Flotek Industries, Inc. (FTK) Q1 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to Flotek Industries’ First Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow management’s prepared remarks. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Bernie Colson, Senior Vice President, Corporate Development and Sustainability for Flotek. Thank you. You may begin.

Thank you, and good morning, everyone. We appreciate your participation. Joining me today are John Gibson, Chairman, Chief Executive Officer and President; Ryan Ezell, Chief Operating Officer; Michael Borton, Chief Financial Officer; James Silas, Senior Vice President of Research and Innovation and Nick Bigney, General Counsel and Chief Compliance Officer. On today’s call, we will first provide prepared remarks concerning our business and results for the quarter. Following that, we will answer your questions you have. We have now released our earnings announcement for our first quarter 2022 results, which is available on our website. Today’s call is being webcast and a replay will also be available on our website. Please note that any 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 releases and the risk factors discussed in our filings with the SEC. Also, please refer to our reconciliations provided in our earnings press release, as management may discuss non-GAAP metrics on this call. I'll now turn it over to John Gibson. John?

Thank you and good morning everyone and thank you for joining our discussion of our first quarter results of 2022. First let me welcome Bernie Colson to the leadership team and leadership team and introduce him to you. You just heard him speak. I'm extremely excited that Bernie has joined Flotek to lead our corporate development, sustainability and investor relations strategies. He's recognized as an experienced investment and ESG leader in the energy sector with more than two decades of experience in investment banks, institutional asset managers and a renewable energy holding company. Bernie was most recently with Delaware Investments, where he was a portfolio manager, energy team lead and helped develop the firm's first ESG labelled fund focused on the energy transition. Bernie is exceptionally bright and a big thinker and I believe he's going to help drive Flotek's corporate strategy. I'm extremely excited to have him here on the Flotek team. Now before we cover the quarterly results, let me say we're thrilled that we convene our call today having closed the expanded nonexclusive 10-year contract with ProFrac to deliver our full suite of downhole chemistries to a significant portion of its hydraulic fracturing fleets in North America. This agreement is truly transformational for Flotek and for the industry. Through this agreement, E&Ps now have a comprehensive, vertically-integrated completion solution that reduces emissions and delivers green chemistries, thereby protecting air, water, land and people. Over the next decade, we anticipate this agreement should create backlog of more than $2 billion in revenue for Flotek, including anticipated revenues well in excess of $200 million in 2023. We're very excited that we just completed the first full month of our partnership with ProFrac, which began on April 1. We're off to a very strong start, which Ryan will discuss in greater detail in his remarks. We are on target to achieve positive adjusted EBITDA, excluding convertible notes, amortization before the end of the fourth quarter 2022. With the initiation of our contract with ProFrac comes changes to our Board of Directors. As you will see in our proxy statement, Matt will stand for election to the Board concurrent with the 2022 Annual General Meeting on June 9. As Chairman of the Board of Directors for ProFrac Holding Corp., Matt has been instrumental in pioneering our shared vision of complementary offerings that enable E&Ps to more sustainably develop natural resources, while reducing total cost of ownership. Also of note, ProFrac recently completed its IPO, raising $288 million. We ask for your support in electing him to the Board as he is a key strategic collaborator in driving the adoption of sustainable chemistry solutions throughout the industry. He is a champion of efficiency, one of the best I've met. I should note that with our contract, ProFrac has the option to appoint 4 of our 7 directors. Any additional director nominations will occur after our annual meeting. Until such time, the Board will continue with 6 directors. Concurrent with this nomination, Ted Brown and Paul Hobby will not stand for reelection to the Board. Both Ted and Paul have been outstanding directors, guiding the company through our transformation. They've been personally supportive to me and it brought tremendous value to shaping our strategy, and I'm extremely grateful for their time on the board. I will miss both Ted and Paul. As we discussed on the last quarter's earnings call just 6 weeks ago, Flotek is now a very different company from the past and now that the expanded nonexclusive 10-year contract with ProFrac is closed, I repeat closed, we are focused on looking forward rather than backward. In line with this, and as part of our future financial reporting beginning in the second quarter, we will report on a consolidated basis rather than by segment in light of the scale of our chemistry's technology business. So today, after my remarks, you will hear from Ryan Ezell in his official capacity as COO, followed by Mike Borton, who will provide brief comments followed by my closing remarks. As indicated on our last quarter call, I was concerned about the challenging markets at the beginning of the year where frac fleet activity levels dropped in January. However, activity slowly recovered in February and leveled off in March. As a result, Mark turned out to be the strongest month since before the pandemic. In the end, our quarterly revenue improved 6% sequentially and our adjusted EBITDA also improved by 5% over Q4 2021. Now with that, I'd like to turn the call over to Ryan. Ryan?

