Flotek Industries Inc/Cn/ Q3 FY2020 Earnings Call

Good morning, and welcome to Flotek Industries' Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow management's prepared remarks. As a reminder, this conference is being recorded. It is now my pleasure to introduce Danielle Allen, Senior Vice President, Chief of Staff for Flotek. Thank you. You may begin.

Thank you, and good morning, everyone. We appreciate your participation. Joining me today and participating on the call are John Gibson, Chairman, Chief Executive Officer, and President; Michael Borton, Chief Financial Officer; TengBeng Koid, President of Global Business; and Ryan Ezell, President of Chemistry Technologies. On today's call, we will first provide prepared remarks concerning our business and results for the quarter. Following that, we will answer any questions you may have. Yesterday, we released our earnings announcement for the third quarter, 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 release 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. With that, I will now turn it over to John.

Thanks, Danielle, and thank you to our employees, our shareholders, our customers, and to our Board of Directors. I'm extremely grateful for the strong support that Flotek has received. Additionally, I'm truly inspired by our employees; they've remained focused and committed to executing our vision every day while juggling dynamic demands at home and work, a patchwork of return-to-school procedures, and evolving challenges related to the pandemic. My gratitude for their dedication cannot be overstated, and it's a great honor to work alongside them. Now, before we dive deeper into the quarter, I wanted to welcome Mike Fucci to Flotek's Board of Directors. As the Former Chairman of Deloitte, U.S., Mike is an incredibly respected and influential leader who has spanned his career contributing to the strategic vision of one of the world's most respected professional services and accounting firms. Additionally, over the course of his career, Mike has become a thought leader on human capital, diversity and inclusion, and business transformation. We are very fortunate to have Mike join us. Thank you, Mike for joining Flotek's Board; I really look forward to working with you. Now, let's turn to the third quarter. Overall, our quarterly performance showed some positive signals, but we are by no means satisfied with our results, and we have more work to do. As I said last quarter, navigating through this global market disruption caused by COVID and demand destruction has been the most challenging environment that I've experienced in my career. Even so, I remain very optimistic about the future of Flotek. We're doing everything possible to position ourselves to be a stronger company in 2021; that means having the discipline to make some hard decisions today. Last quarter, you met Mike Borton, our new CFO, on his third day at Flotek; and every day since then, he has been diligently identifying areas where we can improve our business performance, strengthen our processes, introduce efficiencies, and implement cost reductions. I continue to be impressed with Mike's attention to detail and commitment to high standards. I'm very glad he is here. Together with the leadership team, Mike has driven several important initiatives that, while difficult today, mean we emerge stronger for the future as the market recovers. Among those are an impairment, inventory write downs, and workforce reductions; this is a period of transition for us. We believe we have the right leadership team in place to help us accelerate the transformation of the company and are making the necessary adjustments to our business model. We're building a culture that drives value creation for all of our shareholders, an entrepreneurial culture, with chemistry as the common platform, underpinned by a passion for customer success and shareholder returns. Flotek has a clear path forward for growth and profitability, and our team is focused on results. With regard to the macro environment, let's address that first as it's been the inescapable force impacting our business performance. Although the world started to slowly emerge after COVID lockdowns in the third quarter, the fundamentals for the oil and gas market remain severely challenged. A drastic slowdown in oil and gas activity across the spectrum significantly limited customer CapEx activities from the wellhead to the gas pump, many of which have been put on hold while some sites were completely shutdown. Additionally, midstream budgets for gathering and processing have decreased 60% year-over-year, while U.S. drivers reduced their road mileage by approximately 34%, with a corresponding drop in the consumption of refined fuels. That said, we're still seeing some positive indicators. Crude pricing has begun to show signs of improvement from last quarter, although still at low levels. Refinery throughput has improved, although margins have remained compressed and customer demand has not moved in tandem. Some customers have resumed modest levels of completion activity in the Permian, and we saw increased demand for our specialty stimulation chemicals in particular, in select international