Flotek Industries, Inc. (FTK) Q3 2017 Earnings Report, Transcript and Summary

Good morning and welcome to Flotek Industries Inc Third Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. There will be an opportunity for you'd ask questions at the end of the Company's prepared remarks and operator will provide instructions on how to ask your questions at that time. [Operator Instructions] This conference is being recorded. At this time, I would like to turn the conference over to Matt Marietta, Flotek's Senior Vice President of Corporate Development and Investor Relations. Mr. Marietta, you may begin.

Thank you and good morning on behalf of the Flotek team. Joining me this morning are John Chisholm, Flotek's Chairman, President and Chief Executive Officer; Rich Walton, our Chief Financial Officer; Josh Snively, Executive Vice President and our Head of Operations as well as other members of our leadership team and board. Our earnings press release was distributed this morning and is available on the Flotek website. In addition, today's call is being webcast, and a replay will be available on our website. Before we begin, our formal remarks, I would like to remind everyone participating in this call, listening to the replay or reading a transcript of the following. Some of the comments made during this teleconference may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and other applicable statutes reflecting Flotek's views, comments or expectations about future events and their potential impact on performance. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements, but they are not an exclusive means of identifying forward-looking statements on this call. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from such forward-looking statements. These risks are discussed in Flotek's filings, including our Form 10-K, with the US Securities and Exchange Commission. With that, it is my pleasure to turn the call over to John for opening remarks, followed by a financial review from Rich and insights into our operations given by Josh followed by our outlook. We will open for Q&A after the remarks. And with that, John?