Thank you, John, and good morning. Let me first provide key highlights on our contract with ProFrac before providing quarterly commentary. In April, we concluded the first month of our partnership with ProFrac and I'm extremely pleased to report that we are off to a very strong start. We ended the month of April supplying downhole chemistry to 8 ProFrac fleets across 4 major basins. Since the end of April, we've gained two additional fleets, bringing the current total to 10 with plans to further increase the number of fleets we are supporting throughout the quarter. In support of each fleet, our team is providing prescriptive chemistry recommendations by conducting X-ray to fraction analysis to evaluate the composition of well site cuttings, build water and crude testing, flow lot and reology profiling and bioassay testing. In total, we have delivered more than 17 million pounds of chemistry since the start of our relationship. In addition, as part of our integrated approach to digital chemistry, we also have plans to deploy our Verax analyzers on designated ProFrac fleets to evaluate field gas usage at the well site. We believe this will be a powerful use case to protect our customers' capital equipment as well as reduce greenhouse gas emissions in the field. As I highlighted last quarter, the ProFrac agreement is nonexclusive. And once the contract is fully operational, we still have the ability to double our manufacturing capacity utilization levels without significant capital investment. We look forward to continuing to build a strong partnership with ProFrac over the coming months and years, and we will be updating you on our progress in the future quarters. Now looking at the quarterly performance of our Chemistry Technologies segment, we continue to make steady progress in growing market share and outpacing industry activity levels. As John mentioned, we saw hydraulic fracturing fleet activity levels decreased dramatically at the start of the year with unexpected disruption in January, a flat market activity overall in the quarter compared to the prior quarter. Despite that, March was our best performing month in terms of revenue since January of 2020. And overall, our Chemistry Technologies revenue increased 2% sequentially, outperforming the market. In addition, I'm optimistic about the second quarter as the month of April shaped up to be significantly improved versus March with MACE showing the same positive trend thus far. As we look at organic growth, I'm particularly pleased that we are continuing to see customer portfolio expansion with both domestic and international E&P operators as well as service companies as we deliver on our continued commitment to diversify our revenue stack and minimize risk of customer concentration. In fact, 12% of our revenue in the quarter was attributed to the customers. And when looking back over the last year, we've grown our customer base by more than 37% since Q1 of 2021, reducing our concentration of revenue and our risk. Further, we are simultaneously leveraging our in-basin service delivery model to technically evaluate and deploy custom chemistry solutions in alignment with our value proposition, delivering straight to the rig site and off rail spurs. This model increases our efficiencies enabled us to aggressively pursue market expansion. And in the spirit of continuing to minimize risk, we will continue to leverage our increasing volumes with key suppliers to secure future purchase prices and material allocation volumes with our top product lines for 2022 as we focus on our accelerated growth. And as we scale our volume with our suppliers, we're able to reduce costs and expand margins. And with that said, we're also feeling the impact of inflation across our supply chain from rising freight and raw material costs to delivery delays due to poor congestions. These are industry-wide and typical global trends, and we are adjusting our pricing accordingly so that we can preserve our margins. In summary, I'm very optimistic about the future, and I'm excited about our mission to provide differentiated solutions that maximize value to our customers by elevating their ESG performance, lowering operational costs and helping them achieve improved return on invested capital. And before closing, I would now like to welcome Ron Halsey as Vice President of Data Analytics. Ron brings extensive analyzer, automation and oil and gas experience to Flotek as a global business leader with a proven history of business transformation while increasing market share, revenue and profit. Most recently, he served as Vice President of Artificial Lift automization and optimization at ChampionX, where he led transformation and growth of the global production optimization business. In his new role at Flotek, Ron is responsible for developing and leading profitable growth through market penetration, structured business optimization and process improvement. I'm excited to welcome Ron to the team. Now I'll turn the call back to Mike to provide key financial highlights.

