonderful solution for what we're trying to do in this energy transition. Because we want to be focused on operational efficiency and also greenhouse gas emissions and also that renewable source chemistry that has less impact on the environment.

I think we might have -- be having...

Did we lose you, Jeff?

Ryan, can you hear me?

Yes, we do now. We lost you for a second, but we do now.

I apologize for my technical challenges today. You all -- or Flotek signed an amendment on the supply agreement that was filed in an 8-K back -- I think it was in January. Can you talk about the rationale behind the amendment and what that amendment does for Flotek?

Yes. The amendment was basically an evolution of the contract that's come with the evolution of our relationship. When we started this contract, we looked at it as just a supply agreement that spanned about 10 years, and we're looking at a certain volume of chemistry. And as we've become to work in a stronger partnership with ProFrac, we found opportunities for that to improve in terms of our full service delivery model. And when we look at what happened with the contract is -- we had a slight increase in the ramp period. And then we also looked at services that we charge as part of the full service support that wasn't originally looked at in our contract component, which increases the total value of the contract for Flotek in the long term.

You all have had to adjust your field operations and how you distribute chemistry to different basins. What are the most impactful things you've done recently to better allow the company to serve the ProFrac contracts, but also to continue to build your transactional business with other customers?

Yes. So for us, this whole process has been an evolution of building Flotek into a company that can withstand chemistry delivery throughout the cycle. And what's been a key component of that and not only the ramp-up for a ProFrac contract, but also what we do for our transactional business is to literally streamline our supply chain operations, where we brought our supply chain closer to the basins where we execute. And the in-basin manufacturing, digitized logistics, automated tank telemetry and leveraged economies of scale have really improved our capabilities to deliver not only ProFrac, but also all of our transactional customers.

Just on the transactional side, can you just talk briefly about the ramp you all have seen in that business over the last 6 quarters?

Yes. That's an awesome question. For us, it's something that we're extremely excited about. Because when you look at a comparison of Q1 of '22 to where we're going to be in Q2 -- I mean Q1 of 2023, we've seen about a 79-plus percent growth in our transactional business, which is where we deliver a lot of our complex nanofluids and value-add technologies. And that business has been growing, like you say, for 6 straight quarters. And we'll see that continue to grow through 2023.

How much of the ability to supply that growth is just driven by the scale and the steps you all have put in place to supply ProFrac? In other words, it sounds like you're able to leverage the increased operational things you're doing to supply both markets for the benefit of Flotek.

That's correct. As we've increased our economies of scale and brought the supply chain closer to the basin, it makes us a very strong competitor in the market as we continue to gain market share. Particularly our transactional business has -- it's given us a lot of street credibility, the volumes that we move in basin, that comfortability to bring on new customers. Because in a highly competitive market, one of the things you have to overcome is the cost of change where you have incumbents. And because of our footprint and our size now, we're really starting to be able to overcome that gap very easily because of our known presence in the basin. So it's been great synergy created between the ProFrac supply agreement and what we're doing on our transactional business growth.

Are the margins in transactional chemistry, are those similar to ProFrac? Or how do they compare?

When we look at those, honestly -- internally, we look at those as almost 2 completely different business models. The revolutionary contract with ProFrac, again, is a whole service delivery model that includes service revenue components and pricing components for the full suite of chemistry. Not all of our transactional business has the various types of chemistries. They're more focused on estimated ultimate return recovery from a reservoir, a lot of complex nanofluid sales. And it was really core components of the value-add part of the business. And so the margins looking at them 1:1 are a little bit different in terms of -- just because the structure of the delivery mechanisms are quite different.

Given the volatility in the market right now with natural gas prices having come down and oil bouncing around, but the oil rig jump seems to be fairly steady at the moment. Can you talk about maybe how the migration in completion crews and rigs from gas-oriented basins maybe to oil-oriented basins impacts your business?