Thank you, Matt, and thank you all for joining today's call hosted from our Global Research and Innovation Center Headquarters, in Houston. I'll begin by giving a summary of our quarterly results, followed by an overview of business segments and ongoing strategic initiatives aimed at maximizing our ability to generate free cash flow in future periods regardless of the commodity price scenario. Rich will then review our financial highlights for the quarter and provide additional financial details followed by Josh, whose role at Flotek was recently expanded oversee operations for our entire organization. We are pleased Josh has accepted this critical role and we're confident in his vast experience in Chemistry manufacturing, efficiency improvements as we believe this change will further integrate our organization. Josh will provide an operational overview in our Energy Chemistry Technology segment and update around our citrus end markets and ongoing initiatives at Florida Chemical our integrated operating subsidiary within our Consumer and Industrial Chemistry Technology segment. Finally, I'll end with closing remarks and outlook before taking your questions. Overall Flotek's third quarter results were below expectations primarily due to challenges we faced related to Hurricane Harvey but also impacted by client slowdowns in the Rockies region in our ECT segment. Our CICT segment performed relatively in line with our expectations while we were able to execute higher than expected sales after Hurricane Irma created disruptions in the global citrus market place. The third quarter was disappointing; however, our ability to extract cash from our business highlights the shift we've made from a diversified oil field equipment provider which requires higher CapEx into an asset light pure play specialty chemistry technology company. For continuing operations, which encompasses our Energy Chemistry Technology or ECT and Consumer and Industrial Chemistry Technology or CICT segments Flotek's consolidated third quarter revenue was down 6.7% sequentially and up 23.5% year-over-year. Adjusted EBITDA for the company was $3.3 million and we generated free cash flow net of CapEx of $6.8 million in the third quarter. To provide an update in our Energy Chemistry Technology's segment. Total revenues declined 7.1% to $61.2 million compared to the second quarter and the segment generated adjusted EBITDA of $11.7 million. Domestic revenues declined 11.5% sequentially in the third quarter and outside of approximately $5 million which can be attributed to hurricane related issues significant decreases in our Rockies region negatively impacted our results. Our clients in this region have step back completion intensity and in some cases moved away from optimized completions as take away capacity constraints have limited well flow performance. This is the primary driver for domestic complex nano-Fluids or CnF revenues declining 16.3% and volumes declining by 18.4% sequentially, outside of the hurricane related impacts that we've previously disclosed. This region should benefit from higher commodity prices and increase take away capacity in future periods and we believe these issues are transitory as operators continue to focus on driving better economics through technology over the long run. Our conventional chemistry revenues or non CnF components of ECT grew 2.5% sequentially. Demand remained strong for our friction reducer product lines and patented pressure reducing fluid or PRF as well for our full fluid systems in our prescriptive chemistry management or PCM platform. The emerging trend of decoupling which began with the downturn in commodities has reached less than 10% of completions and while no blue print has been established, it is clear that indications are that this trend is very favorable to operator's economics. It is our view that this trend will grow overtime, who'll also influenced by equipment capacity, product pricing and technology. Flotek was a first mover in this trend in chemistry and full fluid system design represented by PCM and we believe operators will continue to shift to use our leadership as the standard in this ongoing shift. Internationally, ECT revenues expanded 85.3% from the second quarter or by $2.5 million primarily driven by higher CnF sales. Canada rebounded from a larger than normal seasonal slowdown and sales were higher sequentially in all regions except Latin America which was negligible in size as a percentage of international revenue. Canada remains our most significant geo-market, but outside of Canada's typical seasonality we expected international activity will continue to fluctuate on a sequential basis due to the nature of large shipping orders and inventory management, which creates lumpiness as we continue to penetrate new markets. We believe the opportunity for high margin growth will evolve with completion techniques around the globe. However, we're also taking a close look at certain geo regions, which may not have the same opportunities as others and rationalizing costs in those areas which should also help our broader G&A reduction initiatives. We remain as committed as ever to research and innovation which continues to expand our market opportunities and deepen our client relationships. Our pipeline of client specific projects at our R&I facility increased by 12.2% quarter-over-quarter and October continued the positive trends into the fourth quarter. In addition, our initiatives with IBM utilizing the reservoir cognitive consultant capabilities position Flotek to capitalize on this demand once we've commercialized our offering. We see operators working towards aligning CapEx and cash flow which should bring a more stable US shale market when we'll likely smooth out the large fluctuations we've experienced in the few years. We believe it is unsustainable for the industry to expand and contract at the pace it has since the commodity cycle turn down. We welcome an era of a narrower spread between cash flows and capital spending of our clients and see the importance of technology differentiating oil and gas producers globally. Flotek is uniquely positioned and that we do not have any major CapEx, hiring or equipment spending needs as we penetrate new clients in geo regions. Our leadership position in the speciality chemistry and completion chemistry and marketplace coupled with further G&A reductions are intended to increase our profitability in a more flat spending outlook environment. Moving to our Consumer Industrial Chemistries Technology segment or CICT less than 90 days ago we had anticipated citrus pricing to moderate due to significant increases and forecasted global crops. For example, the Brazil crop alone is expected to grow greater than 50% versus last season's levels. However, Hurricane Irma has impacted the near to intermediate term pricing dynamic as Florida suffered substantial losses in its current crop. Revenues in the CICT for the quarter were $18.3 million a decrease of $1 million from the second quarter. Adjusted EBITDA of $1.9 million was slightly lower from the second quarter due to product mix and declining prices prior to Hurricane Irma. We're continuing to penetrate new clients and market channels and believe our margin profile in this segment has potential to improve in coming quarters. We believe, we're ideally positioned in the citrus value chain and will continue to serve the needs of growing list of clients. Moving to the balance sheet, subsequent to quarter end we reduced the balance on our revolver by another 25% or $10.2 million to $30.4 million after reducing the balance from $48.8 million at year end 2016 to $42.7 million at the end of the second quarter or by 11.8%. We are effectively in a debt neutral situation as our only current borrowings are backed by current assets and we will continue to utilize our borrowing to fund working capital demands in our growth. I would like to highlight that we generated $7 million of free cash flow during the quarter after capital expenditures. Additionally, while it's taken sometime to reflect in our financials I'm pleased with companywide efforts to reduce G&A and find areas of operational and efficiencies improvement. Our efforts are far from over however and we believe we can believe further reduce SG&A levels in the coming quarters. As stated last quarter, while to some it may seem like changes have not come fast enough we can say that we're making an impact in our business and we will not sacrifice critical relationships or jeopardize our growth opportunities in this process. In the third quarter, we repurchased 630,000 shares of stocks for $3.7 million and we have $50.7 million of remaining board authorization on our share repurchase program. Additionally, we will continue to assess the M&A marketplace. I'll turn it over now to our CFO, Rich Walton to provide a review of our key financial information and provide an update. Rich.