Thank you, Ryan. As John and Ryan mentioned earlier, the structure of the ProFrac supply agreement is an industry first. This unique model of exchanging convertible notes for a long-term supply agreement comes with some important GAAP accounting implications, 2 of which I would like to explain. First, there will be a quarterly noncash entries to account for the mark-to-market adjustments to the convertible notes or the one-year life of the notes. You may have noticed a $3.9 million adjustment in Q1. That applies to the mark-to-market adjustment to the initial $10 million notes issued as of March 31. I want to emphasize that this was a noncash adjustment and was added back in the statement of cash flow. You can expect to see similar noncash adjustments each quarter, but the magnitude is impossible to project as it is based on its share price and other variables; second, there is a $50 million of additional notes to be issued associated with the ProFrac contract expansion that closed earlier today. The fair value of those notes will be marked to market as of the contract close date, which is today, May 17. That updated market value plus the original $10 million of notes will be amortized over the life of the ProFrac contract will be reflected as an offset to revenue in our GAAP financials. Again, this will be a noncash item, but certain GAAP dictates that the notes and amortization be subtracted from revenue in our GAAP financial statements. While we cannot predict the exact magnitude of the GAAP revenue offset at this time, we wanted to ensure that nobody is taken off guard with these items starting in the second quarter. Now moving on to the income statement in Q1; the revenue was $12.9 million for the quarter, up 9% from Q1 2021 and 6% from Q2 2021. SG&A In the first quarter of $4.9 million was significantly lower than Q4 2021 of $5.8 million and then $6.1 million in Q1 2021. As with Flotek continues to focus on lowering corporate expenses, including third-party fees for audit, legal and reduced use of outside consultants. Our adjusted EBITDA for the first quarter was a loss of $5.4 million, which continues the trend of improved EBITDA losses, improving over last quarter's loss of $5.7 million and nearly better than the first quarter 2021 loss of $6.6 million. Now let's move on to the balance sheet performance. At the end of this quarter, we had cash and equivalents of $24.8 million versus $11.5 million at year-end. The cash balance was favorably impacted by the pipe issuance in February and several improved working capital metrics, partially offset by the Apache losses, which included fees for the closing of the pipe and the previously mentioned ProFrac supply agreement. The company has $4.7 million of loans associated with the PPP loan program. The company applied for forgive substantially all of the loan in late Q3 2021, and we expect to hear back soon from the SBA. As we look forward into 2022 and 2023, our goal is to continue to leverage our improving working capital while significantly growing top line revenue. In April, as part of the monetization of noncore assets, Flotek sold the Waller, Texas facility for $4.3 million. In addition, our Monahans, Texas facility is in the late stages of executing the agreement with anticipated close in the coming quarters. We continue our relationship with Piper Sandler on very additional cash generation activities to help in addressing our future working capital growth dates. At this point, I will pass back the call to John for his final remarks.