markets, primarily in the Middle East. In summary, we saw some improvement in the market, but not nearly enough to get excited about that the market is recovering. As a result, it was a difficult quarter with mixed results. The drop in economic activity and weak demand is weighing on sales across our business segments. Last quarter, we closed our acquisition of JP3, a data and analytics technology company serving the oil and gas industry. With our first full quarter of JP3 results included in our financials, performance fell way short of expectations as JP3 sales were impacted by dramatic reductions in capital budgets by midstream and downstream customers. As a result of these conditions, we took a hard look at what we could achieve in the near term, in light of anticipated ongoing market disruption and the necessary resources needed to transition to a recurring revenue model. After this analysis, we concluded that we should take an impairment charge across several categories for JP3. We also completed our quantitative and qualitative analysis of inventory following the acquisition to assess market values and the anticipated customer demand. In tandem, we're lowering operating expenses to be commensurate with the revenue decline we anticipate from moving to a recurring subscription model and reduced demand in a difficult market. These cost reductions include a headcount reduction of 35% within the segment, as well as a decrease in other operational costs that are not directly tied to near-term revenue generation. These actions were not taken lightly, but were necessary as we manage our business to minimize the impact on our liquidity in 2021 and beyond as we transition to subscription-based revenues. Additionally, I'm also pleased to announce that TengBeng Koid has assumed the duties of President of JP3. We recruited Koid to Flotek last quarter, following more than 30 years of experience in the oil and gas industry. He is a proven leader building enterprise-wide software solutions for energy companies across the full hydrocarbon stream, and he has demonstrated a strong track record expanding businesses to international markets. I have full confidence in Koid and our team at JP3 to build a very strong future. In the long-term, the business has considerable growth opportunities; we remain confident about the compelling strategic financial benefits as JP3 diversifies Flotek's business across all segments of the hydrocarbon value chain, and its technologies are helping customers accelerate digital transformation by providing the real-time data necessary to manage crude oil and natural gas processing. We also have the opportunity to address potentially greenhouse gases with JP3, and so emerging markets are a real opportunity for us as well. Gordon will address the migration to a subscription-based data model and also highlight our growth strategy to expand our market penetration, both domestically and abroad. Transitioning to chemistry technologies and our newly launched sanitizer and disinfectant business that we'll often refer to as JanSan business. Through the quarter, we experienced pricing pressure as suppliers with lower quality products offered deep discounts to liquidate inventory ahead of the anticipated tightening of regulatory standards, which we believe will drive those products off the market. We trust these disruptions will be temporary. Even with the recent announcements about the anticipated COVID vaccines, we still believe there will be a long-term change in consumer and business behavior. It will take some time for vaccines to be proven, manufactured, delivered, and administered widely, and there are still large unknowns about the number of Americans who will take the vaccine without data related to long-term effectiveness and side effects. Most importantly, I'd like to emphasize that we're building out a product portfolio in JanSan that extends beyond sanitizer to address a broader set of needs in the janitorial and sanitizer market, which transcends the current pandemic. Overall, our chemistry technology segment experienced sequential improvement, as we've seen an uptick in energy chemistry activity, both domestically and internationally. As a result, we are pleased to see a 52% increase in overall segment revenue in the third quarter versus the second quarter. Now, let's move to liquidity and cost measures. We continue to take decisive action scattered by our strategic pillars to best position Flotek for the future. Our balance sheet remains healthy, and we are focused on bolstering our financial flexibility. As a reminder, earlier this year, in order to preserve our liquidity, we reduced headcount, lowered salaries of our executive team, curtailed discretionary spending, and decreased compensation for our Board of Directors. Throughout the quarter, we continued to work with our suppliers to negotiate cost on raw materials, negotiated reductions in our leases, and reduced our freight costs. Now, I'm going to turn it over to Koid for further discussion of JP3 efforts to drive revenue. And then we'll turn it over to Ryan Ezell, who will give an update on the trends at the chemistry technology segment, including the process of our new JanSan operations.