We've seen -- it's been interesting because there are quite a few of the operators that we've seen in the East Texas area, which have some of the more heavy gas basins, have actually been rather sustained, and the ones that have longer term depending on their strip pricing. But we -- overall, we have seen some moving out towards the Permian and transition out there. So you'll see a slight dip in activity and then pick back up in the Permian and move to a more transactional nature as you see these operators shift a bit.

Late last year, Flotek in its Data Analytics business started to deploy some of your Verax analyzers on ProFrac's frac fleet to help them monitor field gas. Revenue in that business was up sharply in fourth quarter of 2022. I think it was up 245%. Can you talk about what that opportunity could mean for Flotek?

Yes. We are extremely excited about our JP3 business. That business is continuing to gain an extreme amount of momentum. When we're talking specifically around the field gas applications, those have moved from what we call a pilot basis to full on operations now. We have almost 15 units in the field operating on frac fleets, monitoring direct field gas quality, particularly around what they do in the BTU counts. And that process with ProFrac has just been an amazing deal in terms of how we're improving the amount of field gas utilization and cutting down the application of diesel fuel, which again drives improved greenhouse gas emissions and helps us deliver on that value proposition that we've been working at full term.

Is that application maybe getting noticed by other people who might have similar issues with field gas and how they deal with it as they want to either use it to generate infield power or do something other than burn it?

Yes. We see that growing quite tremendously in terms of -- the one application being direct running of the hydraulic fracturing fleet by the stream of gas or the field gas utilization. The other thing is into the compressed natural gas market as well as what we see in just overall power generation, whether they're using turbines or different units to generate electricity. And all these things help us broaden the applications of JP3 source further upstream than where we've traditionally been and mostly those golden applications in midstream. And it's picking up a ton of interest. We're consistently in customer meetings, pilot testing, et cetera, that's going to accelerate similarly to what we've seen in the ProFrac contracts.

You mentioned on the earnings call some things you all were doing around manufacturing the analyzers. Can you just elaborate on that and what kind of economic impact that might have on your ability, one, to supply the analyzers that people want, but also economic benefit for Flotek?

Yes. On our initial acquisition of JP3, when we look at the unique light source that we have in their infrared flow cell, we did have some manufacturing constraints originally and how fast we could produce the actual spectrometers. And now with this new supply room that we have, we are not hindered or bottlenecked by the production of the units now. And not only that, we've seen a 60-plus percent reduction in the cost to manufacture the unit. So for us, it makes us much more competitive in the current golden application markets, but more importantly, it's going to open up some other applications that we see that we're really excited about outside of the trans mix and the read vapor pressure measurements and even what we're doing on the field gas operations. It also enables us to transition to a monitoring-as-a-service rather than direct capital sales, which we're really excited about in terms of recurring revenue and building our backlog of revenue in JP3.

Ryan, it was clear in the third and fourth quarters last year when you all were maybe experiencing some growing pains, ramping up your business, that the main challenge in front of the company in 2023 was going to be when you start to convert the revenue ramp into positive adjusted EBITDA. You always talked a lot about that in recent months. Can you talk about the savings that you have achieved so far? And what kind of things you're doing to achieve incremental savings on the cost of goods sold side of the equation to generate positive EBITDA?

Yes. We took a holistic view of our operational P&L from cost of goods sold through what we do with directs and indirects and all the way through SG&A. And in our conference call at the end of the year for 2022, we talked about things like we reduced head count by 12% since the end of Q3 in '22. We're continuing to reduce over time. We've seen that come down in operational efficiency by almost 30%. Our plant utilization is going up. Our in-basin facilities for cost of goods supply, they're up and running. We've also reduced our dedicated trucks by digitizing our overall framework on last mile logistical delivery. We're also exiting our rig, which was our core office, which was completely underutilized. We're in the process of doing that. And we've retendered a massive amount of our spend on our cost of goods sold. All those things we see equating to over $18 million in savings in 2023. And as we're ending Q1 of '23, I can tell you, we're on track for those and happy with the progress.

Bond, are some of the G&A and just some of the administrative initiatives that have been underway, are those incremental to the $18 million of savings that Ryan outlined?