Thank you very much,. I'd like to close the call by announcing the departure of Mike Borton, who you just heard from and thanking him for his time and contributions to the company over the past 2 years. Mike joined the company at a time when we really needed steady financial leadership and a critical evolution in our finance and accounting functions to overcome historical challenges to build a new foundation for success. When he joined he promised that he would place all of his effort into helping the company gain a stronger footing. He's accomplished this, and today, we stand as a much stronger company with a brighter future. Mike is someone I truly admire. And for his unwavering principles and for his work ethic for his integrity for -- he's just as someone that all of us feel as a friend, and we trust. He's been instrumental in rebuilding our finance team and new processes and as well as helping to build a productive relationship with our auditors. We're going to miss Mike, and I wish him every success as we all do here as he transitions back to the technology industry. I'm also excited to announce that Seham Carson will become our Controller and Interim CFO. Seham joined Flotek just over a year ago as Head of Internal Audit, and she has been an outstanding addition to the team. She is responsible for strengthening our financial reporting and building fit-for-purpose SOX controls for our business. She successfully managed the transition of our auditors to last year and has been a trusted adviser to our Board, especially our Audit Committee. We are confident that Saham is the right person to fill this critical role in the organization at this time. You will hear from her next quarter, and I look forward to you getting to know her. In the meantime, please help me welcome into her new role. Now thank you, again, shareholders for helping us unlock this incredible opportunity and secure the future of our business with the ProFrac contract. We're really excited about what lies ahead for us and the supporting all of our customers to include ProFrac, and we just want to encourage you to participate in the annual meeting and represent your interest by reading thoroughly and voting your proxy. Thanks so much for your continued support of Flotek. And let's turn it into questions now.

[Operator instructions] Our first question comes from Eric Swergold with Firestorm Capital.

Congratulations on closing the ProFrac. Also welcome Bernie to the team. My first question is for Ryan. For those of us who are generalists, can you give us maybe a conservative revenue number per fleet per month for the chemicals division? And then for John, I have a more general question in terms of whether it's getting any easier to get into C-suites post ProFrac announcement?

Yes. Thanks, Eric, for the question. When we look at it, we've really done quite a bit of analytics and we based the revenue generation per fleet generically for the market based on the basin that it's operating in. When you look at what we see in the Northeast versus East Texas versus West Texas, South Texas, et cetera, we see strong revenues typically from the East Texas because they typically run a either a slickwater and or a version of a hybrid or cross-link system. So you could see anywhere from $450,000 to almost $600,000 a month per fleet on general chemistry usage without significant value-add upsell. West Texas runs in the Permian Basin is in the $400,000 to maybe $500,000 a month. South Texas around that $500,000. And the Northeast kind of varies depending on the type of produced water that we're looking at in the polymer package for this friction reduction and so you see anywhere for that $0.5 million to $600,000 in the Northeast depending on that and that's the generic way we look at it. We're a little bit higher for those in like in the Williston and/or stuff in the what I call the northern regions. But that gives you kind of an idea on what we're looking at for the industry side on the, I'll say, revenue per month of most fleet. So on the generic slickwater type package systems.

Got you. Thank you. And Yes. Second question, Eric, is a good one. Having the ProFrac contract, obviously elevates our profile, but I would say that the C-suites have opened up to us as we begin to talk about sustainability, social license to operate and our environmental solutions. And our intense focus on everything that we do, providing them with an improvement in their sustainability and so we're getting access to the C-suite. And I think this only enhances it and in particular, with service providers. So having this relationship with ProFrac will open us up to the other service provider C-suites more so than it does even to the E&Ps. But again, this is about sustainability. It's about being a green chemistry leader and I think that's why the doors are open there is our customers are really embracing this and I think that's the future for the industry.

Thanks guys.

Our next question comes from Don Crist with Johnson Rice.

So I missed the touch of the call, but I just wanted to ask how the ramp-up is taking place as you add additional ProFrac fleets? And are you seeing any kind of growing pains throughout your logistical network that you have existing right now? Are there any growing pains there?