Thank you, John. As John mentioned, while we faced challenging market conditions, we've utilized this time to accelerate our strategy to penetrate the international market, transition our business model, and focus on targeted applications of our game-changing technology. On the international front, JP3 in the past only served the North American market. In September, we hired a seasoned business development leader in the Middle East to help us drive JP3 penetration in the Middle East, Africa, and Asia. Since then, we have had many meaningful engagements and have received very favorable feedback from potential customers, and are responding to many requests for proposals. While international sales require longer lead times, we are optimistic about opportunities over the mid to long-term, and we are preparing for deployment of our technology to this market; this is very exciting. Secondly, we are transitioning and fast-tracking our business from traditional equipment sales to a subscription-based model; this will provide the greatest value for JP3's customers and our shareholders in the long-term. While we will maintain some level of equipment-based contracts to accommodate customer needs, we are aggressively shifting to subscription-based contracts, which will accelerate our recurring revenue. Additionally, we continue to maintain strong relationships with existing customers and are building new relationships to expand our customer base. For example, in working closely with Phillips 66, we signed a collaborative agreement with them in the second quarter. As part of this agreement, we will provide data services offering that will optimize transmix, which is the natural mixing between adjacent batches of different fuels being shipped in a common pipeline. This offering provides real-time data, which enables faster decision-making that will help reduce transmix and increase profitability for refined fuel producers, transporters, and terminal operators. We are encouraged to see very positive feedback from the value of this partnership and validate the strength and value our customers are seeing using our unique technology. We look forward to expanding adoption of this application in the market.

Thank you, Koid. As a reminder, our chemistry technology segment includes both, our energy chemistry technologies, as well as our emerging janitorial and sanitizer businesses, and I'm deeply proud of our teams who are executing successfully. I'll first provide an update on our janitorial supply business, which is referred to as JanSan. Last quarter, we launched Flotek's line of FDA quality hand sanitizers for industrial and consumer applications. Our initial efforts were cultivated as a result of community outreach that began in the first quarter when we started producing and donating hand sanitizer to local communities, first responders, hospitals, schools, homeless shelters, and senior residential communities. Subsequently, we recognized the opportunity to diversify our corporate revenue stream into a rejuvenated high-growth potential market that was a natural extension of our specialty chemistry experience. By leveraging our chemical production capabilities, and ISO certified facilities, we applied our world-class R&D footprint to deliver an expanding line of high-quality FDA and EPA registered products. Today, we're actively selling FDA and EPA registered janitorial and sanitizer products into multiple markets, including hospitals and medical facilities, the travel and hospitality industry, food services, e-commerce and retail, sports and entertainment, and other industrial and consumer markets. The inclusion of disinfectants and surface cleaners to our existing hand sanitizer line establishes a full product offering for the JanSan community, particularly those in commercial and industrial applications. Although we saw some pressure in the third quarter in our hand sanitizer business, with the high demand for hand sanitizing products, the market experienced a flood of new entrants, often with low-quality or even contaminated raw materials. More recently, in anticipation of the FDA reverting back to its original higher quality standards, the opportunistic producers of substandard hand sanitizer have been dumping inventory into the market as they exit the industry, which has disrupted the supply-demand balance. As John said, we believe this disruption is temporary. More importantly, buyers are becoming further educated today and recognize the need for regulatory compliance to deliver high-quality products that Flotek offers. As a result, we're starting to see repeat buyers of our hand sanitizer products and a higher focus on product quality metrics by commercial and institutional buyers. We are now selling in 25 states and have increased our distribution customer base by 28%, and end-use customer base by 49% quarter-over-quarter. Additionally, we are selling our products direct to consumers on Amazon. The customer feedback is positive and consistent; Flotek's products are among the highest quality technologies in the JanSan industry, with proven supply chain and logistics capabilities that differentiate us in the marketplace. We're building out our channels to market for a long-term and sustainable business, and we have expanded our JanSan product portfolio to include disinfectant wipes and sprays, surface cleaners and degreasers, and manufacturing partnerships with emerging technologies in the JanSan industry. I'm also happy to report that with the recent addition of our new packaging line, we further enhanced our capabilities, reduced costs, and accelerated our order fulfillment process. We see many opportunities ahead, particularly in JanSan, and are optimistic about these in the long-term. As we continue to build out our capabilities, we will invest in marketing resources and talent with strong distribution and sales experience to further develop our relationships in the JanSan market. Our JanSan initiative exemplifies how we are adapting and reallocating resources to high growth businesses that would drive positive returns. And we look forward to providing additional updates as we progress in this exciting market. Now switching to a few comments on our energy chemistry business, which first of all, let me say it is improving, and I would like to provide a few highlights in this regard. Although market experts have commented on declines in chemistry usage and negatively impacted contracting opportunities due to M&A activity, there are macro factors that are helping to drive energy chemistry. As demand began to exceed production at the end of the third quarter, completion and fracing activity slowly moved upward, and we've seen select customers increase usage of our specialty chemistries as their completion activities resumed given the production improvement and return on invested capital our products deliver. In fact, in a recent visit to one of our largest customers, Flotek received high praise due to the strong partnerships we've created together with an unwavering focus on consistent delivery of our chemistries, technical support services, and well-site implementation. Furthermore, I'm pleased with our international opportunities, which are driving upside in our energy chemistry business. In the Middle East, we've been named the Chemical Partner of Choice to provide a broad range of cold tubing stimulation additives to a major national oil company through partnership with end-market and international service companies. This opportunity and others will drive our growth in the Middle East as we look out over time. In addition, as Mike will discuss in greater detail, we have continued our focus on cost reductions and supply chain improvements which include inventory management and rationalization of our finished goods count resulting in greater efficiencies in our business. In closing, I would like to emphasize that our energy chemistry business, as of today, is truly a transformed business. Over the past year, we've driven down our operational costs, renegotiated logistics and supplier contracts, and accelerated efficiencies in our business processes. We built a leaner business that can meet the needs of the oil and gas market of today and the future, and we offer something unique and valuable in the marketplace: delivering cost-effective chemistry solutions, designing and implementing optimized chemistry, and helping operators increase production at lower cost per barrel produced. As we look ahead into 2021, we are focused on reintroducing Flotek to the market, and building stronger relationships with our active and successful customers to expand our global market share. And with that, I'll turn over the call to Mike Borton to discuss our financial results.