No, that's all included. I mean I think we touched upon the fact that we've reduced headcount by about 12% since the third quarter, which included a number of executive-level positions that obviously bring more weight to a cost savings perspective. So we've sort of realigned the top with -- our goal is to grow profitability. So in terms of the cost savings from a salary and benefit perspective, those are all included numbers Ryan in citing. But another thing we're trying to do is really attack the professional fees that the company has had to incur over the last few years. Line of sight, we think there's at least $3 million of savings that we can wring out, professional fees this year versus last year. And obviously, the goal is just to increase that level of savings this year.

Do you have -- can you share with investors or participants a time line on when you hope to be positive?

Here's what we'll say, Jeff. We said pretty definitively on the conference call that we are going to have positive adjusted EBITDA this year. We're certainly going to have positive gross margins. We think the cadence of those 2 things happening, you're likely going to see a positive gross margin in the near term. And then as the SG&A benefits continue to come through below the gross margin line, ultimately, that flips over to positive adjusted EBITDA. So we're not forecasting that it all happens at one time, but it could potentially come in stages. And we think the first of those stages will happen here pretty soon.

Let's talk about the 10-K a little bit. You -- when you filed the 10-K back, I think it was on March 21 or March 23, there was some going concern language from your auditor, and there was also the notion that you all have uncovered some material weaknesses. What steps -- let's talk about these kind of one at a time. Bond, what steps are you all taking to manage working capital and fund the business and mitigate some of the funding risk?

Yes. Obviously, we've talked about our desire and efforts to get an ABL in place. We continue to work through potential capital providers to put an ABL in place. I think Ryan and I have had meetings with 8 to 10 different lenders. We're still working through due diligence. Obviously, it gets a bit complicated when you're trying to leverage receivables because of the ProFrac relationship and the concentration there. So we're trying to work through some options. In terms of working capital, I think we've been pretty clear that we've been able to really negotiate positive working capital positions relative to our receivables versus our payables with the ProFrac Group specifically. We have some clauses where we can receive payments in as few as 10 days with a slight discount and ultimately settle up all balances within 45 days. On our supplier side, we've negotiated the majority of our contracts for payables to the suppliers in a 60-day time frame, some even a little bit further out than that. So using just DSOs and DPO relationships, we've been able to fund the business with cash on hand. I will say that cash at the end of the first quarter is going to be about flat with cash at the end of the year. So we've been able to maintain sort of a flat cash balance for the first quarter. Obviously, we'd like to have an ABL in place at some point this year just to provide a little bit more cushion. But nothing I can speak of here today outside of the fact that we are having discussions, and we're doing our best to get something done.

I think the material weaknesses that were referenced might have been just due to the growing pains that the company had from a business standpoint last year. Can you talk about what you're doing on that end?

Yes. And look, I certainly don't want to undermine the significance of a material weakness. We take internal controls very seriously. But you're exactly right. When we did the postmortem on what happened, it's a symptom of the growing pains that we're experiencing throughout the business in terms of the ramp-up. And it really boils down to just enhancing lines of communication behind some of our clerical folks. We've added some staffing in a couple of places to augment some controls in place, and we fully believe we'll have all material weaknesses remediated by midyear.

Flotek, I think there was just the other day, received a notice from the New York Stock Exchange that the average daily share price had fallen below $1 for 30 days, which I guess, puts you as -- it's a continuous listing requirement. Flotek approved at the special meeting of shareholders in May of last year, a reverse stock split. Is that something that's on the table to remedy the NYSE listing requirement?

As it relates to the NYSE specifically, I think you have to or you're required to say that we effectively have this reverse split that's been approved as a tool in our tool chest to remedy if all else fails. Certainly, we are looking to get back into compliance from an organic perspective through positive gross margins, positive adjusted EBITDA through our results over the next 6 months, along with any success we may have on the capital raise side. So certainly, the plan would be to organically cure the dollar deficiency. But we do have the reverse split approved, as you said, at a 1 to 6 level in the event that we have to go that route to cure the deficiency.