Thank you, John. As we've previously discussed the assets liabilities and results of the drilling technology and product technology's segments continue deep to be presented as discontinued operations. During the third quarter, the company completed the sales substantially all of the remaining assets of the company's drilling technology segment for $1 million in cash consideration and a note receivable of $1 million due in one year. The company expects to have sold or liquidated all asset and settled liabilities related to these two segments by year end. A customary escrow holdback of $1.9 million should be realized over the next 13 months. The financial statements in the Form 10-Q and going forward should more accurately represent the results of our core businesses, Energy Chemistry Technology's and consumer and industrial technology's as continuing operations. For the third quarter we reported total revenue of $79.5 million compared with $64.3 million in the prior year period. An increase of $15.2 million or 23.5%. On a sequential basis, quarterly revenue was down $5.7 million or 6.7%. Energy chemistry quarterly revenue was $61.2 million an increase of $16.1 million or 35.8% over the prior year period. A sequential quarterly decline in revenue of $4.7 million or 7.1% was experienced in the energy chemistry. International sales for this segment increased $2.5 million during the third quarter of 2017 compared to the second quarter of 2017. Consumer and industrial chemistry revenue for the third quarter down $1.1 million or 5.2% sequentially and down $1.1 million compared to the same period of 2016. Our third quarter consolidated operating margin was a negative 3.9%. The segment operating margin was 11.2% in the energy chemistry segment and 5.4% in the Consumer and Industrial Chemistry segment. Corporate general and administrative expense was $10.3 million flat from the third quarter of 2016 and a reduction of $0.9 million from the second quarter of 2017. Our corporate G&A during the third quarter as a percentage of revenue decreased to 13% from 16% in the third quarter of 2016 and 31.1% in the second quarter of 2017 as we progressed our cost reduction initiatives. During the first nine months of 2017, the company incurred non-recurring charges of $1 million related to execute retirement and $0.4 million related due to shareholder lawsuit and SEC inquiry. Early in the fourth quarter the company took significant measure to reduce contract labor and consulting expenses. Segment selling and administrative expense was $9.3 million a decrease of $0.5 million from the third quarter of 2016 and a reduction of $0.1 million from the second quarter of 2017. Segment selling and administrative expense as a percentage of revenue decreased to 11.7% from 15.2% in the third quarter of 2016. Non-cash compensation was $3 million in the third quarter. For the quarter research and development expense was $2.7 million compared to $2.3 million in the same period of 2016. This increase of $0.4 million in attributable to meeting customer demands and for new product development and new chemistries which are expected to expand the company's intellectual property portfolio. For the third quarter, Flotek reported a net loss from continuing operations of $3.4 million representing a loss of $0.06 per share on a fully diluted basis. This compares to a net loss from continuing operations of $1.9 million for the third quarter of the prior year. For the first nine months of 2017, Flotek reported a net loss from continuing operations of $5.3 million representing a loss of $0.09 per share on a fully diluted basis. This compares to a net loss from continuing operations of $2 million for the first nine months of the prior year. Flotek recorded a minor tax expense for the three months ended September 30, 2017 compared to an income tax benefit of $0.9 million in the prior year. A reduction of an expected tax benefit of $0.6 million related to stock based rewards that beginning in 2017 must now be charged against income. At September 30, 2017 the company had accounts receivable of $56 million compared to $47.2 million at December 31, 2016. At September 30, 2017 days revenue and accounts receivable was approximately 64.5 days compared to 62.5 days at December 31, 2016. For the quarter ended September 30, 2017 the provision for doubtful accounts was $0.2 million. At September 30, the allowance for doubtful accounts is $1.1 million or less than 2% of the receivable balance. At September 30, 2017 inventories totaled $70.7 million compared to $58.3 million at December 31, 2016 an increase of 21%. This increase primarily resulted from higher cost for citrus oil. This inventory historically builds during the first half of the year and is now being used. The impact was more pronounced this year because citrus oil cost inflation. While the volume of citrus oil held constant and was the same at September 30, 2017 and September 30, 2016 the average unit price was up significantly. During the third quarter inventory decreased $7.7 million. Our inventory turnover at September 30, 2017 is approximately 3.2 times per year. At September 30, 2017 borrowing under our revolving credit facility was $40.6 million and there was undrawn availability of $34.3 million. Our credit agreement was amended on September 29, 2017. It increased a maximum revolving advance amount by $10 million to $75 million and extended the maturity for two years until May 2022. Limits on capital expenditures were increased for 2018 and thereafter and the amount of permitted repurchases of our common or preferred stock was increased by $10 million. During the first nine months capital expenditures were $6.2 million compared to $10.6 million in the same period of the prior year. Expected capital expenditures for 2017 have been further reduced to a range of $9 million to $11 million and we expect to be toward the lower end of that range. During the third quarter, the company repurchased 630,000 shares of its common stock or $3.7 million or an average price of $5.85 per share. As of September 30, 2017, the company may make additional share repurchases of up to $10.7 million. During the third quarter the company files a universal shelf registration on Form S-3 with the Securities and Exchange Commission. The universal shelf was declared effective by the SEC on October 11, 2017. This filing permits the company to sell new securities to the public with a maximum initial offering price of up to $350 million. As a reminder, our financial statements report the continuing operations of our Energy Chemistry Technology and Consumer and Industrial Chemistry Technology segments. The Form 10-Q provides a description and analysis of our discontinued operations. This drilling technology's and production technology's in the foot notes. We continue to be focused on monitoring capital expenditures, lowering SG&A cost, protecting our liquidity and growing our core businesses. And now I'll turn the call over to Josh. To provide an operational and performance update of the company.