Thank you, Ryan, and good morning, everyone. Since joining Flotek in early August, I've been extremely focused on evaluating the quality of the books including the balance sheet, accounting processes, spending prioritization, expense commitments, and our cash management, cutting our banking relationships by also spending time with our new auditors. During the first three months at Flotek, I've started implementing several strategic priorities that will help us to create a stronger organization. Additionally, based on my prior experiences with multiple technology companies, where we were able to successfully transition to a recurring revenue model, we have reset the financial framework and underlying assumptions going forward for JP3. We must ensure JP3 is optimized structure to minimize the cash needed as we transition to a new model. This means the company will have cash outlays for the inventory upfront to require more cash than a one-time product sale, with an impact on both revenue and cash. That said, JP3 has enough inventory on hand to indicate the actual cash outlays in the near-term. I want to pause here to emphasize the benefit of transitioning to a subscription-based revenue model, as it leads to a longer term higher margin recurring revenue stream with an associated higher multiples given its predictability. In short, as John noted, we are making and will continue to make the necessary business decisions to minimize our use of cash. First, let me address the impairment we've reported this quarter for JP3. As we resolve the extended impact of COVID-19, and the continued decline in oil and gas demand and spending budgets, especially in the refinery and mid and downstream markets, we recorded an impairment charge of $11.7 million for goodwill and a $12.5 million charge for intangible assets. These adjustments were completed in conjunction with an independent valuation company and the auditors. Secondly, we also took the opportunity to evaluate our inventory across the company. Over the past several months, I've been working with our new and very talented VP of Supply Chain, Shane Wise. As a result of that initiative, we have adopted new policies and rationalized a large portion of our inventory by reducing hundreds of underperforming product SKUs. Consequently, during the third quarter, we have taken an excess of obsolete reserves of $9.6 million. The charge is made up of two parts; first is the reserve of $5.7 million related to the chemistry technology segment, and $3.9 million for JP3. Additionally, during our inventory assessment following the JP3 acquisition, the company identified measurement period adjustments totaling $2.3 million that were made to the initial purchase price accounting. I would like to emphasize that these adjustments are all one-time in nature, and as a result of these actions, we can better manage our inventory position and profitability moving forward. Next, as far as the purchase agreement terms for the JP3 acquisition and the earnout conditions associated with the Flotek stock performance; the company recorded a liability of $2.5 million in the third quarter. The payment was transferred to the escrow account in early October for the acquisition terms. The $2.5 million transfer to escrow replaces the previously escrowed 3 million shares; those shares were distributed to JP3 shareholders in the fourth quarter. I'd like to note that there are now provisions and a change in the fair value estimate. We're not considering acquisition purchase price adjustment, and thus Flotek recorded $3.2 million charges that impacted operating income during the third quarter. We also want to remind you that in the second quarter we changed our reporting methodology as a result of the JP3 acquisition, and are presenting our results in two new reportable segments; chemistry technologies and data analytics. The chemistry technology segment was previously referred to as the energy chemistry technology segment, but now includes our recently launched janitorial and sanitizer operations that Ryan just described. The data analytics business was created in conjunction with the acquisition of JP3. Also, please note, our third quarter results are the full first quarter that included business operations and expenses for JP3. Now, moving on to the income statement; during the third quarter, consolidated revenue was $12.7 million, up 43.5% from $8.9 million in the second quarter, and below the $21.9 million during the same period last year. The sequential improvement was primarily driven by an uptick in energy chemistry activity, as demand picked up both domestically and internationally from the second quarter dip. The sharp decline in revenue year-over-year is largely a result of continued volatility in the macro environment for onshore drilling and completion activity impacted by political and economic events in foreign markets. In addition, COVID-19 impacted our productivity as a result of reduced customer demand for our services and products with the exception of our sanitizer operations, which just recently ramped up during the second quarter of 2020. Consolidated operating expenses were $29.5 million in the third quarter of 2020, and increased 24.47% from last year's level of $23.6 million in the third quarter. Excluding these one-time adjustments of $9.7 million of inventory and $3.2 million of acquisition-related expenses, we were pleased to report that expenses declined nearly 30% year-over-year. Corporate G&A declined $3 million to $2.7 million versus $5.7 million last year due to a reduction in overall compensation spending and lower discretionary spending, including professional fees, partially offset by one-time severance charges. Our depreciation and amortization expenses declined $1.5 million to $500,000 in the third quarter versus $2.1 million last year. Research and development costs were at $1.5 million in the third quarter, slightly below the second quarter level of $1.6 million, and down from $2.3 million last year. We reported a loss from continuing operations of $45.2 million or a $0.66 loss per diluted share in the third quarter of 2020, compared to a loss of $11.2 million or a $0.19 loss per diluted share last year. EPS included a negative impact of the JP3 impairment of $0.36, rationalization of inventory of $0.14 in JP3 continued consideration of 5%. These three one-time items represented the vast majority of the total recorded loss per diluted share. Our adjusted EBITDA for the third quarter was a loss of $6.5 million, which narrowed from a loss of $8.2 million last year. The improvement in adjusted EBITDA is probably due to lower expenses as previously discussed. Now, moving on to the balance sheet performance. As John mentioned previously, our cash position remains healthy, and we are focused on preserving our liquidity. As of the end of the third quarter, we had cash and equivalents of $49.1 million versus $59.9 million in the second quarter. The company and JP3 combined had $5.7 million of loans outstanding pursuant to the Paycheck Protection Program. During the quarter, within the chemistry technology division, we reduced SKUs by 35% as we focus on managing our inventory in an efficient manner. We estimate that SKU reduction will result in annual savings of more than $1.3 million in inventory carrying costs. Let me pass over the call back to John for some final remarks.