That's a great question. I would say when we look at it, what we would consider the initial contract that we signed for the 10 fleets, we've already achieved those numbers. We got to that at the end of April. And for that ramp-up, we didn't see anything what I would see to be significant growing pains. There is no doubt there is a tight trucking market out there. We've expanded our trucking capability significantly, which we were already planning in the ramp-up. So it wasn't a big adjustment for us on that aspect. As we look at the newly signed expansion to get to the 30 fleets. We're in the process now of collaborating with ProFrac and the introduction of those fleets in the coming weeks and the ramp-ups that we'll do there. The good news is when you look at it, the chemistry and trucking is available to there's chemistries on these fleets today, right? We're taking share with this work. And for us, it's literally just kind of the start-up of the initial buys of the supplies in the market. We forecasted this to our key suppliers already in an outlay, rolling into H2. And so I don't see in the near term any huge issues other than what are some of the typical I would say, global type issues that we're seeing right now with it. But in my mind, the biggest problem we've had has just been a lot of -- the trucking has been a little tight, and that's to be expected in the type of activity we have in the market right now.

I happen to visit the plant Marlow here just a few weeks ago, and I was on the call with Jason White, who runs that plant yesterday, and I think one of the best anecdotes that I've heard is Jason has been with us for almost 15 years or better. And a quote from Jason is this is the busiest I've been since I've been with Flotek. So -- and they're moving it through up there. We've got great loyalty fantastic team. And as we ramp up, I mean, they're right with it and are enjoying the level of activity.

I appreciate that color.

And -- that's pretty exciting, Don, when you think about them the busiest he's ever seen it, and he's seen it when it was a $1 billion market cap. So I look at that and I go, we've got a great road ahead.

Yes, exactly. And just out of curiosity, when do you think you'll get to that full 30 -- or 31 fleets that they're running today? Is that going to sometime in the fourth quarter or before that?

It will have -- I don't believe we'll get there in Q2 because we're obviously almost halfway through the quarter now. I'm expecting us to get there in H2, and we're still working through those ramp-ups right now to see because it's more about when you look at ProFrac's core fleet versus the newly acquired fleet that they picked up when they acquired FTSI and the onboarding of those and looking at that schedule from that aspect. But we're pretty excited. They've come as fast as we've been able to onboard them so far, and we're pretty excited about the rate right now.

A good way to look at it is we only had the 10 fleet 3-year contract up until the time we closed. And on that 10-fleet 3-year contract in the first month, we had already gotten to approximately 8 fleets with partial chemistry on each of those fleets. And that would tell you how aggressively they're trying to get to that 10 number on the original contract, I think they'll be equally aggressive in rolling out that 30 fleets. And so it would be a great way to ask them on their conference calls how fast is it going to get there, too. So you can cross-correlate here, Don.

I appreciate all the color there and best of luck to you.

I think we don't need luck much anymore. We just need to execute this within our control. I feel like I'm out of that lucky page. It's -- feel blessed.

Our next question comes from Mike Heim with Noble Capital Markets.

I wanted to ask a little bit more about some of the supply cost issues you're facing in the -- or is it 11% year-over-year jump in the cost of goods served. I appreciate your comments about saying you'll adjust the prices accordingly. I guess my question would be, is it simply a matter that you've been a little bit behind on raising prices. Or are the competitive pressures that prevent you from doing that? And then finally, is there anything in the ProFrac agreement that addresses your ability to raise prices?