Thank you Rich. I'm honored to take on the role of Operations for the entire organization and believe through greater efficiencies we will maximize our ability to generate cash flow for our shareholders. Beginning with our CICT segment, we've positioned our inventory to withstand citrus market disruptions that the global citrus industry is experiencing since Hurricane Irma. As we announced last quarter progress continues to occur and the expansion of Florida Chemical and the new distillation tower being installed this month enhances our capabilities and to new citrus [indiscernible] opportunities and or relieved any potential bottlenecks with our citrus isolate production. We've established new channels to make with our Japan sales office, which contributes to our first Asia end market sale in October. We believe we have a runway of opportunities in our CICT segment and we have laid the ground work to capitalize on our strong position in the global citrus markets. To provide an overview of the impact from Hurricane Irma on the global citrus industry we believe crop damage in Florida will lead to tighter supplies. This is already caused prices for citrus oils to increase and is unlikely to alleviate until at least the end of the second quarter of 2018. This has changed our outlook from last quarter but is important to keep in mind that the current Brazilian crop is expected to climb 50% or greater to last season. To put this into context, the growth in Brazil more than offsets the volume of the entire Florida citrus crop. It is for this reason we believe the Irma associated impacts is temporary and we have adjusted for this market dynamic. And taking on leadership of the cross [ph] segment operational activities we can leverage our manufacturing and G&A efficiencies of the entire Flotek organization. Under my leadership, we will drive out operational in efficiencies and further integrate our two segments. This requires a full review and our cost controls, execution, logistics and ability to stay ahead of changes in our clients' demands. And part of our transition we have de-layered reporting structures in our business that reduces G&A at the corporate and field level while creating greater visibility throughout our organization. Many of these changes have occurred by the full impact of these changes are unlikely to be fully realized until early 2018. We have a number of systems implementations and optimizations that are underway that will further allow us to eliminate cost at a variety of levels. Provide more clarity in our ECT segment as John noted, we experienced a step back in our Rockies region. We see this issue occurring and the region as fairly transitory. PCM activity has increased in the third quarter which has broadened our customer base and expanded our direct sales opportunities. However, with this growth, we've experienced some growing pains and cost inefficiencies related to deliveries and building out scale in this offering. As we manage through the ramp up of our PCM activities. It should be noted that our gross margin profile has and may continue to fluctuate as scale is achieved. With that I'll turn it back to John to offer concluding remarks.