I'd like to take a moment to share a few closing remarks. When I joined Flotek in January, I laid out a few strategic objectives for growth including reducing our dependence on rig count, expanding new product lines that create a greater amount of backlog and/or annually recurring revenue, and further differentiating our offering from competitors while enhancing our capability to provide digital transformation of chemistry, and strengthening our market share for our current product lines. At that time, of course, none of us knew how dramatically the market would be disrupted. However, we've adapted our business while focusing on executing against our strategy, which still holds even in this market. And while nowhere near satisfactory to me in terms of progress today, we are making progress and laying a strong foundation for 2021 and beyond. First, we're committed to preserving our liquidity and maintaining a healthy balance sheet. We're fortunate to have Mike at the company to support retention of our capital, and to help drive a culture with a commitment to the leanest cost structure while delivering superior customer service. We are building a more diverse income stream. Through the acquisition of JP3, we're diversifying our business and offering downstream, midstream and upstream customers' access to unique digital transformation of products and services. We also have the potential to take this offering into the greenhouse gas and ESG segments, and we're investigating that while at the same time looking at all of this digital transformation to build us a recurring revenue model. Additionally, with the launch of our janitorial and sanitizing products and logistic services, we further diversified our business beyond hydrocarbon markets to include industrial and consumer markets. From an operational standpoint, we have available unsold manufacturing capacity in the chemistry technology business for both energy and JanSan products, with the capabilities to deploy to the most attractive market opportunities. Without adding much additional cost, we've created additional products that can really help us on the revenue side and Flotek. We also see a notable international opportunity set for all of our businesses in the oil and gas focused products to include both JP3 and the energy chemical technologies, where we believe we're going to see much less volatility in the days ahead versus domestic markets. And so we're very pleased that we've expanded into the international segment already. In closing, chemistry is our core competency. We have developed three strong business labs centered around creating value from chemistry. While it's difficult to determine when the world returns to normal, we're putting in place the right measures and investments to emerge in 2021 and beyond as a stronger company prepared for the future with optionality. We still have a lot of work to do and we're committed. And I'll turn it back to you now for some questions. Thanks so much.