So I'll break them down a little bit into the 3 main categories where I understand the question. So the -- the first one I would say is that there's no doubt the competitive landscape in the provide chemistry in the hydraulic fracturing world in the North America land is pretty tight. There's I can -- we were also work we just won the day. There were almost 21 chemistry competitors on site, have a different chemistry, I would say, part of the tendering phase and technical testing. And so that's held pricing through what I take through some of the inflationary aspects. But as you've seen, there's pretty much a tightness on the, I would say, the mechanical side of the pumping side of the business with equipment. We're starting to see that on some of the chemistry aspects as well. And then a lot of the small molecule drivers we're now into the point of being able to translate that pricing over into price increases because you have taken consideration turn rates in regard to pricing push out from your suppliers, et cetera. And we're starting to see that catch up on us. And the good news for us is, if you look at the accelerated volumes that we have, it's helping us kind of stave off some of the inflationary aspects. And so I'm hoping and we're confident to start seeing some margin expansion happen in H2 due to our higher volumes and our leverage capabilities there. When I look at it in terms of the ProFrac agreement itself, if you go back at some of our investor calls, we actually have some of what I consider to be the lower-end technology items move at a cost-plus thing. So we're able to maintain a margin no matter what the inflationary aspects are on those. And then we still have the capability to value-add technologies. So I would say that we're really excited -- what our capabilities will be able to do in terms of leveraging the volume to provide margin expansion, stave off inflation and then also utilize the -- what we do with our ProFrac contract to push out some of this pricing aspect to the end user.

But we're still seeing gross losses right now. And then John's comments were going to reach EBITDA positive by fourth quarter. I guess what makes you feel so confident that we can do that?

Well, I would say that for us, when you look at the cost structure where we are is going to be -- basically, the revenue we're picking up is going to have minimal additional, I would say, high end like direct costs from a component to us, and we're going to start to see incremental fall-through through the larger volumes of products being sold and an improvement in value-add technologies, which have a much greater margin than like some of the what I would call core chemistry that we move in terms of friction reducers that come with the picking up of the work and interaction with the E&P operator through our relationships with ProFrac and other direct companies.

And Mike, that's another way to look at it is we were operating right at the boundary where a company that just barely had enough revenue to survive, and we're using cash for survival through COVID. That's completely changed. And so now we've got scale and scope so that the fall-through grows as the revenue grows. And we're pretty excited about that. We're pretty disciplined about our approach to spending on the SG&A side. And we're seeing the scale and scope provide us better pricing from suppliers. All of those things add up to margin expansion. And that's why I'm really confident in predicting that we'll get to a month free cash flow, and then we'll have sustainable profitability after that.

Okay. So you would say that the -- since we started the contract in April, you're actually seeing higher margin business already?

The answer -- I'm always trying to steer life margins too much, but I would say on the margin side, we're going to be reporting those as we go forward. So you'll see them. And we do have margin expansion. I mean it's -- we take a look at the customers we're selling to. And the great part about this business is we have that core business that Ryan discussed. And then after you get there, it's becoming a lot easier for us to explain why additional higher-margin chemicals will improve the well's performance. And so we've got a lot of opportunity for improving their operational performance and their production performance. And so that -- we'll call that upselling -- would you like fries with this is an excellent example of how we're increasing the size of the sale per fleet and with each customer, and it's going well because we have real excellent documentation on what it is that we can do, that improves their environmental performance, their well performance and their operational performance.

Okay. We'll keep a close eye in the June quarter. Thanks for your time.

Thank you very much, Mike.

We should probably go ahead and wrap it up, operator.

This concludes our question-and-answer session. I would like to turn the conference back over to John Gibson for any closing remarks.

Thanks, guys, for joining today. Obviously, this is the beginning of a great journey and so I'm excited about what we're going to report at the end of Q2, the end of Q3, the end of Q4 this year because we're just getting started. I feel like we're gaining momentum. This is a train that's left the station, fully ready to go to distance. We're building the team that's going to be able to take us there. We're seeing absolute concrete evidence of how strong the partnership can be with ProFrac. We're seeing how good the organic business can be and the good housekeeping seal of approval, we've gotten through this contract with an industry leader. We're excited about Matt joining the Board because he is truly a visionary and committed to the improved efficiency in this industry and how that impacts emissions. It's just everything about where we're going, feels incredibly positive right now. And I'm more excited about reporting out next quarter than it was this one as we're just getting started, and we're sort of having to look back at just one month. Give us a chance to show you three months, six months, nine months, and you're going to see the real impact of the contract that you guys were so great and approving. So thank you and please get out there and read and vote the proxy here for the AGM and we'll talk to you soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.