Thanks, Josh and before we take questions I would like to offer an outlook and add some concluding thoughts. While we acknowledged disappointments in the quarter. We continue to progress the company towards and asset light pure play specialty chemistry business model that is positioned to generate free cash flow regardless of the commodity price. To that note, as a month end in October we have a $27.4 million net debt position and current liquidity of $47.5 million which includes undrawn balances on the company's revolving line of credit. This is as strong as a financial position Flotek has been in since I began leading the organization in 2009. In ECT, visibility in the fourth quarter has challenged given the anticipated holiday slowdown, commodity swings and client desire to align CapEx with cash flows. However, recent success with new clients opens the door for further penetration of our CnF product portfolio as evidenced by more wells being identified by operators in their public remarks which have utilized our technology. To that extent, we are excited to see well names and programs in the public domain, we will continue to refrain from speaking about their success. In our CICT segment where we have greater client visibility, we anticipate a normal seasonal slowdown however we expect the top line to be in the $15 million to $18 million range with flat margins. On the cost front, we will continue to drive G&A lower, we've undergone an extensive cost reduction program to outline our strategy we've reduced our total continuing operations headcount by around 10% to in this time last year to current. In addition, we project [indiscernible] salary and benefits have declined by 15% and expenses by employee on expense accounts are down more than 30% from a year ago. We've also eliminated consulting and contract labor positions which reduces the spending in this category by 40%. In all, our long-term target is to operate at 20% or below G&A level relative to revenues which we're targeting in early 2018. For the fourth quarter, we believe we will recognize an additional $1 million of cash savings or a total of cash SG&A level of $15 million to $16 million for the quarter which will be mostly recognized at the corporate G&A line. We expect further savings into 2018 which we look forward to update on this ongoing initiatives will take time to reflect through the financial reporting. As we move forward our business is more efficient, our cost are structurally lower and we see opportunities arising to continue our long-term outperformance of growth relative to benchmarks. Finally, I'd like to thank our shareholders, employees, clients and stakeholders for their support of Flotek. And to all veterans we thank you for your service and honor you on this upcoming Veterans Day weekend. With that operator, we'll now open the call to questions.

[Operator Instructions] our first question comes from the line of Georg Venturatos with Johnson Rice. Please proceed with your question.

John, I just wanted to start on ECT segment. In relation to your top one or two customers and certainly we saw in the Q some continued follow through there, but can you maybe just provide us what you can in terms of discussions there with your key customers as that's been a point of emphasis in recent quarters with investors and then secondly within the ECT segment, just kind of wanted to get an updated market share status as it relates to obviously you guys called out the Rockies but Permian and Eagle Ford and just get a sense of this year penetration targets have changed at all given at least the trend we've seen in the last quarter or so.