We will now begin the question-and-answer session. Our first question today comes from Joseph Von Meister with Intermarket. Please go ahead.

Hi, guys. Can you tell us what the hand sanitizer sales were in the third quarter and where you'd like to see that business in a year from now?

I'll start out. We're not breaking it out because we were really trying to maintain some competitive advantage in the marketplace associated with competitors. But I will say that it was depressingly lower than what I would have expected and we didn't see growth quarter-to-quarter and mainly because of what Ryan stated earlier. We saw a lot of people that dumped sanitizer and at the beginning of the quarter, we were principally looking at sanitizer. But over the last three months, we've diversified that product line where we can be a real JanSan player, because people want to buy a portfolio of products in that segment. They're not interested in a single product sale. Ryan, jump in there.

I think you're correct. And to reemphasize that, John, I think when we first entered the market on our philanthropic efforts, our first commercial sales and the JanSan business came from that. Quickly after being in there for a few weeks, we realized as we were looking at long-term sustainable business, we needed to address the full portfolio that not only talked about the hand sanitizers and the various dispensable options, but we then started to discuss the full-service market around them on the JanSan business, which is substantially larger as a whole than just hand sanitizer. So that's when we moved into a lot of areas of surface disinfectants, sprays, wipes, degreasers, cleaners, and all those things that are our core competency chemistry related to Flotek, and don't cause any burden on us to move in that transition. Since then we've launched a substantial line in that area and seeing good movement. What we're starting to see now is building blocks of recurring customers on longer-term contracts with fixed orders on a monthly basis, which is the target of what we want to be in the sustainability side of the market.

And then on JP3, I know that the pipeline guys and refinery guys have been under a lot of pressure, but what's the outlook for the Phillips 66 joint venture and business opportunities related to that?

Good. Thank you for the question. Related to the Phillips 66 partnership, through the introduction, we were presented with quite a number of potential customers. Many of them have progressed, but I understand one of them has even progressed to a proposal. So I think the value that is derived from applying the technology for that transmix is huge. The response has been positive and we are looking forward to some positive results in the near-term.