My understanding on these types of notice is that if the company can show a plan, remedies some of these issues and correct them, then the NYSE can be relatively flexible on these types of notice. Is that fair?

Yes. Look, I mean, we're a customer of the NYSE. We pay fees to them to be a listed company. So certainly, they're going to be flexible and they want to work with their constituents to be able to maintain their listing and to be able to maintain fees. So I think that's just a natural part of the relationship.

I mentioned a little bit earlier the February conversion of the PIK notes that were issued to investors in connection with the original ProFrac agreement -- and ProFrac also received shares as consideration of that agreement and end -- I'm sorry, notes -- and notes in consideration of the amended agreement that was put in place in May of last year at the special meeting. So they have a conversion coming up. Ryan, can you -- I'm sorry. Bond, can you talk about what the balance sheet will look like once all those PIK notes are off?

Yes, it's a good question. I think it will drastically clean up our balance sheet. I think the complications of the ProFrac agreement are maybe lost on some when they look at the balance sheet, just on the face value. There appears to be a lot of leverage on the balance sheet. But in reality, after the mandatory conversion to equity, you're going to have a huge shift from effectively long-term debt to stockholders' equity, which is going to -- it's going to paint a truer picture of the unlevered nature of our balance sheet where effectively the only debt we'll have post conversion is a small stub piece of a PPP loan, about $400,000 that carries a 1% interest rate. So there's going to be a big shift in the second quarter. And at that point in time, you'll see the clearer picture of just how unlevered we really are.

And then just to kind of move on the proxy that you all filed this week. Flotek issued to ProFrac some pre-funded warrants in June of last year. And I noticed in the proxy that there is an amendment to authorize issuing the shares under that. And I guess it's important to note for people that that will also bring in another $4.5 million of cash into the company. So with your comment around the balance sheet being debt-free and an additional $4.5 million in cash coming presumably once that amendment is approved, concern around anything with related to the 10-K or the going concern language has nothing to do with your leverage ratios, it's just -- I'm sorry, your leverage levels. It just has to do with managing the business and managing the grower.

That's correct. We've had a history of, obviously, negative adjusted EBITDA. And I think the auditors typically take a pretty conservative stance on going concerns. So we've just got to go out and prove it to auditors that we're going to generate positive returns this year. We are going to try to bring some new money into the business. Certainly, the $4.5 million will help if ProFrac does, in fact, elect to get the shares to be issued and the shareholders -- the non ProFrac shareholders do vote on that regard. So I think there's a lot of things that we're working on that will come to bear in terms of changing our auditor's opinion on a going concern. And certainly, they issued a going concern in our 10-K. So when we issue our 10-K this year, we'll once again prove that they were wrong.

We've talked today about a number of things, kind of wide-ranging discussion on both the operational improvements that you all are putting in place and will continue to put in place to deliver on the notion of converting revenue into adjusted EBITDA. Ryan, as you sit here today in the President seat, could you just kind of summarize your views on the investment outlook for Flotek as you think about the rest of 2023?

Honestly, Jeff, I look right now and I've never been more excited to be a part of Flotek. When I look at us from an investment story, we have a very dynamic and strong new management team in place. We're going to continue to have rapid revenue growth year-on-year. We're going to cross into positive gross margins and subsequently positive EBITDA before the end of the year. And we're continuing to have significant balance sheet discipline to run this business efficiently and focus on our innovative technologies on how we look at the resiliency of our business through the cycle. And holistically, hydrocarbons are going to be around. And we really need to be focused on reducing greenhouse gas emissions, having sustainable chemistry and also having cost efficiency, which impacts all of our customers to stakeholders. And when I look at Flotek, we are strategically built to succeed in this space and help lead the energy transition. And that's core to our mission, vision and value proposition. So I couldn't be more excited to be part of Flotek and the success we're going to have in 2023.

I think we'll leave it there for today. Ryan and Bond, I really appreciate your time this morning, and I look forward to hosting another fireside chat with you as you continue to move through this year.

Yes. Appreciate it, Jeff. Thank you.

Thanks, Jeff.

Thank you.