Sure. Our retention rate quarter-over-quarter is as high as it's ever been throughout the year. In fact, we increased the number of unique clients by a little bit over 10% third quarter over second quarter. As I've said consistently on these calls this is - when you have transformational technology and you're not going to have as much as folks would like to have a predictable, steady growth it just doesn't happen that way. I think that kind of bears out with other transformational technologies over the last decade or so in this industry. So, from time-to-time there will be a leveling and in some cases, it may even decrease as the market continues to work its way through and we continue to penetrate. Another statistic is that our amount of revenue directly to clients in the quarter was 66% two years ago this time it was essentially 10% and so that trend we believe is very encouraging as it gives us the direct contact with the clients that expose them directly to our technical capability. We've and again folks that have followed the story of the way we reported we've made a decision in terms of not talking specifically about clients, although I think folks have seen over the last four or five maybe in the last four or five weeks certain clients have talked about their frustration of not having the amount of frac heads available that they wanted to have, certain clients have talked about an overall 20% lack of efficiency in the completion process and certainly that was an effect for us, but we've just taken the approach that we're not going to specifically talk about well performance unless that client does it themselves. Regarding the top two we don't see any benefit in expanding on communication there because we have certain confidentially agreements with those folks and we honor that and we hope everybody respects that with the question that you provided there, and I hope that kind of extra granularity in terms of the retention, the increase in clients, the increase in business that's flowing directly through to the client gives you greater context.

Now that makes sense. John, I appreciate at least those data points and what you can't provide us here on the call. On the margin side, just wanted to hit on this as well and obviously we saw EBITDA margins in the ECT segment. We were lower than we were looking for and certainly kind of tough quarter down 500 basis points. Can you maybe breakout and you did a little bit, but the factors obviously mix shift likely there. Citrus pricing but just kind of want to get a sense of what we can see in terms of potential recovery in the margins from where we are and looking at this particular aspect that can improve. I know that Josh mentioned kind of mid-2018 to kind of see that really reversal in citrus pricing with the Brazil crop coming on.

Right so I think the kind of gem to take out of that question is that, the CnF margins are essentially flat. We've held up those margins, we've made a real focus on that. We've made a real focus on maintaining the pricing model on that. The PCM margins are in a state of flux, Josh talked about that a little bit and I'll give you kind of business approach in answer that. In the fall of 2016, when we really started this and the industry really started to gain momentum on decoupling and disaggregation, self-sourcing, whatever different people want to call it. It's been my view over history that you're giving really kind of one change to make a first impression because when you take on the responsibility delivering the chemistry package directly to location. Those operators are expecting seamless performance to what they've been used to. I think there's a tendency to over staff that to ensure that it gets done right. And it's take us sometime to really understand the optimum amount of folks that are needed to be able to provide that service and that's part of the rationalization of the people that we've undergone in the last quarter that we've talked about and we're still working through like when now products are returned to us because they're not all completely pumped. It's a different situation than when we were selling directly to service companies and if they didn't use it, they'd save it and use it perhaps on the next well. So, the return freight [ph], the return logistics and all that it's still a work in progress which from time-to-time has effect on the margins, but it's something we've got our hands around and again with Josh's position there. The connective of the logistics and the supply chain between CITC and ECT. We're pretty confident that those margins will improve. Does that help?

Yes, no, no thanks. John. Last one from me. And then I'll re-queue. But on the SG&A front, look this has been a long discussed topic and certainly pleased to see you guys put that in the release today. I know you've been putting a lot of efforts in that. Just wanted to confirm, but just in terms of timing. It sounds like [indiscernible] called out sequential reduction here fourth quarter, but as we look to the full efforts that you've done. You think it's going to be largely full realized in the early part of 2018, is the right way to think about it.

Yes, I'd say first quarter you'll see another kind of step change maybe a tail in the second quarter. But I think we believe your assumption is correct there. George and we're already as we talked about with the free cash flow and all that, seeing early benefits of that imitative. I think we wanted to call out to the folks that are listening are going to transcript. It goes all the way to really looking at inside the expense accounts in terms of, can we as efficient as possible. So, this has been a top to the bottom effort of really looking at how can we make Flotek as efficient as we can to be able to deliver the returns we want.

Got it. Well appreciate the answers. John.

Sure.

[Operator Instructions] and gentlemen we're showing no further questions on the audio lines at this time.

Okay. Thank you, operator and thanks folks.

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation. And ask that you kindly disconnect your lines. Have a good day everyone.