The other part that I like about where we are on JP3 and cohort leadership is, we see a pretty extensive set of opportunities on the international market. However, we're being a bit cautious in predicting when we'll be able to reach those because we're still getting all of the certifications and registrations required for the international markets. You can't just ship there and violate any of the U.S. law. So we're being very particular and there are laws associated with shipping fiber and fibers have different links and encryptions associated with any of the models we might put on the chip. So we're being careful; we see a way forward and it's clear. So I'm expecting that we'll be able to report back on that and JP3.

Thanks, guys. Great job in the tough quarter, really.

Our next question will come from Daniel Burke with Johnson Rice. Please go ahead.

Let's see. John, maybe a question for you and another one on JP3. In terms of the performance of the business in Q3, maybe not quite up to your initial expectations, I guess I was just trying to better understand if that's the consequence of maybe underappreciating just the intensity of the COVID-related impacts that business has seen in terms of its end markets, or if it's really more about the pivot to a subscription-based model and that taking longer to effect or being a little trickier to effect than maybe previously anticipated. Can you help me understand that?

Thank you for the insightful question, Daniel. I was very optimistic about JP3 when we acquired it, expecting COVID to subside much sooner than it has. Unfortunately, we were mistaken in our projections for the remainder of the year, mainly because we did not have access to customers or sites. Even recently, during an installation, an employee was exposed to COVID, which delayed our work. These operational challenges accounted for a significant portion of the shortfall, with COVID being about 80% of it. The remaining shortfall stems from the transition of our sales force from selling hardware to subscriptions, which has been more difficult than we initially thought. We brought on a new salesperson in the U.S. experienced in subscription models, and she is fully committed and enthusiastic about our potential. Another international salesperson with similar experience is also helping us. We're working on transitioning customers who previously purchased hardware into subscription models, but this has proven to be more challenging than expected. Many customers still prefer to own hardware. Additionally, we face uncertainties in our future forecasts, especially regarding how to communicate our offerings, as some countries may still require hardware and maintenance agreements instead of subscriptions due to regulatory differences. We have more to understand, but I remain excited about our progress.

Yes, I'm still with you guys. That's very helpful, John. I guess the other one I had, maybe a little more straightforward. Could you talk about either the timeline or if it's easier, maybe the revenue top line that you see at this point after the cost reductions you've affected this year, your latest thoughts on where that top line needs to be to kind of get closer to an EBITDA breakeven type of level? Thanks.

Well, one of the reasons we have Mike is he keeps reducing our costs, so the top line is coming down. We're still focused on that and we've got to be relentless because unfortunately, I can't answer your question. And the reason I can't answer it is because there's still so much uncertainty that if I go out beyond Q4, I begin to lose my clarity on how the market's recovering. I would have thought COVID would have abated, did not. In fact, it's surging in the northern hemisphere, so that's impacting us again. We see vaccines and we have no enthusiasm yet around vaccines from this management team primarily because there's still a lot of uncertainty regarding when it'll be available, how many will be available, how it will be distributed? So our predictions, I'm just going to say, we're going to really work hard, but I can't forecast with the accuracy that I'd like. So the thing that I can do is manage cost with a vengeance and that's where we're going to have to focus in the near term.

Fair enough. Okay. All right, guys. I'll leave it there. Thank you for the time.

Thanks, Daniel.

Our next question will come from Eric Swergold with Firestorm Capital. Please go ahead.

Good morning, guys. I've got three questions for you, all unrelated to each other. The first one is, are we going to have NOLs from the charges you took this quarter to protect earnings going forward? And can you quantify that?

Better turn that over to Mike.

So it's going to be timing. As you probably know, we had roughly about $50 million of NOLs coming into 2020. That had a 20-year carryback and 100% use. 2020, the good news is tax losses in 2020 will go up forever, but only to be able to use at 80%. Now let's talk about the inventory write downs. Until we actually dispose of that inventory, we can't take the tax benefit of it. But our goal is to get rid of that inventory quickly. Because you'd like to cash. Whoever values we can get, it's based on the write downs and that would be a tax benefit at that time.

Okay. Second question is on the JanSan product line; something that's going to be Flotek branded, or private labeled or both?

I'll start out and let Ryan finish up here, Eric. The answer to that is yes. We looked at our ability to produce chemicals, whether they be for energy chemistry, such as the CNF products or for disinfectants, sanitizer, surface cleaners. For us, that's capacity. And we intend to try to get to maximum use of our capacity to blend in sand chemicals. And so whether we're doing it for the energy side or for the JanSan side, it turns out that we have the same labor, we have the same facilities, we have the same equipment, our assets are roughly the same; we did modify a small portion so that we could get FDA registration. It's so efficient that anything that we do on the JanSan side is very accretive to our overall chemistries, revenues, and profitability. But we plan to do whatever makes a profit for our shareholders. Ryan?

Just to add on a little bit more detail along with John, is that we've done a significant investment into a high-velocity study on what were the best options for Flotek in terms of the commercial markets, which includes industrial and institutional buyers versus the retail side and some cost effectiveness on how we go about approaching both of those. Basically, what we're seeing is our advancement into the commercial side, whether it be institutional or industrial, plays into our strong suit around our ability to deliver logistically, our cost structure, how we can leverage our supply and cost advantage and get out there. For that, that's a blend of what we would consider to be private manufacturing, white labeling, and establishing the Flotek brand because these institutional buyers are driven by EPA and FDA compliance which is a strong suit for us. Now, as we establish ourselves in that market, we feel that through our e-commerce businesses, we can create a training sandbox for that and brand development, which will start to establish a stronger Flotek brand inside potential retail business. But those are all weighted against the fact of the significant investment it takes on the marketing side that goes straight out and addresses a retail market. So those are some of the strong points that we're looking at why we like the commercial markets better, all these initial outgo, and that balance of private contracting and establishing the Flotek brand inside institutional buyers.

Thank you. I have a question that may not be directly related to the main topics we've discussed. I found this call very informative. At a recent industry conference, Flotek shared new data on an improved CNF product line, which reportedly offers an increase in performance compared to the previous version. Do you have any early feedback on how consumers are responding to this updated product?

Dr. Silas?

Sure; I'd be happy to comment on that. That was in particular with a couple of clients that we're exploring within the Midland basin. Based upon our expertise and experience in the area, we recommended some slight changes and modifications along the CNF product line. We're very happy with what we're seeing with us. We think we have a satisfied customer in that, using that particular product, and we're excited about being able to introduce that to more customers in the area as well. Again, this is part of our reservoir-based chemistry knowledge and experience coming to play.

Great, thanks very much. Go get them, guys.

Thank you.

We will now turn it over to John for closing remarks.

Yes. Let me sum up here where we are. I wouldn't normally give any guidance, but I'm going to provide a bit of Q4 macro environment guidance at the moment. We've seen a lot of consolidation in the U.S. domestically. It's one of the reasons I'm excited about the expansion internationally. NOCs don't tend to combine in less volatility in those markets. So our commitment to being international is important to us. But that is going to potentially slow down some of the potential sales that we have in Q4, just because while consolidating, people tend to take their eye off their operational ball. The second one is we're coming up on holidays. And so COVID is an excuse to go home early and not spend any more of your capital budget. So we do have customers that may take off from Thanksgiving through January 7. Finally, COVID is resurging. While we are still in here, playing away every day, I'd say Q4 is going to be more the result of industry activities and I'm not really excited about it but I'm not depressed about it. We've got the right things going on; we're talking to the right customers. I leave in just a few days to go on a trip throughout Oklahoma and Texas to visit with customers that we're excited to talk to and explain what we do. But how quickly that turns into revenue? I'm concerned about COVID, I'm concerned about the holidays, and I'm concerned about consolidation because it's involving some of our better customers. With that, thank you very much. We really appreciate you guys. Our focus entirely is on getting some returns for shareholders and so we'll stay at it. Have a good holiday, and we'll talk soon.

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